Address by The Hon Lindsay Tanner MP
Minister for Finance and Deregulation
ICGN 2009 Annual Conference
Sydney
Monday 13 JULY 2009
I acknowledge the First Australians on whose land we meet, and whose cultures we celebrate as the oldest continuing cultures in human history.
I am pleased that I can join you to take part in this conversation about the future of corporate governance. It is an important part of a much bigger conversation about what shape corporate and financial regulation should take in the post-recession global economy.
The Australian Government is an active participant in the international forums in which this conversation is taking place, including the G-20, the IMF, and the Financial Stability Board.
What we bring to these forums is the story of how Australia, through over two decades of reform, has developed a regulatory architecture which has proved very resilient throughout the global financial crisis.
We also bring a more recent story of how through an aggressive fiscal policy stance and a willingness to embrace necessary short term regulatory interventions the Australian economy has been buffered from the severe downturns currently being experienced by most advanced major economies.
I want to talk more about the Australian response to the global financial crisis in a moment, as well as offer a perspective on what direction the global community should take in response to the crisis.
First however I would like to lay out some orientation markers for understanding the broader trends that lay underneath the acute crisis we have experienced over the past twelve months.
As the next session of this conference will discuss, it is a crisis which has highlighted the irrevocable fact of globalisation.
It is a crisis marked by an unsustainable boom, built on widespread disregard of risk, and which has delivered the most severe global recession in 75 years.
And it is a crisis which has shown that the state’s power to regulate markets can only meaningfully be considered against the backdrop of the global regulatory environment.
Indeed it is the depth of global integration in recent times which has led to established domestic regulatory arrangements being undermined.
In recent times, the pace of innovation in developed world financial systems has simply outstripped the capacity of centralised regulators to keep up.
As the OECD’s Adrian Blundell-Wignall has pointed out, this environment produced in 2004 a series of factors whose emergence ultimately triggered the great crash of 2008.
In 2004 the Basel II agreement on capital adequacy rules for financial institutions was settled. It projected very favourable treatment for residential mortgage lending, which, coupled with opportunities available through clever financial engineering, greatly increased the incentives for financial institutions to invest in residential mortgages, relative to other options.
The market for residential mortgages is relatively mature in major developed nations. As the amounts of money involved in this market were substantially increased in recent years, two things occurred, particularly in the US market. Housing prices went up, and less creditworthy borrowers were drawn into the market.
Aided by interest rates kept at excessively low levels, the conditions emerged for a perfect storm in the US economy. Sub-prime lending soared, standards collapsed, and a housing bubble inflated rapidly. Complex financial engineering then spread this bubble to the rest of the developed world.
In the wake of the Enron scandal, regulation of government-backed mortgage securitisers Fannie Mae and Freddie Mac was tightened. The resulting gap in the market opened up further opportunities for private financial institutions that they had long demanded.
Regulators also relaxed their supervision of investment bank financial models, and allowed them to substantially increase leverage ratios.
Blinded by the sophistication of modern finance and their principals' aversion to regulation, regulators failed to keep up with the pace and scope of financial innovation.
Financial institutions will always seek to get around regulatory restrictions on risk-taking in boom conditions, because the market forces them to. When big returns are being made, the market conservatives fall behind.
Some western societies have developed a “money for nothing” culture which produces a great deal of irresponsible risk taking. Low savings rates, excessive personal debt, risky margin lending, non-recourse mortgages and easy access to risky financial products are just some examples of this.
Had the enormous deficits of the United States emerged in any other country, global markets would have corrected them long before they reached the point they did.
But because of the US dollar's status as the world's reserve currency, and the United States' global strategic dominance, the correction didn't happen. By the time the house of cards collapsed, most of the developed world was deeply involved.
As the collapse has occurred it has laid bare the tremendous misallocation of resources in rich economies in recent years.
As long ago as 1984, Nobel laureate Professor James Tobin warned that western economies were throwing more and more human and financial resources into financial services, remote from the production of goods and services – what we would typically call the real economy.
Tobin predicted that this would lead to vast rewards for people in the sector out of all proportion to the social value of their work. His prediction proved to be pretty accurate.
At the peak of the boom in 2007, 40 per cent of all corporate profits in the United States was accruing to the financial sector, which accounted for five per cent of all private sector jobs.
The financial sector was literally milking the productive sector.
The boom in financial services delivered enormous sums to bankers and other professionals, but much less to the wider economy that the financial sector is supposed to serve.
Of course, producers in specialised areas will always tend to behave in ways that inflate their own incomes at the expense of their customers.
Wall Street is probably the most extreme example of this in human history. Unfortunately they were gambling with Main Street’s money – and they were playing blindfolded.
And it appears that the government and regulators didn’t notice.
The most immediate lesson of the crisis is that globalisation is now deep and pervasive. Misconceived comparisons are often made with the pre-First World War era to suggest that there is little new about modern globalisation. We might just as well take a typical car from each era and declare them to be the same thing.
Our economies are now so interconnected that major disruptions and imbalances threaten nations that are ostensibly uninvolved.
And because financial intermediation is now so thoroughly global in nature money can easily flow to the weakest regulatory points. When regulation fails spectacularly, strong national regulatory frameworks may not protect individual nations from the consequences.
The Australian financial system has withstood the impact of the global crisis well, although our reliance on commodity prices and developed world growth means that we will still carry part of the cost.
Over the past year the Australian Government has taken a number of steps to ameliorate the impact of the crisis and support the stability and resilience of our financial system.
In October last year we moved to protect retail depositors and Australian financial institutions through deposit and wholesale funding guarantees.
These guarantees have shored up confidence and corrected the wholesale funding disadvantage faced by Australian banks as a result of policy interventions in other jurisdictions.
The Government has supported the securitisation market and promoted competition in the mortgage lending market through investing in residential mortgage-backed securities.
Unlike other countries, the Australian Government has not had to inject capital into financial institutions.
Our Four Pillars policy, which prohibits major bank mergers, has made it difficult for Australian banks to acquire the scale needed to become major global players. Australian banks were not drawn into the US sub-prime mire like some European banks.
Australia’s regulators have long been vigilant in their role overseeing and monitoring the financial sector. The importance of this role has only increased during the financial crisis.
Our relatively well-capitalised banks and strong financial sector is testament to the work of our regulators, in particular the rigorous stress testing of Australian banks undertaken by Australia’s prudential regulator earlier this decade.
Crisis management arrangements and issues of system-wide integrity are regularly reviewed by our Council of Financial Regulators. These arrangements, which include hypothetical cross-jurisdiction crisis management, have thankfully not had to be put into practice.
The Australian government has backed up its strong regulatory arrangements with an aggressive fiscal stimulus strategy.
The Government’s stimulus measures have been designed to boost liquidity in the short term to support aggregate demand and jobs, while investing in the nation’s infrastructure over the long term.
The stimulus packages announced prior to the recent Australian Budget are expected to raise the level of Australia’s GDP by 2¾ per cent in 2009-10 and 1½ per cent in 2010-11, supporting up to 210,000 jobs.
In addition, the measures announced at the time of the Budget are expected to raise the level of GDP by a further ¾ of a per cent in 2009–10.
Fiscal stimulus is complementing the effect of the ‘automatic stabilisers’ – parameter increases in government payments and reductions in taxation revenues – and the easing of monetary policy by the Reserve Bank of Australia.
The RBA has also moved to ensure sufficient liquidity in the financial system by expanding its money market operations during periods of particular stress.
Australia’s regulatory arrangements have stood us in good stead through this crisis. However it is clear that, in this crisis and in future crises, strong domestic regulation will be insufficient if the global picture is weak.
Reforming regulatory arrangements in this area will not be easy. We cannot simply restore past regulation, as appealing as it may be to some.
The world has changed beyond recognition, both in the United States, in Australia and the rest of the developed world.
Whether we’re talking about the United States or Australia, we need a regulatory regime that’s appropriate for 2010 and beyond, not one that simply reinvents the past.
While it is too early to be prescriptive about the shape of future regulatory and governance regimes, we can be clear about some basic lessons from the global financial crisis.
The crisis has highlighted how fundamentally important trust is in a market economy. The wider our economic horizons become, the harder it is to sustain the systemic trust that allows the system to function.
Rebuilding financial regulation on a global scale, enhancing transparency and increasing capital adequacy requirements are only part of the picture. For global capital markets to function efficiently, they must be based on a relational framework that sustains trust.
But perhaps the most important lesson to take from the crisis is the need to build institutional and regulatory frameworks which fit the modern economy.
We must not let images of economies past guide our approach to reform. We must accept that the script for the new accommodation between markets and government is yet to be written, and that we have the responsibility for writing it.
Just as the Great Depression gave birth to the New Deal, so too must this global recession trigger the implementation of a set of market arrangements which suit the contemporary world.
As we survey the wreckage of the great collapse of 2008, this framework is still very much a work in progress.
While this framework must reflect lessons learned, it must be built around the emerging future economy. It’s true that we can’t be entirely clear about what the new economic story will consist of.
Its fundamental elements though, are relatively discernible, and can be captured by a simple phrase: sustainable long term growth.
This means greater emphasis on education and information technology, more saving and investment, more flexible and adaptive regulation, and diminishing environmental drawdown.
In conclusion, I would like to emphasise a point I made at the beginning of this address, and that is how essential global coordination of regulation now is.
If we are to avoid future giant asset price bubbles, systemic Ponzi schemes, and massive financial imbalances, financial regulators need to be on the same page.
Fortunately much of the initial architecture already exists with the Financial Stability Forum, the Basel accords and the International Monetary Fund. The recent G20 summit laid the foundations for further progress.
Our collective response to the first global recession since the advent of globalisation will require consistent and coordinated action on the part of governments world wide.
But it will also require a will to reform on the part of the international corporate community.
Bodies like the International Corporate Governance Network play a crucial role in pushing the reform agenda, and disseminating the best ideas and practice to ensure the corporate world does not repeat mistakes of the recent past.
I encourage you to use this conference to pursue this opportunity.
Thank you.
| Media Contact: | Website: |
|---|---|
| Nardia Dazkiw - 0418 144 690 | www.financeminister.gov.au |
