The government’s decision to hold the line on its deposit guarantee, and to tell mortgage trusts and others to effectively become banks if they want access to it, will have a profound impact on the way savings are collected and allocated.
It is like the transformation of Morgan Stanley and Goldman Sachs into banks, marking the disappearance of the investment banking industry in the US. And like that, it will have important unintended consequences — more on that below.
Unless the credit crisis and turmoil on global investment markets come to an unlikely swift end, there may not be an Australian investment management industry within three years.
No loss, you might think. I have campaigned against the high fees and marketing practices of the retail funds management industry for the better part of a decade, and railed against the way supposedly independent financial advisors are employed as commissioned sales agents, so you might think I would celebrate their demise.
In fact despite its many flaws, the system of institutions regulated by the Australian Investments and Securities Commission collecting savings and providing capital has worked pretty well.
Yes, they all charge too much and frequently misrepresent the safety of the products, and there have been some very large robberies, but do we really want to just abolish the buggers and to go back to the sixties when all the money was in bank deposits?
I have often been accused of being indiscriminate in my criticisms of the industry — “tarring all financial planners with the same brush”, as many have written to me — but even I wouldn’t have breezily told them all to get jobs as bank tellers, as the Prime Minister has now done.
The mistake is making the bank deposit guarantee free for nearly all.
Money is now likely to bleed, and sometimes rush, out of savings accounts that are not part of authorised deposit-taking institutions regulated by the Australian Prudential Regulatory Authority — out of those institutions, that is, that don’t submit to the risk-weighted capital rules and oversight that that involves.
And the key reason for this, ironically, is that the non-bank financial services industry is dominated by banks.
When Commonwealth took over Colonial, NAB took over MLC and Westpac took over BT and Rothschild, the line between banks and non-banks was deliberately blurred.
Banks lent their APRA-supported image of safety to a bunch of ASIC-regulated fund managers. The marketers of these funds were able to imply they were included in the ring of confidence; other firms that happened not have been acquired by banks, like AXA, AMP and Perpetual, rode on their coat-tails.
And now we find that there is a very big difference between them, even within the same bank. Ralph Norris at Commonwealth Bank has made sure we understand the difference by freezing redemptions on seven of Colonial’s mortgage trusts.
I was talking last night to a former Reserve Bank official who wondered what the big deal was. He had always assumed that when APRA was set up and regulation of the banks was shifted from the RBA and at the same time broadened to include credit unions and building societies, that they were all guaranteed by the government and would never be allowed to fail.
Yes, well, he might have known that but no one else did. There was never an explicit government guarantee over APRA-regulated institutions, so the line between them and the ASIC-regulated sector was able to be blurred.
Now there is an explicit guarantee and the line is sharp and clear. If any other firm wants to get it, they have to somehow get their hands on some capital and queue up down at APRA to fill in the application form.
This might have been possible 18 months ago, but not any more. Risk capital is unavailable except from governments, and they are giving it away to a select few. It is Catch 22 — you have to be proved mad to get out of the army, but if you want to get out of the army, you must be sane.
The problem is that even banks can’t get capital in anywhere near the quantity needed to match all of the risk assets currently sitting in their own managed funds, let alone everyone else’s.
Who is going to buy the $20 billion or so in mortgages in the now-frozen mortgage trusts, to allow investors to retrieve their money, if the buyers have to come up with $1.6 billion in new capital? Where does that come from?
Even if CBA decided to acquire at face value the $3.3 billion in mortgages within the seven Colonial trusts that have now been frozen, it would need at least $250 million in extra capital. It’s not there.
And that’s without the run on the funds management business extending to funds and trusts that own all types of securities, as opposed to just mortgages.
There’s, oh, a trillion bucks in them.
Roger Preston of the BBC is reporting this morning that the conversion of Morgan Stanley and Goldman Sachs into banks has had a huge unintended consequence on hedge funds. Morgan Stanley and Goldman were first and second on the league table of prime brokers, lending on margin to hedge funds.
Now that they are banks, they are prevented by regulators from lending as much relative to their capital as they could before. That’s the whole point.
But that, along with the collapse of both Bear Stearns and Lehman Brothers, has led directly to the collapse of the hedge fund industry.
Preston says: “So the US authorities should have known — and presumably did know — that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.”
So the conversion of Morgan Stanley and Goldman Sachs has resulted in the run on the Australian dollar, as hedge funds dump assets because their lenders can’t lend as much as before.
Maybe it’s a good thing, I don’t know. The Aussie dollar was propped up by over-geared hedge funds, just as our corporations have been propped up by fund managers whose safety was oversold by commissioned financial planners.
Let’s just get rid of the lot of them, see what happens. No risk!