Australia’s previous Liberal Party Prime Minister John Howard “came out swinging” last week in support of the policy agenda his government shared with the preceding Labor Party government of Bob Hawke and Paul Keating: “neoliberalism”.

In his recent op ed in the Fairfax press, “Five great reforms are an essential legacy“, Howard defends “neoliberalism”, and argues that the financial crisis was actually the result of distortions to the financial system by well-meaning but ill-advised government tampering with the financial system:

The world, including Australia, will not respond effectively to the global financial meltdown unless we properly understand its origins.

The subprime debacle originated in the United States, where the regulations about the making of loans were far too lax. It was a laudable social goal to spread home ownership as widely as possible, but the method involved the distortion of the financial system. Failures of regulation have contributed to the severe economic circumstances we now face. I do not seek to defend the excesses on Wall Street and elsewhere. However, these failures and the challenges we face do not represent a systemic failure of capitalism or indeed of the market system…

There is no doubt that government enthusiasm for promoting home ownership added to the current crisis, and much of this emanated from governments keen to reap the political benefits of extending home ownership to its electorate. A proud new home owner is likely to vote for the incumbent government whose “reforms” enabled him or her to gain the title deeds to a house, rather than merely handing over rent to a landlord — or so politicians appear to believe.

In the USA, this took the form of successive Republican and Democratic administrations promoting home ownership via the laughably named institutions (to non-Americans!) Fannie Mae and Freddie Mac. In Australia, we had a panoply of enticements into home ownership that went beyond even the American bias, including encouragements not only to own one’s own home, but to be a landlord as well. (I wonder how many politicians truly grasped the irony — and ultimate futility — of that combination?):

  • A “First Home Buyer’s Grant” that gave those who had not previously owned a home a cash grant of, at various times, $7,000, and $14,000 to help them purchase that house. In an attempt to revive the now flagging Australian housing market, this grant has yet again been increased from $7,000 to $14,000 for the purchase of an existing house, and $21,000 for the purchase of a new dwelling. This boost is supposed to be temporary…;
  • State top-ups of this scheme that increase it to $24,000;
  • At various times the scheme has been temporarily boosted. Howard’s Government introduced the scheme as an allegedly temporary offset to the impact of introducing a Goods and Services Tax [GST] in 2000. He then doubled it in an attempt stimulate the economy during 2001. Now Rudd’s Government has done the same–and topped it by tripling it for the purchase of a new dwelling.
  • No capital gains tax on sales of an owner-occupied house — so that the entire capital gain from selling your home on a rising market is tax-free;
  • Tax deductibility of interest payments on purchases of additional houses, with the expectation that this will encourage the construction of accommodation for renters. Known as “negative gearing”, it allows a landlord to deduct interest payments from his/her rental receipts, and get a tax deduction if the rental income is less than the interest bill; and
  • The rate of capital gains tax is half the rate of income tax — which encourages people to speculate on capital assets rather than work.

This perverse combination of incentives encourages both home buyers and speculators to compete against each other with leveraged funds on the Australian housing market.

Howard himself contributed to this farce by introducing the First Home Buyers Grant in the first place, never removing this “temporary” scheme after the GST adjustment phase was over, doubling its rate as an economic incentive during the 2001 downturn, and by setting the capital gains tax rate at half the income tax rate. His attribution of blame for the financial crisis to government intervention would have been somewhat more believable if his speech had included a “mea culpa” for his own contributions.

But even so, he presented a half-baked theory of what caused the crisis, and a view of economic reform that, in future years, will be derided as naive. He proposed that “five great reforms” were the core of the neoliberal agenda:

In 1980 our nation needed five great reforms. We needed to deregulate our financial system, fundamentally change our taxation system, make our labour markets freer, reduce excessively high tariffs and rid the government of ownership of commercial enterprises that would be better run privately. By 2007 these five great reforms had been achieved.

Those five reforms were an essential Australian contribution to what one might properly describe as the neo-liberal experiment of the past 30 years…

The merits of Howard’s final four “reforms” are still open to debate, but how anyone could champion the first reform — the deregulation of the financial system — as a “great” reform in today’s climate beggars belief.

As I argued in the Roving Cavaliers of Credit, financial deregulation was based on a misguided belief that the financial system operated like an ordinary market for goods, where the market itself would work out a sensible volume of and price for credit. A proper analysis of how money is created shows instead that a deregulated financial system will pump out as much credit as borrowers can be enticed to take on. In a world in which leveraged speculation on asset prices is possible, that will lead to the economy taking on so much debt that it will ultimately fall into a debt-induced crisis — which is where we are now.

Once in this situation, deregulated finance then amplifies the problem by going from supplying too much credit to cutting off the credit tap in a manner that reduces overall economic activity.

So the financial deregulation that Howard championed last night, and that successive Labor and Liberal governments introduced, led not to a better functioning economic system, but to a financial catastrophe that is still in its infancy.

To argue that the entire crisis was due just to the subprime scam, and lax financial regulation, is to ignore the obvious signs in the data that too much credit was being generated relative to income. These signs go back to mid-1964 in Australia, and to Armistice Day in the USA.

Right from day one of the post-WWII period, the US financial system grew debt faster than than the USA economy grew its GDP. As a result, the ratio of debt to GDP rose from a manageable 45% of GDP in 1945, to 290% now (without factoring in the impact of derivatives, etc., which will surely require drastic upward revisions of the recorded level of debt). In Australia, we practiced 20 years of prudent finance — from 1945 till 1964, all under a Liberal Government–before the days of profligate finance began — also under the same Liberal government.

Financial deregulation simply assisted the finance sector’s own innate tendency to pump out as much debt as it would manage, and each “rescue” of the financial system by regulators like the Fed in the USA and the RBA in Australia simply encouraged the centre of financial speculation to move from one asset class to another. The Subprime Scam was simply the last gasp of the system, which was pushed so far by the naive belief that conventional (“neoclassical”) economists have in free markets for everything that they stood by while the finance sector pretended to make money by lending money to people with a history of not honouring their debts.

Even though the sub-prime scam was extreme, it was simply the current system pushed to its extremes: it was not an aberration due to lax regulation, but the final gasp of a system that was always pumping out too much debt, and had already many times overextended itself into what should have caused a corrective crisis.

Now we are being held in a permanent financial crisis by governments attempting to revive the system while continuing to honour debts that should never have been issued in the first place.

The one aspect of Howard’s defence of his economic agenda that is plausible is his argument that Rudd “cherry-picked” history to describe everything the Liberal Party did as neoliberal, while portraying the Labor Party (ALP) as non-neoliberal. In reality, both parties supported a neoliberal agenda–the Liberals merely went further in following that “logic” to its inevitable denouement.:

However, it is not plausible for the Rudd Government to argue on the one hand that Australia has entered the financial crisis in better shape than just about any other nation, and yet declare my government guilty of the extreme neo-liberalism which has allegedly brought about the crisis. The strength of the Australian banking system is a direct result of a sensible balance between market forces and prudential regulation adopted by my government not long after it came to office…

The construct of Rudd’s essay in The Monthly is clear. The wicked neo-liberal governments of Margaret Thatcher, Ronald Reagan and John Howard pursued policies of total deregulation that let the market rip, yet the more benign social democratic administrations such as the Hawke government, the British Labour governments of Tony Blair and Gordon Brown and the American Democrats under Bill Clinton followed a different path and got the balance right. It now falls, according to Rudd, to the social democrats to unite to save capitalism.

I expect that the belief that the Australian banking system is immune from the problems that have beset the rest of the world will be sorely tested in the next year or two, as the macroeconomic crisis caused by financial deregulation strikes at the heart of Australian home ownership. The level of household debt in Australia is as high as in America (when measured in terms of each country’s GDP), and though all the focus has been on the USA’s irresponsible lending to the subprimes, in fact household debt in Australia grew three times as fast as it did in America in the last twenty years.

The Australian financial system is thus dependent on all Australian mortgage holders being able to service their debts, when the only source most of them now have to do that is their jobs. As jobs go as the crisis deepens, the solvency of the Australian financial system will be sorely tested.

No-one will then claim that financial deregulation was a “great reform”.

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Peter Fray
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