MORTGAGE funds won't be rushing to take up the Rudd Government's suggestion that they upgrade to banks to qualify for the Government's guarantee on bank deposits, and there is in fact only one comprehensive way to resolve the problems flowing from that guarantee on bank deposits: withdraw the guarantee.
Until that happens, non-banks are going to be at a competitive disadvantage for a considerable period. Certainly until the world financial system regains its balance, and possibly for three years, the length of time the Government has stated the bank deposits guarantee will be in place.
It's difficult to believe that anything other than desperation and a desire to pass the buck prompted the Government to float the idea that funds should reconstitute themselves as banks.
Banks are highly regulated beasts. There are limits on the type of business they can do — they are not, for example, allowed to provide guarantees for non-bank subsidiaries, which puts the kibosh on the idea that the big banks should solve part of the problem by guaranteeing the non-bank funds they also operate.
They must underpin their assets with capital, which is set at a minimum of 8% of assets, and must have highly refined risk oversight and accounting systems to track and control operational risk, credit, liquidity and market risks.
None of the funds that have frozen redemptions to halt a flood of withdrawals by clients headed for the safety of guaranteed bank deposits can currently meet these standards.
The ones owned by the biggest groups — CBA's Colonial operation for example, or AXA, both of which have suspended fund redemptions — could, if they wished to — but not today, tomorrow, next week, or next month.
Capital is in short supply globally, and would not easily be located or reassigned. And while the Government is allocating more resources to the Australian Prudential Regulation Authority, it would — and should — take time to put the physical and intellectual infrastructure into place (the rules require that bank capital, bank systems and know-how be on site), and for APRA to stress-test it.
In short, for most non-bank funds it's a wacky idea, and won't work. Which brings us back to the original dilemma: the bank deposit guarantee, and its impact on non-bank money managers.
There's no doubt that the Government had to guarantee bank deposits when it did. Ireland's earlier decision to guarantee its banks forced every government to follow suit, or risk being swept away by fear-laden depositor runs to regimes that did offer the guarantee. By the time the Rudd Government acted, a run was developing here in the smaller banks.
And the bank deposit guarantee accelerated a move by investors out of managed funds and into the safety of the now explicitly guaranteed banks, rather than creating a run. Money had been moving away from funds into cash, government debt and bank deposits all year, as it always does in financial crises.
The reality is that the Government cannot extend the bank deposit guarantee to managed funds, because the quality of managed funds varies. Mortgage funds, for example, can contain large portfolios of top-rated house mortgages, or single commercial properties. They can own established properties, but they might also own properties currently under development and, in this environment, at risk.
Supplying liquidity to the frozen funds would also only solve part of the problem.
Liquidity could come from parent entities, or even from the Reserve Bank, if it took the extraordinary step of temporarily exchanging cash for selected, high-grade mortgage assets owned by the funds. But that would just fund the run: as long as fear is abroad and the bank deposit guarantee is in place investors are likely to want to make the shift.
The best long-term solution is to re-establish the status quo, by withdrawing the bank deposit guarantee, and replacing it with the more limited, $20,000 deposit insurance scheme the Government announced in March, before the crisis went nuclear.
The markets are going to have to stabilise for that to occur. But if stability returns next year there would be a case for truncating the three-year term of the bank guarantee.
Good with the bad
THE yin and yang of the market meltdown was supplied by St George and JPMorgan yesterday. St George's last profit result before its marriage with Westpac was not bulletproof: the group's capital base was skinny at year-end, and loan impairment expenses rose.But bad loan provisions are still low — in home lending, they are about a seventh of levels reached in previous downturns — and St George's profit was up 12% in the second half, and not tainted by crisis write-downs.
The problem is that the results are backward looking. Annual home lending growth has already slowed from a peak of 22% to about 12%, but St George CEO Paul Fegan says that the housing shortage, population growth and falling interest rates mean growth is unlikely to drop below 10%.
But it all depends on the damage of the market meltdown, and yesterday as a local sharemarket rally faded ahead of an expected overnight US interest rate cut, JPMorgan predicted a global recession: negative growth for the world this quarter and next, including three consecutive negative quarters in the US, four negative quarters in Japan, Europe and Britain … and two consecutive quarters here, in this quarter and the first three months of 2009. The first local recession call, but not the last.
