All roads lead to Rome.
And all arguments lead to banking.
That seems to be the way it works anyway. Almost every story we write has a direct or indirect link to the banking sector. Although in reality the banks are really just the ‘beards’ covering up the real culprits – government.
But even so, today we’ll have another crack at our corrupt friends in banking.
Yesterday afternoon, after we’d knocked out the October issue of Australian Wealth Gameplan, we thought we’d re-read a couple of the Money Morning stories from earlier this week.
It was Tuesday’s edition that stood out. And not just because of the superb writing style either!
It was the transcript from ABC Radio of banking analyst Brian Johnson questioning an unnamed ANZ Bank economist that caught our attention again.
If you haven’t read it yet it, take a look now by clicking here.
There’s something eerily bizarre about it. It’s just more evidence – if it was needed – that the banks have one thing on their agenda, and that’s to lend as much cash as they possibly can.
Don’t worry about the risks, because that will be back-stopped by the taxpayer anyway.
The banks’ greed for more interest income is unstoppable. In fact, either in tomorrow’s Money Weekend or Monday’s Money Morning, expert chair builder and assistant editor, Shae Smith will look at how the banks will shortly scam even more loans onto their books.
But anyway, as we were reading through a couple of the comments on Tuesday’s article left by Money Morning readers, one of them stuck out. It was written by ‘Kohl’:
“I would like an explanation of the $13 trillion in ‘OFF BALANCE SHEET BUSINESS” as detailed in the RBA’s B4 table. $191289 million of this is identified as credit derivatives not related to foreign exchange or interest rate swaps. Maybe property? No one ever talks about this startling $13 trillion “off-balance sheet ” business.”
Actually, we’ve got a feeling that we’ve brought this up before, but we’ll give it a good going over again anyway.
Kohl is right, according to the Reserve Bank of Australia (RBA), banks in Australia have $13,006,783,131,920.80 of off-balance sheet finances. That’s a lazy six billion over $13 trillion.
But don’t just take my word for it, click here and look for yourself.
Most of it relates to interest rate contracts and foreign exchange contracts. Plus there’s a tiny $191 billion that’s just classified as “Other.” Clearly $191 billion is too small a number to worry about itemizing.
As I’ve mentioned before, I make no claim to being an expert on the workings of a bank balance sheet. To me the whole business model just stinks and I’d rather not have a bar of it.
However, we’ll make of it what we can. But if you know more about banks and their balance sheets and what they do with the off-balance sheet stuff then feel free to leave a comment on the Money Morning website.
According to the RBA data, the banks have $8.5 trillion worth of interest rate contracts. A number that’s too big for our Canon LS-100TS calculator to cope with.
But whatever it means, it’s quite clear that the banks have a massively huge enormous exposure to interest rates. I’m sure you knew that already, but seeing numbers as big as these should put it into some perspective.
So what are these interest rate contracts for? Our guess is it’s part of their hedging strategy to try and protect them against interest rate movements. This helps them lock in ‘guaranteed’ profits regardless of what happens to the underlying interest rate.
What else does it mean? Well, it undoubtedly has a big connection with the housing and mortgage market. Remember that Commonwealth Bank has about 50% of its lending book exposed to residential mortgages.
And even better than that, as technical analyst Murray Dawes pointed out recently, Bank of Queensland’s business has a 73% exposure to residential mortgages. That’s a figure which the bank claims makes the bank “safe.”
It stands to reason that the off balance sheet interest rate contracts are tied into mortgages. We can see that if we rely on a couple of stats from the RBA.
First is a chart I’ve knocked up showing the growth in off balance sheet interest rate contracts going back to 1989 – that’s the earliest data the RBA has:
As you can see, in the last twenty years these contracts have grown from less than $1 trillion, to just under $9 trillion now.
The next chart shows bank lending to the residential owner-occupier mortgage market:
Is there a connection?
Who knows.
Maybe.
Or is it just a coincidence. Oh, and by the way, the Bank Lending chart doesn’t include ‘securitisations’, that’s where the bank has packaged up loans and flogged them off as AAA or AA securities.
But whether there’s a connection or not, it doesn’t matter the real important point is that we’re talking big numbers here. We talking about numbers that could break an economy in two even if a small percentage of the ‘assets’ went smelly.
Talking of which, also remember that a banking balance sheet or off-balance sheet is like no other.
Sure, banks have assets and liabilities like anyone else. But that’s pretty much as far as the similarity goes. The rest is just smoke and mirrors. Let me give you a quick comparison.
If you’re looking at the balance sheet of a supermarket chain, its assets are inventories, property, and equipment. Plus it’s got other stuff such as receivables and intangibles.
But the lion’s share of its assets are things that you would generally call an asset. It’s something the company owns.
Take a look at the balance sheet of a bank and you’ll see it’s entirely different.
In the liabilities column the bank lists everything that it owes people, eg. Savings deposits. And in the assets column it lists… well, it lists what it claims to be “assets.”
These “assets” of course, are nothing more than other people’s obligations and promises to owe the bank money. The banks stay afloat on a ‘promise.’
In other words, if you’re a first home buyer who has taken out a $280,000 mortgage, then the bank lists that as an asset.
But it’s not much of an asset is it? An asset that’s based purely on the ability of a bunch of people to keep paying their bills. If those people suddenly stop paying, what happens to those “assets”?
That’s easy to answer, they get revalued to fire-sale prices.
The complacency which the mainstream press has towards the banking industry staggers us. They have the false impression that bankers are meticulously assessing the risk of the borrower and declining loans if they don’t fit in.
Of course that’s all nonsense. Banks don’t decline borrowers – not until they’ve exhausted all possible avenues first. They can’t decline borrowers, they need to bring on as many borrowers as they possibly can.
Anything to make sure the value of their existing assets, or loans to borrowers remains high.
And to do that they need to grab as many deposits as they can too. If you read mainstream commentators such as our friend Michael Pascoe, you’ll think it’s a good thing the banks are bidding for your business.
Don’t believe a word of it. It’s desperation. The banks need the deposits so they can continue lending out as much money as possible. They’re grabbing at your pockets, pleading for you to allow them to look after your hard-earned money.
But look out, because as soon as the value of loans written starts falling, it will put pressure on the value of their existing loans. And once that happens, the Banking Death Spiral formation will begin.
Other Stuff on the Markets
The S&P/ASX200 closed yesterday at 4,859.90, up by 28 points, while overnight on Wall Street the Dow Jones Industrial Average dropped by 47 points to 10,062.94. In Europe the FTSE100 finished at 5,222.95, down by 0.63% and the CAC40 was down 0.03%.
The price of gold in Australian dollars is trading at $1,141.48, while in US Dollars it is trading at $1,050.85. And the price of silver in Aussie dollars is $18.89 and in US Dollars it is $17.38.
The Aussie dollar gained a little versus the US dollar, trading at USD$0.9208, and improved against the Japanese Yen JPY83.37.
Crude oil closed overnight at USD$77.58
For the biggest movers on the market yesterday click here…
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http://en.wikipedia.org/wiki/Fiat_money
Fiat currency was anathema to American President Andrew Jackson. Jackson went so far as to pass the Specie Circular in 1836, which required all payment for government lands to be in gold or silver coin. The Austrian School of Economics has long held that no sound economy can long endure under fiat money, with prominent Austrian Economist Ludwig von Mises arguing in his book, Human Action, that, “What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit boom is built on the sands of banknotes and deposits.
It must collapse.
http://dailyreckoning.com/fiat-currency/
Hi PF
I am out of my depth when we get into the nitty gritty of banking, balance sheets and accounting, but at a basic level – isnt this the core issue… You said:
“I can say that bank housing finance is very safe in Australia, although the writers of this blog will disagree.”
Now if you are right (housing finance is very safe in Australia) then the mortgage debts that the banks have encouraged probably wont be an issue and with a bit of meddling the bubble can continue on for as much as a decade.
But if the assetts that the Banks have as collateral on their loans are highly overvalued, then obviously deflationary forces would mean housing finance in Australia is a ticking time bomb, waiting for painful revaluations).
Now we have argued this issues for weeks now, because I think we both realise the importance of determining whether there is a Oz real estate bubble and if so, how big is it and what will happen if it pops.
I will point out however, that the reasons I was so skeptical of the QBE LMI report on house prices was justified. Their assumptions were rubbish (i.e. did not factor in accurate interest rate increases, clearly in order to distort the results). The more desperate the propaganda, the more worried the industry is and that is not a good sign.
Nice article, Kris. It highlights the smoke and mirrors applied to cover up these issues.
I too don’t know how exactly what all of those off-balance sheet assets are. But it’s pretty clear to me that no-one (RBA, gov’t, banks themselves) are keen to declare it either. If no-one can figure out what those large amounts really mean, then that must be by definition a risk.
Anyway, it’s a moot point that the banks are massively exposed to residential mortgages. We see plenty of evidence of that with the government stepping in with the deposit guarrantee, first home buyers boosts and now an additional $8b in RMBS. And I have no doubt we’ll see more. Without all of this government assistance, the banking sector would have collapsed long ago. So I too cringe whenever I hear the mainstream media and the government talk up the strength of Australian banks. If only the average person on the street knew just how precarious the banks really are.
If the value of loans written starts to fall and/or property prices fall, I’d expect there to be all sorts of accounting trickery to be employed. We’ve seen it in the US with mark to market rules suspended and I suspect we’ll see something of that sort in Australia too if it starts to turn south. It’s fine to revalue an asset upwards, but it’s not ok to revalue the same asset downwards. I’d call that corruption.
To me, all of this simply signals that the government will do whatever it can to support residential property and therefore the banks. It certainly helps that the majority of national savings are wrapped up in housing and that there are votes in it for the government. The banks know this, so there is no reason for them alter their behaviour – whatever they do, they know the government will bail them out.
Ralph – while I agree that any assessment of the Banks’s future has to assume a lot of Government support, it is worth considering (I believe) the reaction of mortgage holders. If assets prices here are propped up by accounting trickery just to make balance sheets look healthier than they are – surely this trickery would not also work on a mortgage holder in negative equity.
Paying back $1m in principal and interest over 30 years for a house that is worth $400K and plummeting in value will not be appealing to may battling mortgage holders and some may decide to declare bankruptcy (resign to being renters and maintain their sanity and marriages!)…
So while I agree with Ralph that zombie banks will exist, the housing industry and market will be very similar to the UK and US. I dont know if Australians will be happy to see private institutions given public funds to look as if they exist. A full scale nationalisation is probably more likely.
Hi PuntPal – Mate like you I don’t mind acknowledging that I am out of my depth in trying to fully understand these figures, and we would all need an explanation from the RBA and Apra to begin that process. It would appear that other posters and the writers are also struggling to comprehend the figures. For that reason I tend to disregard it as not as alarming as it may appear to some.
The fact that the figures are readily available gives me comfort. I know that these figures are heavily scrutinized by Treasury, the RBA, Apra, and every economist including Dr Keen. In fact you could ask him on his blog if this is a matter for concern. I did ask another commentator but alas no reply.
I’ll give you my best explanation of loan valuations, but if someone more knowledgeable wishes to correct me, then please do so.
Asset valuation of loans is the debt. They may be sold off onto the securitisation market, and the lender will take a percentage of profit, and still continue to manage the loans. The loans then become off balance sheet and are owned by an investor. The exact terms of that investment, and any recourse to the bank is out of my area of knowledge, and may vary on each transaction.
Basically the risk is held by the mortgage insurer. In all insurance contracts, predictable losses are covered, but in the USA when losses went beyond that mark the value of the loan portfolio became suspect as losses may then revert to the investor. In other words the insurer could no longer cover the losses and the insurer may have become insolvent due to those losses. In that case the lender was left holding the full risk.
Banking is like insurance in that respect. Whilst cash flows, bad debts, profits, and extraordinary items remain within predictable parameters all will be manageable, but beyond that and events can become dangerous.
The securitisation market is still relatively young, and I expect that global standard practises are being re-written after the experiences from recent years. We will have to wait and see how it evolves, but my bet is that it will be a lot more robust and be more heavily controlled.
I’m not sure if that helps at all. There are still plenty of questions unanswered.
The guys at money morning are correct just 180 degrees out of kilter.
We will not see a crash, the billions floating around… who cares were on top of the world, look mum I’m on top of the world.
If we cast our minds back to say 2004 for example you will see our interest rate was one of the highest of any OECD country. The biggest concern to the financial industry here was the $175 billion + dollar mortgauge industry, well that was roughly it’s value about then could have been greatly threatened by say Japan raising it’s interest rate to say two percent and the greenback hitting say the dizzy heights of say six or seven percent. Only the greenback and Pound drew in more investment as they were the stronger currency. Countries had a huge US dollar backed Borce so it was advantageous to keep it in it’s lofty position no matter how hated and worthless it really was. Not forgetting the whole oil industry is underpinned by petrodollars etc.
Some speculate that the whole premise for invading Iraq was Saddam Hussein and his threat to move to petro-euros.
As the Iraq debacle intensified and costs blew out the common view towards both currencies became somewhat jaded but that was before the effect of the unregulated banking industry it’s super dodgy lending practices and toxic filth packaged up as AAA stock was flooded on to the market.
Again the people suffer because of such regulatory bastardry as their home loan has been so re-packaged, bundled and on sold as AAA stock no one can actually trace back the money thread to see who really owns the asset as so many banks have gone bust the poor sod can’t sell their property for a proper market value so the property ends up being repossessed by the state or county then on sold at fire sale prices which devalues the housing stock and so the self feeding machine consumes more lives produces more debt with no end in sight.
Let us also not forget the supposedly regulatory financial reporting bodies who should have been investigating all of this stock but were instead happy to give banks like Lehman Bros a AAA rating even though they were leveraged by some 80% in comparison to most regular banks which are only around 52% leveraged.
Read Bear Sterns, Northern Roc, Citi Group WAMU and some three thousand privately owned banks who have now folded.
If we trace back the key pillars in all of this, it has been the repletion of the Glass Stagel Act, followed by the financial services act (quite literally secreted through congress) all backed up by totally unregulated lending practices an absolute instilled belief that you can walk away from anything in the US including huge amounts of debt courtesy of Bush junior changing the bankruptcy laws.
When you add to that by telling the Central China Bank to get lost after it lost some 10 Billion in the Lehman bros collapse so you know there is no love lost there but far more investment interest here as we are the only performing western economy at the moment.
Ok that maybe a slightly grand claim as Europe has picked up considerably so expect that pony to catch up some time soon.
Yes 20/20 hindsight is a wonderful creature as is the high interest rate we came down from then settled at a rate around 3% while the other OECD countries panicked slashed and burned their rates and any chance of really getting their economy firing yet again. So far from being a real threat to our economy by hitting the panic button the US, Japan and UK did us a real favour by slashing and burning. Ok japan came from 1.75% or so but back to almost zero after a ten year doldrums is still a hit to Japans investment industry, which in turn will help drive it’s economy be it electronic or manufacturing onwards and upwards.
While the world went to hell in a hand-basket we sat at 3% interest rates like a fat kid in the corner of the world mainly ignored until we got a gorgon in the corner as well.
As oil based economies were looking for cheaper alternatives took notice when that gas field was announced as going ahead economists and financial wizards from around the globe saw the fat kid and could hear in the background “record lows not seen for thirty years the local media screamed”
Get in quick while the going is good the banks said it’s not going to last for-ever they cautioned.
That peek in to the corner has now turned in to a feeding frenzy, the money-men from over seas have had a look at us and they liked what they saw.
So like selling cheap smack to a druggie the banks have spruked cheap money to a population addicted to the value of it’s housing stock.
The overseas investment houses have seen a great opportunity to invest in stock, which may not be perfect but it’s getting a far better return than local assets.
Maybe we will have a housing crash when the rest of the world recovers and the money is taken back to where it would have been prior to the GFC.
I used to work with a chap who took great delight in telling me his house was worth over a million dollars. Bur he always got cranky when I reminded him he could not afford to buy lunch as his morning packet of smokes and a coffee broke his budget for the day. That fairly well sums up this country now.
We can judge when the banks reigned back their lending practices after the “equity mate” adverts vanished from the press and television media / advertising slots.
So even in a climate where housing repossessions are at an all time high the banks like the pushers are still selling smack to a barely alive corpse.
So when the addict gets taken off to hospital the life support of a Govt bailout may sustain life but the quality will be untenable for most unless radical action is taken to keep people in their repossessed house until they become financially fluid again or we will witness people selling all of their house hold goods on the front lawn as per the first great depression here or current day depression in the US.
So the reserve bank may actually be watching and strategically planning after observing how useless having a 0.1% interest rate is at stimulating an economy.
Japan has been there since the 90’s. Now is the time to strike has been the catch cry in the RBA. Lets get that rate up to drag in even more investment from around the world.
Look at our world class infrastructure, fantastic commodities, all that natural gas, land in abundance all yours for a very reasonable price. Come on down and spend spend spend.
So don’t expect house prices to fall our interest rates to go down any time soon or business investment to slow down any further as all of those items have now hit rock bottom. When you’re the only place selling a stable economy rising commodity prices and lots of energy to sell to the world your on to a winner. Our real financial clue dancing around in the background and possibly our only governing factor could very well be the price of Oil. Time will tell.
Whatever it is that parabolic graph shows the whole picture. You can run but you can’t hide. Any technician or chartist would know the consequences of this shape.
Fair points, PuntPal.
I think the aim of the gov’t assistance to the home mortgage industry is to prevent as many ordinary householders from going into negative equity as possible. Once there is significant negative equity, houses sell for less, people want to pay less for them, consumer spending goes down because people can’t tap their equity to fund discretionary purchases, banks write loans of smaller value and so on. It kicks off a downward spiral. So then yes we are looking at bank nationalisation if that situation occurs.
I figure the government is hoping that the bailouts can push that ugly situation down the road a bit while they hope the economy picks up its own head of steam again. So now the question becomes what happens if the economy doesn’t want to return to normal. I think it comes down to how long the government can keep spending. We can be sure that it’ll be at least as far as the next election.
Seems like the whole world economy is a massive ponzi scheme. The only thing that has stopped this being exposed is the government bailouts and money creation. I was going to say printing, but I don’t think they even bother doing that anymore.
As long as the taxpayer keeps bailing out banks, that charge them for the privilege through all means from massive bonus’ to bank fees (how does that work anyway?), this system will continue.
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