WAYNE SWAN MP
MEMBER FOR LILLEY
ABC RN BREAKFAST
FRIDAY, 14 SEPTEMBER 2018
SUBJECTS: Global Financial Crisis, Collapse of Lehman Brothers, Fiscal Stimulus.
FRAN KELLY: Ten years ago tomorrow, September 15 2008, global markets were shaken by the collapse of the Wall Street bank, Lehman Brothers.
VOICE 1: What in the world is happening on Wall Street?
VOICE 2: Two-year no-yields went from 1.90% to 1.66% in the blink of an eye.
VOICE 3: I have never, live, looked at the Dow Jones Industrial board and seen a 600-point loss.
VOICE 4: Who knows where this is going to end up? I mean, this is volatility we haven’t seen of course since 1929.
KELLY: A credit crunch was already underway, but the collapse of Lehman Brothers was the trigger that catapulted the world into the Global Financial Crisis. That would eventually lead to, amongst other things, 9 million Americans losing their homes in the sub-prime mortgage crisis, plunging the US and Europe into years of recession. Australia dodged the worst of the GFC, avoiding recession and massive unemployment. But ten years on, the legacy is still at play, with rising income inequality and job insecurity in turn fuelling a populist surge in the West. Meanwhile, parts of the world are still saddled with mountains of debt. And some analysts warn that’s laying the seeds for the possibility of the next financial crisis.
To discuss the GFC and its aftermath, we’re joined on Breakfast this morning by Wayne Swan – he was Australia’s Treasurer in the Rudd Labor Government when the GFC hit. He joins us from Brisbane. Elizabeth Sheedy, former banker, and now teaching financial risk at Macquarie University in Sydney, is in the Breakfast studio with me. And on the line from New York, Tom Easton is the US Finance editor of The Economist magazine. Wayne, Elizabeth, Tom, welcome to Breakfast.
WAYNE SWAN, MEMBER FOR LILLEY: Good morning.
ELIZABETH SHEEDY: Thank you.
TOM EASTON: Thank you.
KELLY: Wayne Swan, let’s start with you. You were the Treasurer of Australia, you had a front-row seat at the table as the world watched this collapse. What were your thoughts as we saw Lehman Brothers collapse?
SWAN: Well, fear. That was the day it went from being a big deal to being truly frightening. And of course from the 15th of September, right though until about March in 2009, we were on a rollercoaster ride. I mean, we had, within days of Lehman Brothers, AIG almost fall over but to be rescued. But through the next months, on the stock exchanges around the world, there was a catastrophic drop of confidence which then fed back into the real economy, leading to very substantial drops in global demand. Effectively, global demand fell off a cliff. And pretty rapidly, by Christmas of that year, we were seeing economies across the world – first of all developed, and then developing – go backwards at a very substantial rage. So, truly frightening. Really, on many occasions, it felt like Armageddon was just around the corner and fear for our people.
KELLY: Ok, Elizabeth Sheedy, you were working in the banking sector, I think, at the time? Was it immediately clear to you the magnitude of the events the world was witnessing?
SHEEDY: Well actually, Fran, at that point I was already at Macquarie University teaching. But certainly from an academic’s perspective, the student interest was intense and we were looking on with great interest. And I have enormous respect for people such as the Treasurer and of course the regulators working through that period. It must have been horrendous.
KELLY: Tom Easton, The Economist writes that the collapse of Lehman Brothers was the point where the previously unthinkable became real. America was the epicentre of the crisis. The Fed, the US Government, let Lehmans fail. And then stepped in and rescued the banks, threw trillions at the economy to get it going again. In a rare gathering this week, all three men responsible for the response to the crisis – the former US Fed Reserve Chairman, Ben Bernanke, ex-Treasury Secretaries Timothy Geithner and Hank Paulson – admitted they could have done a better job explaining their actions. Let’s just listen to Timothy Geithner.
GEITHNER: I think the hardest thing was sitting at the table with my wife in the morning, with her reading about what we were doing, and just seeing on her face the mix of despair and doubt. And she looked at what we did and she said, she was like, “really?” I think that was the hardest thing. And of course, that was mirrored by what we faced across the country.
KELLY: That’s the Treasury Secretary at the time, Timothy Geithner. Tom Easton, was his wife right to go, “really?” Was it the right response? Was the only problem with how they explained their actions? Or the fact that they threw so many trillions of dollars at the economy to get it going?
EASTON: That was an interesting comment, wasn’t it? The hardest part was explaining the actions. Which kind of implicitly says, of course we did all the right things, but we just didn’t articulate it particularly well. And the reality is the world economy did recover to an extent. It does function, to an extent. We didn’t have some of the worst consequences of the crisis that people thought we might have. For instance, the massive intervention that went on didn’t produce exorbitant inflation, it didn’t undermine the US dollar, at least not yet. So they were fairly successful. I think that two things are unclear. I don’t think that the financial crisis is well understood at its inception, and I don’t think the response is really particularly well understood. And I think there’ll be a consensus, broadly, that we really don’t know what the consequences of the response going forward are. Our argument is that a lot of things that have happened that may make the next crisis, which will inevitably come, particularly difficult too. And I’m sure my colleagues on the show would agree with that.
KELLY: Well let’s go to that with you, Wayne Swan. Because your government – it didn’t take long for the critics to start blaming you for the response. Yesterday on AM, the Deputy Reserve Bank Governor Guy Debelle described that moment as looking over a cliff. You decided that handing out cash to households in Australia was the best way to keep us from falling off that cliff. Do you think that you had trouble explaining that, and do you have any doubt that that was the right response?
SWAN: There’s no question that we had probably the most effective response in terms of fiscal policy around the world outside of China. And the consequence of that was we didn’t experience a recession – one of two advanced economies not to experience a recession. But I do agree that we should be fearful a little about the future. Because first of all, you would not in our current circumstances get the global coordination and cooperation that was put in place between the end of 2008 and through March 2009, to avoid the worst of the Great Recession – to avoid that Great Recession being any deeper than it was. I mean, who could imagine the US coming to the table and working with other advanced and developing countries to put together a coordinated response such as that one? And secondly, we are still seeing in the debate a reluctance to admit that the powerful use of fiscal policy is the most powerful thing you can do when demand drops. You see, people are trying to redefine the crisis as being a consequence of excessive government debt, when actually the crisis was actually a consequence of the financial markets and their behaviour. So the truth is that fiscal policy is the solution in the circumstances we were in. The failure to deploy fiscal policy fully in the United States and in other parts of the developed world meant that we had a weak and anaemic recovery from the Global Financial Crisis or the Great Recession as it’s known overseas, and people are still saying, and pointing to government debt as being the core of the problem, which is not.
KELLY: Ok. Elizabeth Sheedy, the Australian Government spent money – go hard, go early, go households – but the other response was to guarantee bank deposits. The crisis also brought about a new wave of banking regulation. Banks were forced to hold more capital, lending conditions were tightened. Have those changes been enough? Has the response – following on from what Wayne Swan said there – has the most important response occurred? Has the system changed enough to ensure a banking-led crisis doesn’t happen again?
SHEEDY: Well I think the first thing to say is the balance sheet reform has been very comprehensive has been very comprehensive and I would say quite successful. Banks are now holding considerably larger capital buffers and considerably larger buffers of liquid assets. So that’s a huge change, and it greatly reduces the probability of a global, systemic banking crisis, such as what we experienced 10 years ago. However, I don’t think we can say that is enough, because what we also need to see is the implementation of what I would call risk governance and risk culture. In other words, taming that buccaneering spirit that is so well exemplified by Dick Fuld, who was the CEO at Lehman Brothers. So, you know, even the biggest capital buffer is going to struggle to protect an institution against foolhardy decisions.
KELLY: Tom, let me bring you in there. The economic editor at The Times, Philip Aldrick recently wrote that, quote, “averting a financial crisis does not mean that another gut‑wrenching financial crisis can be avoided” and the bad news, he says, is that some of the same pre-crisis dynamics are emerging again. He says that the heart of the problem is that too much cheap credit and too much debt – which I guess follows on from what Elizabeth was saying, you can’t necessarily weed the foolhardy behaviour out of the system. What do you think? Are the banks poised again for a crisis?
EASTON: That’s a really interesting question. I disagree about the cultural issues. I think that markets are always going to have that. The question is, how do you enable failure? Let’s have a look at what’s back since the crisis. Most of the banks that were dominant before are dominant now. The rating agencies that were considered to have failed abysmally in the crisis continue to have almost all of the market share today, 97 per cent. But almost more importantly, housing prices in the United States, which were perceived to be at the core of the crisis – one of the rare areas of consensus was that American housing played a huge role in this stuff – housing prices are back almost to where they were. And that’s either a very good thing, because it’s a recover, or a bad thing, because it represents a stretching of credit once again. America has not fixed its fundamental housing problem. Eighty per cent of – let me get my statistics correct. The sharpest rise in housing appreciation has been in the lower-income segment. In the lower-income segment, 84 per cent of the mortgages are processed through Fannie Mae, Freddie Mac, or insured by the FHA, that’s the government agency. The standards for lending in those areas are 3 per cent down payments and 50 per cent loan-to-value ratios. That’s a very, very stretched financial situation. So those people who argue we haven’t fixed the fundamental problem – for instance, in housing, which almost encourages heavily leveraged purchases which are subject to all sorts of volatility, or in the banking system which may have just been protected – well that’s true, we haven’t changed that. We haven’t created a system for failure which will perhaps squeeze out the buccaneering system – or sorry, the buccaneers that my colleague on this radio show mentioned. And I think that’s the way to do it. You have to have a way where people can fail and get thrown out of the market. Right now, instead, we have a heavily regulated system. I want to say one more point about that. The tempering of that regulated system is many, many mathematical models for stress tests, but very, very few people understand how those models are constructed, they’re very, very hard to understand. They have other, peculiar consequences. They may concentrate risk in certain areas. Models that did exist before the crisis concentrated risk unduly in the housing sector. And therefore we could have a crisis again because of the solutions – what we’ve done to help things is regulatory structure based on models, and what we haven’t done, which is fix the housing system in America or actually have market penalties from any of the institutions that were involved.
KELLY: You’re listening to RN Breakfast, it’s seven minutes to 8. And Thomas Easton; Tom just a quick one from you before I go to Wayne Swan, who I know has strong views on this – the rise of populist governments, protectionist thinking. Do you believe we can see a direct line from the GFC to the rise of a populist leader like Donald Trump?
EASTON: You know, you can make that line, but I think there were problems beforehand that have manifested themselves now in those sort of feelings. I think there’s a sense that many of the trade agreements, that even if you favoured free trade in general, that the agreements themselves weren’t properly structured and that there were other inequities in the system that went on that would have led to some sort of change in government structure regardless of the financial crisis. The financial crisis probably aggravated that kind of thing. It didn’t help that bankers got huge bonuses in 2009 and kept them, but the structures that led many people to believe they were being left out – both things were in place before the financial crisis. And I don’t think that the financial crisis – it may have exacerbated them, but that cake was being baked regardless.
KELLY: Wayne Swan, what’s your view on this?
SWAN: Well, I think that the Great Recession did shine a light on trends in the US economy and across other developed economies that had been going on for some 20 or 30 years. And what it shone a light on was the suppression of living standards of working people in the United States and across other parts of the developed world. So that when unemployment hit double digits and stayed there for six or seven years, what that said was a whole generation of people were bearing the burden for fault lines in the financial system. And people became incredibly resentful. And I think you can draw a direct line between the suppression of living standards of working people across the developed world – and particularly in the United States, and the fact that that was exacerbated dramatically by events of the Great Recession – and the political extremism that we are now seeing across the developed world, and the rise of people on the radical right and the radical left around the developed economies. So it is true that underlying what occurred in the Great Recession was that it exposed the fault lines which had been developing for some years across developed economies. And we are now living with the political consequences of that.
KELLY: And are we learning the lessons? I mean, the bankers are still getting bonuses, the companies are making profits again, but wages growth is low, and Tom just told us about the lending patterns in the housing market to the low-price housing market in the US; are we not learning the lessons of that?
SWAN: No, we’re not. Because executive salaries are now back where they were in 2008, so people who lost their jobs and were out of work for years and years look above them and see people receiving obscene salaries. We’re not learning those lessons at all. And if you look to the United States, their solution to drive the economy is to blow out the budget deficit and give massive tax cuts to people on the highest incomes.
KELLY: Ok, let me bring Elizabeth in.
SHEEDY: Yeah. And in fact, I think we could argue that some of the misconduct that’s currently being revealed by the Royal Commission is in fact an unintended consequence some of those earlier reforms. Because as banks have been de-risked, it makes it much harder to earn those pre-crisis levels of return on equity. So when you’ve got bankers that are under intense performance pressure, I think it’s inevitable that some of them are going to cross the line of acceptable behaviour in order to meet those aggressive targets.
KELLY: So what does that mean? The Royal Commission’s made things worse, or that everyone has to get used to not earning such big bucks?
SHEEDY: The latter. I think what we really need to see is people accept that banks can’t continue to earn those sort of returns.
KELLY: You’re listening to RN Breakfast. We’re speaking with Wayne Swan, Elizabeth Sheedy, and from the US, Tom Easton, editor of The Economist magazine. Elizabeth, just to stay with you – your thoughts on the build-up of debt now? Analysts say the next financial crisis may come from China, where there are soaring levels of debt. Should we be concerned of this?
SHEEDY: Look, these are the sort of things you always need to be keeping a close watch on. My personal view is it’s almost impossible to predict when the next crisis is going to be. That’s a mug’s game. From my point of view, as a risk-management expert, I stick with the Boy Scouts’ motto – always be prepared. Another crisis is coming, we don’t know when, but be ready.
KELLY: Tom Easton, just finally from you. Regulators have whacked the banking sector but there’s concerns that the unregulated shadow banking sector that you’ve been talking about holds these same sorts of dodgy financial products. Do you think they have learned the lessons – at what level have lessons been learnt there on Wall Street?
EASTON: So, you know, unlike my esteemed colleagues here, I’m not looking at the broader structure of inequality and stuff; I’m looking at the structural issues in the financial industry. Because I think, actually, employment is improving quite well in America. I think the regulatory consequence was a mess. I think it was a mess because the legal challenges to the banks were formidable. They are a tremendous amount more regulation. There were a number of cases brought and a huge amount of fines -- $300 billion or something collected. And yet there were almost no legal cases made against the banks. And when people challenged – so banks settled most of the cases that were against them, and said that they had no choice, because if they didn’t, they would lose their licence to operate. But for the same reason, the individuals who were investigated by the government fought challenges, because they thought their livelihood would end if they ever settled a case. And you know what? Almost every case against an individual was either dropped or won. I think there was one case the government one. Now you could say that’s just a pathetic display by the government, or you could say that there was something more profound going on and that the whole legal attack on the banking system was misplaced. The result is that the regulatory – I mean, the tableau, we can never really clarify. We don’t know what they did wrong, so it’s very hard to say what they should do right.
KELLY: Wayne Swan, we’ve got 30 seconds for you. Sorry, just briefly – do you, looking back, have any doubt that the things you put in place, including the guarantee of bank profits [sic, deposits] was the right move and should remain in place?
SWAN: Absolutely. I mean, our economy performed the best of any economy in the developed world for the half-a-dozen years afterwards and it’s continued to do well. It would not have been in that position if it weren’t for the actions we took in that period.
KELLY: Wayne Swan, Elizabeth Sheedy and Tom Easton, thank you very much for joining us on Breakfast.
SHEEDY: My pleasure.
SWAN: Thank you.
KELLY: Wayne Swan is a former Treasurer and was at the helm of the economy when the GFC struck. Elizabeth Sheedy is an academic in financial risk at Sydney’s Macquarie University and Tom Easton is the US Finance editor at The Economist magazine.
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