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Adapting our architecture to challenging times: address to the Brookings Institution, Washington D.C.
Deputy Prime Minister and Treasurer
3 December 2007 - 27 June 2013
ADAPTING OUR ARCHITECTURE TO CHALLENGING TIMES
ADDRESS TO THE BROOKINGS INSTITUTION
10 OCTOBER 2008
Let me say what a pleasure it is to be able to come here and discuss some of the most important issues facing all of us today at one of the world’s foremost think tanks, the Brookings Institution. For us in Australia, the work you do at Brookings is one of those great global public goods the United States provides to the rest of the world. We follow its work closely.
We send some of our smartest young people here to be visiting fellows - including people like Michael Fullilove, who I’m delighted to see here today. And some of our most prominent intellectual elder statesmen, like James Wolfensohn, are among the Institution’s leaders. Brookings for us and for many countries is a model of what a think tank can aspire to be.
More often than not the creators of new Australian think tanks tell me that ‘we want to be the Australian version of Brookings’. Great think tanks are important. Because what the world needs today in the grip of financial uncertainty is hard and serious thinking from hard-headed, warm-hearted and serious-minded people.
Our response must be coherent; it must address the underlying causes of our problems; it must do so on a scale necessary to succeed in reducing the threats we face, and it must be consistent with our values.
Ladies and gentlemen, governments and policy makers like us must seek greater levels of international cooperation to address these global challenges. We’ve done it before, in far worse circumstances.
In 1945 millions of men just like my father came home from the Second World War to rebuild a conflict-ravaged world. It involved hard work and plenty of sacrifice. Within a few decades they were able to create a level of prosperity their parents could scarcely imagine during the depths of the Great Depression.
But they wouldn’t have succeeded without other things - especially the creation of a new international economic framework at Bretton Woods in July 1944. By giving us the International Bank for Reconstruction and Development, the International
Monetary Fund, and what would later become the General Agreement on Tariffs and Trade, Bretton Woods provided the environment of free trade and financial stability necessary for prosperity. It was a great moral as well as economic achievement. Thankfully, this isn’t 1944. Nor is it 1929.
But in broad terms the solution is the same - the application of intelligence, common sense and democratic values to produce an international consensus for cooperation and change.
It is critical that we foster reforms to the international financial architecture which reflect evolving economic and political realities. It’s critical we ensure the necessary political momentum for collective action.
This morning I want to give you an Australian perspective on the crisis, and outline some plans that I believe will help us come out of this crisis with stronger global economic architecture.
All of you here will be well aware of the chronology of the unfolding turmoil in US financial markets over the past year. A crisis that has now claimed the scalps of more than 25 financial institutions around the world and seen borrowing costs rise right around the world.
This crisis has contributed to a serious global slowdown which has seen output in five of the world’s seven largest developed economies either contract or go flat in the three months to June this year.
The Australian Government welcomes the decisive action taken by US law makers to deal with the bad debts that continue to weigh on the US financial system.
But there will be further twists and turns to come and there will be difficult times ahead.
That is why in Australia we have been building on our own strengths, while also working internationally to address the consequences of this turmoil and put in place the architecture to avoid the next one.
Like other countries, Australia has not been immune from global developments. Our share market has fallen, our borrowing costs have risen, consumer confidence is down. And this is having an impact on economic growth in our country. But I’m proud to say Australia is better placed than almost any other developed economy to withstand the fallout.
Just this morning in Europe, the OECD released its 2008 Economic Survey of Australia, which states:
The economy has stood up well to the ongoing global financial market turbulence. So far, the financial sector has withstood the crisis thanks to prudent management, high profitability and strong capitalisation.
This is a strong endorsement of our economy, and one which accords with the IMF’s assessment of Australia released just three weeks ago.
The OECD also endorses the new Rudd Government’s ambitious reform agenda aimed at lifting our country’s productive capacity and addressing climate change. We are doing this through a comprehensive review of our tax system, renewed investment in our physical and human capital and the introduction of an emissions trading scheme.
We welcome the OECD’s support for our reforms and the acknowledgement of the benefits they will bring. The OECD is right to point to the strong, underlying fundamentals in the Australian economy.
We have one of the strongest financial sectors in the world, and also the 4th biggest by funds under management. While just 12 of the world’s top 100 banks have a credit rating of AA or above, four of these 12 banks are Australian.
The dealer-broker investment banking model which dominated Wall Street in recent years has not been as significant in Australia.
We did not extend mortgage loans to sub prime borrowers in the way the US did. While the sub-prime market accounted for about 15 per cent of outstanding US mortgages, in Australia the equivalent number is just 1 per cent.
Australian Government finances are strong, with a projected surplus of nearly 2 per cent of GDP.
And we also find that the weight of global demand and production is moving our way.
Our region now hosts three of the world’s five largest economies. China has become our largest trading partner and India our fastest growing export market. This is supporting our exports and encouraging historically high rates of business investment. It gives us confidence that we can weather this storm. A view shared by both the OECD and the IMF.
While we understand that Australia has many advantages, we are certainly not immune. Even a strong economy like ours is buffeted by recent global developments. That’s why we are investing in our future productive capacity through education and infrastructure, and other reforms to lift our long-term growth potential. And we are strengthening our already strong financial regulatory framework.
I do want to spend a bit of time here on our financial regulatory arrangements.
At a time when a debate seems to be gathering pace around the world about the re-regulation of financial markets, I think the Australian experience has something to offer. Can I say, there’s no mistaking the passion that motivates recent calls for re-regulation.
How can any responsible leader observe all around us the wreckage of this latest bout of financial adventurism without being stirred to act? I understand the passion, yes, but I also know it is a time to act with deliberation and foresight. It is a time to observe the lessons of successful regulation.
Let me start by saying that we are not complacent in Australia about our arrangements. We know that in times like these, even the best systems can and do come under pressure. But our record of avoiding substantial sub-prime exposure both at home and abroad offers an interesting reference point, especially when you consider our status as a fast-growing, developed economy, with a strong record of competition and deregulatory reforms behind us.
Over the past 25 years, Australia has done much to liberalise the financial sector. But in doing so we were careful to develop a model that regulated systemically important institutions and that centralised regulation of deposit taking institutions. In doing so we ensured clear responsibilities within our system. This meant we were better placed than most to respond when the crisis emerged.
Along with the Federal Reserve, our central bank stood ready to provide liquidity to the banking system as required, and to extend the range of acceptable collateral. But, more importantly, our system was robust because of what we did prior to the crisis.
Our banking regulator, the Australian Prudential Regulatory Authority, was scrupulous in stress testing our financial system and ensuring adequate safeguards, long before the global crisis began. We also invited the IMF in to do further stress testing and were quick to adopt world’s best practice.
This helped ensure we did not indulge in the recent excesses and risk taking that has marked recent years in global financial markets. This is in part because we have learnt the lessons of past crises and periods when our banking sector was not so robust. When you are a globally integrated economy, that is very dependant on a stable financial sector, you can’t afford to miss such lessons.
The Australian Government is acting swiftly and decisively in response to this turmoil.
We are implementing the Financial Stability Forum recommendations in full and encouraging their implementation internationally.
We have taken steps to support liquidity in the Government Bond market to ensure our broader financial markets operate more effectively.
We are strengthening protections for deposit holders, through the introduction of a Financial Claims Scheme.
We have moved with other countries to crack down on abuses of short selling.
We have taken steps to significantly improve the disclosure requirements for banks through the implementation of Basel II regulatory capital framework in January.
And to support competition in mortgage lending, the Australian Government will invest an initial A$4 billion in the domestic residential mortgage-backed securities market.
But we also understand the very global nature of this turmoil and therefore the need for global solutions.
The Australian Prime Minister and I have been in close contact with US, UK and European government leaders, as well as those in our own region, with central bankers, and with the heads of the major international agencies who have been grappling with the financial crisis.
Developments over recent days and weeks make this weekend’s IMF and World Bank Annual meetings even more important than normal. They are also why we will be holding hold an emergency meeting tomorrow of G20 Finance Ministers and Central Bank Governors. These are the appropriate bodies through which we address the current crisis and strengthen the international financial architecture.
My meetings with financial market participants in New York yesterday confirmed my view that substantial uncertainty remains and ongoing coordinated action is necessary.
Australia like every other nation will be in a safer position if international cooperation can improve global regulation.
These are the two extremes in this debate. Blind faith in markets is no substitute for being hard-headed. And blind faith in complete regulation all the time is also no substitute for being hard-headed. The answer lies not in more or less regulation, but in better regulation.
It is important for all countries at this time, including the US, to debate the appropriateness of regulatory settings.
We welcome the debate initiated earlier this year by US Treasury Secretary Paulson on his blue print for regulatory arrangements.
This debate needs to be echoed in international forums. It is crucial that existing mechanisms for cross-border cooperation and information flows be fully utilised. It is essential that market integrity is restored.
Well-functioning, well-capitalised financial markets and sound corporate governance are critical.
And it is absolutely imperative that we learn the lessons of the present crisis and transform these into action.
The international financial architecture which takes into account these lessons also needs to take account of the changing nature of the global economy and of financial markets themselves.
We failed to do this effectively in the aftermath of the financial crisis of the late 1990s. On that occasion, the major advanced economies correctly identified a need to improve domestic regulation and strengthen global financial architecture.
They undertook useful work on standards and codes, and on implementing initiatives like the IMF/ World Bank Financial Sector Assessment Program.
The Financial Stability Forum and the G20 were established with financial stability mandates — the G20 bringing together systemically important countries which make up 85 per cent of global GDP.
But the excellent technical work of the Financial Stability Forum has sometimes lacked policy context and sometimes failed to get the political traction it deserved. This is in part a reflection of its narrow membership, which no longer adequately reflects the changing nature of the global economy and financial system. This is critical, as we can’t afford to continue to repeat history.
In 1998 - a decade ago - the G7 agreed, and I quote: “to examine the scope for stronger prudential regulation in industrial countries, greater transparency and disclosure for financial market participants, procedures to respond to financial crises and the coordination of international bodies and national authorities”.
Sound familiar? The world hasn’t moved on enough.
One of my officials, working in a very senior role in the immediate aftermath of the Asian Financial Crisis, once expressed his surprise to me that nobody wanted to talk about the crisis once it had ended.
While much has been done to strengthen policy and institutional settings in emerging markets, there was too little interest in advanced economies in addressing the root causes of that crisis. Instead of being diligently addressed, the key issues were placed in the too-hard basket for another decade - a decade of inaction.
The breadth and scope of the recent FSF recommendations is testament to the failure, not to identify, but to fully act upon the lessons of the Asian Financial Crisis. That is why Australia has been pushing in international forums for the FSF recommendations to be implemented widely and fully to ensure the regulatory balance and incentives are right.
Domestic regulatory reforms in major markets and better cross-border coordination between national authorities are the bedrock of future crisis detection, prevention and mitigation. And it is why we have been pushing in those same forums for a strengthening of the global architecture for crisis prevention.
There is a key role for global institutions in detecting and responding to global problems.
Relevant institutions must be able to effectively fulfil the mandates we have given them — to identify and respond to threats to global financial stability, in particular through improved early warning capability. As part of this, key emerging market economies — some of which are major lenders — must have a voice in renewing the architecture and in devising crisis prevention measures.
The globalisation of financial markets means that all systemically important countries are potentially part of the problem, and they must be part of the solution.
Most recently, our Prime Minister, in a speech to the UN General Assembly on 25 September, elaborated a reform agenda to provide a real political mandate for international institutions to do their job.
The G20 - with its unique membership of systemically important countries and with financial stability placed at the centre of its work program - would provide political authority to have this agenda implemented urgently and comprehensively. It is only through integrating this work into that of the IMF and driving it through the G20 that we can bring real political authority to financial stability issues. Only a sufficiently representative body like the G20, with the potential to respond flexibly to emerging challenges, can bring about reform of the global financial system that is so clearly needed.
At times of great uncertainty, there will always be the temptation to create new forums. But our energies now should be directed squarely at addressing the crisis and strengthening the global financial architecture through the existing forums of the IMF, the FSF and the G20.
The G20 would have a role in driving adoption of the FSF recommendations, along with five additional measures:
First. All systemically important financial institutions would be regulated in similar ways, subject to full disclosure and analysis of on- and off-balance sheet exposures. This would be part of globally agreed best practice standards of financial regulation which would be assessed by the IMF. Central banks in each country would have responsibility for financial system stability.
Second. Banks and others would be required to build up capital in good times as a buffer for bad times, using predictable rules. Capital requirements would in other words vary across the credit cycle. Leverage would be counter cyclical rather than procyclical. This goes further than the current FSF recommendation that supervisors assess the cyclicality of the Basel II framework and take additional measures as appropriate.
Third. There would be higher capital requirements for firms that reward short-term returns or excessive risk taking in their compensation packages.
Fourth. Supervisory systems would be compatible with accounting principles that reflect reasonable assessments of the value of assets over time — so that accounting rules do not enforce procyclical valuation changes.
And finally. Under the Australian Government’s proposed reform agenda, the G20 would also strengthen its input into shaping the work of the IMF and FSF and the implementation of agreed outcomes. The IMF would have a stronger mandate for prudential analysis. And the IMF and FSF would develop early warning systems of impending institutional vulnerabilities and provide timely advice on remedial policies, which has the necessary political authority.
The G20 would itself engage on the risks facing the global financial system based on regular scenario analysis provided by the IMF and FSF. This analysis would be included in an enhanced version of the IMF’s Global Financial Stability Report.
In addition, individual G20 members would provide the IMF and FSF with better information on the stability of their domestic financial systems and cross-border exposures.
This plan will need to find wide acceptance among systemically important countries if it is to be implemented. It deserves acceptance. It is in the tradition of Australia’s regulatory arrangements I mentioned earlier - avoiding a heavy regulatory hand, but ensuring the right protections are in place.
I will be advocating these ideas at the IMF and G20 meetings this weekend, where the Fund will also be reporting on its own efforts to strengthen its analysis and policy advice on financial issues, its collaboration with bodies such as the FSF and BIS, and its ability to identify risks in the future.
What we cannot afford to do is repeat the mistakes of the past — to ignore the lessons of the last 18 months and put aside the hard decisions when conditions improve. And in the far broader historical sense, to ignore the positive lessons of post-war financial history.
As I said earlier, we strongly support the US’s recent emergency measures. The world is now looking to the US to show leadership on regulatory reform, and to all systemically important countries to implement the FSF recommendations and take a critical look at the global architecture. These steps are at the heart of future crisis prevention.
The loud wake-up call the world has just heard must strengthen our collective resolve to agree and implement these necessary changes. Because the current turmoil in financial markets is a pressing global issue.
Real safety for everyone lies in what we learned to do after the Second World War and what we forgot to do after the Asian financial crisis of the late 1990s - to cooperate globally to reach agreement on plans, and then act decisively.
It also lies in ensuring a longer-term view, rather than the short-termism, that just one week ago Kevin Rudd described as a virus, a disease, an epidemic - that lies at the core of this crisis and threatens the future of the globe.
Australia wants to develop with the global economic community a coordinated approach to these issues that delivers a long term solution not just a quick fix. That’s why we want a leadership role for the G20, informed by the work of the Financial Stability Forum, enhanced by some of Australia’s own ideas to improve bank licensing, liquidity, lending and accounting supervision.
It’s up to us - the world’s finance ministers, policy makers and economists - to lead the way, agree a coordinated response, and show that we have it in us to fix this crisis and move beyond it with confidence, to the ultimate benefit of those we represent.