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Thursday, 16 October 2008
Page: 6178


Senator SHERRY (Minister for Superannuation and Corporate Law) (10:59 AM) —I would like to thank the senators who have contributed to this debate on the Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Bill 2008 and related bills and for their acknowledgement that, due to the extraordinary times, the debate on this legislation—which is an extraordinary package of measures—has been constrained. Due to the urgency of this matter, the time frame for passage of this legislation and the extraordinary nature of the measures, there has been an understood approach that the debate and the normal Senate processes that would have been considered appropriate—for example, referral to a Senate committee—have been constrained to less time than would normally be given to much of the other legislation that we have to consider.

I think it is important to briefly summarise why we are at this point—and it is not just the Australian parliament but also a number of other legislatures around the world that are at this point. Much has been made, rightly, of what is known as the US subprime crisis. I think it is important to look briefly at why this occurred. Whilst I think that most Australians are familiar with the term ‘US subprime crisis’ and the fact that the financial crisis in the US system is spreading to other countries, with the potential for significant if not catastrophic consequences for some other countries, I do not think that the fundamental cause is particularly well understood. The fundamental cause of the crisis in the United States was the unfettered, unregulated, unsupervised distribution of mortgages to people who, on any reasonable assessment, could not afford to continue those mortgage payments. That was the fundamental cause. Between five and six million Americans were not so much mis-sold—that is a pretty conservative description—but conned into purchasing mortgages that they could not afford or, under any reasonable circumstances, could not continue to pay once they moved off the introductory or what is known as the ‘honeymoon’ rate. In the United States, you had sales forces doorknocking and telephone canvassing millions of American households, saying and doing anything to effect the sale of a mortgage product. There was no supervision and no regulation of these practices at all in the United States. That was the root cause of the problem that has now infected the US financial system and the financial systems of many other countries.

These mortgages were bundled together and securitised as ‘assets’ into various financial instruments with varying values—hundreds of millions or billions of dollars in value—to underwrite these mortgages that could not be repaid. Financial institutions participated to varying degrees in this process and then onsold these assets and passed them on to other financial institutions. They appear as assets on the balance sheets of financial institutions, and some were passed through to banks in Europe.

One of the other great failings of this process was that of the credit ratings. Agencies classified these assets with a triple A rating. That means that the chances of an asset that was worth, say, a hundred billion dollars decreasing in value were next to zero. It would be very unlikely to be reduced in value and, if it did drop, it would be slight. What happened? These assets have collapsed in value. Whilst it is very difficult at any point in time to assess the real value, they have collapsed. Some of them are worth zero. Some of them have gone from being worth $100 billion down to $1 billion. They have collapsed in value because the rating agencies fundamentally failed to assess the totality of the risk in these products. What is the consequence? The financial institutions that held these assets have been lending out against the value of the assets which have collapsed. They have been lending out to small businesses and to retail customers in a variety of other forms—not just as mortgages but as business loans, for underwriting credit cards et cetera. So you had these fundamental flaws in the US financial system, and this has been the cause of the problem. In turn, I think it is now 25 banks that have either collapsed, have been nationalised or have been forced into merger in the US, in the UK and in some other European countries.

The process of the collapse of these financial institutions has created worry, fear and uncertainty, because the financial markets take a view—along with consumers—that if one bank collapses and then another one collapses and then another one collapses—and there have been 25 in the last six months—when will it stop? Other financial institutions that are safe and prudent get worried that, if they lend money or enter into financial transactions with another financial institution, what if it collapses? Effectively, the oil that ensures the smooth running of the economy is being removed from the system. If you remove the oil from a car, you know what happens to the car—the whole thing seizes up.

These are very, very unusual times. We have global financial market turmoil of historic proportions. I cannot recall turmoil in our financial system of anywhere near the level we have now over the last 20 years, and I think some of the commentators who have referred back to the Great Depression are correct in their observation. We have not seen the extent of this turmoil other than what occurred in the Great Depression. The Great Depression was not caused by the collapse of stock markets; it was caused by the collapse in confidence in financial institutions and their inability to lend because of the collapse in confidence. That is what caused the Great Depression. I have to say that, having been born in the 1950s, I never witnessed or went through the Great Depression, but my father did. He would tell me some of the consequences of the Great Depression. I suppose that people of my generation or younger would never have believed it possible that those events could possibly occur again.

One of the fundamental reasons we are dealing with legislation like this is that we have learnt some lessons from the Great Depression. We have learnt that, in extraordinary times, it is necessary for governments to intervene quite directly in the markets and financial sector in a variety of ways to prevent the circumstances of the Great Depression ever occurring again. It was the failure of governments, particularly in the US, when the Great Depression arrived, to intervene quickly and effectively, to minimise the collapse that occurred. Senator Brown referred to Roosevelt. The great difficulty that Roosevelt presented was that he was elected President after the crash, after the depression started. He was not in a position, because he was not the President, to actively intervene to minimise the causes of the Great Depression. Roosevelt, as effective a President as he was—he was a great President—was acting after the event, catching up with a whole series of measures over the decade of the New Deal, to reinvigorate the American economy and the world economy with a whole raft of measures after the collapse occurred. So governments have learnt that, at least to the extent that you can, you intervene in a timely fashion, effectively, quickly and with extraordinary measures in extraordinary times. This measure represents such an approach.

The turmoil we have seen in global financial markets has the potential to undermine confidence in Australia’s robust financial system. Our financial system is strong. If you compare our banks, our credit unions, our building societies and our insurance companies with those oversees, particularly in the US and the UK and in some European countries, our system is strong. We have had no failures of financial institutions during this period of turmoil in Australia. We have not had any failures because our regulator, APRA, have maintained strong, vigilant oversight, regular reporting, prudential oversight, regulation and control of those financial institutions that they oversight.

The current difficulties in assessing funding in global credit markets are not a reflection of investor concerns relating to Australian institutions, but they are more a general lack of investor confidence in the global financial system. Confidence is fragile. A decline in confidence or mass panic is pretty frightening to behold when it occurs, and we have seen some of these elements in other countries in the last year. When confidence is fragile and we have the failure of a number of large international institutions, that in turn is not just reflected in those institutions in the ways I have described, but it leads to a significant effect on global equity share markets and it is also reflected in elevated spreads in international and domestic funding markets. These are the factors that have led to the unprecedented actions being taken by central banks and governments in a variety of ways around the world.

As I have said, Australia’s financial institutions remain profitable and well capitalised. They do not have the significant exposures to troubled US and European financial institutions or to troubled mortgage related assets. There have been some comments about executives and their pay, but at least executives and senior management in Australia exercised the good judgement and sound sense to largely avoid—with a little at the edges in a couple of cases, but really at the edges—the sorts of exposures that we have seen in US and European financial institutions. This was recently confirmed by the IMF in its Article IV report and by the RBA in its Financial stability review. Nonetheless, Australia is not immune from these very disturbing and worrying developments in international financial markets. Given the broad reliance on financial institutions in undertaking day-to-day economic activity, the ramifications of financial institutions’ distress and current international events are significant. Although confidence in the Australian banking system remains sound, it is prudent to put in arrangements to maintain this confidence and to align Australia’s response with international developments.

One of the great difficulties in this set of circumstances is that we know that our financial institutions are sound and well regulated here. But in other countries, when they adopt responses as a consequence of their local environment and, for example, offer guarantees to financial institutions, it does have an impact here in Australia, despite the soundness of our financial institutions, if we do not offer a guarantee in some particular form. The government, in conjunction with Australian regulators, have been taking steps to strengthen the resilience of Australia’s financial sector in the face of current challenges. So we have a strong system which we are making stronger, and this is one of the measures to do that.

The government has adopted other measures. For example, in my area we are transferring the regulation and supervision of all financial products—we are talking here about bank cards, credit cards, business loans, investments, payday lending—which are currently regulated by the states and territories into one national financial regulatory system. The complex web of financial regulations in the US was another key reason behind the current circumstances they face.

The Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Bill 2008 introduces unprecedented action to deal with developments in global markets and to ensure stability for Australia’s financial system. The bill will improve and strengthen Australia’s crisis management arrangements and gives effect to the Prime Minister’s announcement last Sunday that the government will guarantee the deposits in Australian banks, building societies, credit unions and locally incorporated foreign subsidiaries for a period of three years. The bill also introduces the Financial Claims Scheme. In addition to the FCS, the bill introduces a number of other measures that will enhance and strengthen Australia’s regulatory framework.

There are some issues of detail. I accept that Senator Coonan and others have raised some matters. But we have an independent regulator, APRA, which together with Treasury is well capable of handling the issues of detailed implementation that have been raised.

I do want to say something about APRA funding. APRA funding has not been cut. Some people should check the facts. The government excluded APRA from the efficiency dividend and did not cut their funding. A decision taken on 18 April, which was disclosed at the Senate May estimates—and I do not criticise senators for not all fronting up to APRA at estimates—was such that their funding was not cut. The efficiency dividend was not even applied.

With respect to the consumer regulator, ASIC, I have just announced a package of additional funding of approximately $70 million over four years. And, no doubt, if APRA believe that they need additional funds as a consequence of additional responsibilities, both directly given to them or alternatively because of additional workload, they will make a request for funding and we will consider that in supplementary budget estimates.

I will go to the other two points quickly. Even though we are dealing with this legislation quickly and expeditiously—and, as I said, I thank the Senate for that—the overall consideration of these policy issues does actually go back a long time. In fact, it goes back as far as the HIH royal commission in April 2003. The APRA submission to the HIH royal commission said with respect to insurance companies:

We believe it is appropriate that the existing arrangements for the protection of policy holders be reviewed and consideration be given to the establishment of a formal compensation mechanism. This is ultimately a matter of government policy.

A study of financial systems guarantees led by Professor Davies in March 2004 provided a recommendation to government. So the concept of guarantee in aspects of a financial system goes back five years.

We could spend a great deal of time on this, but my other comment is with regard to the amendment to be moved by the Greens. I point out that what we saw in the United States was excessive salaries and bonuses that were often—not always, but often—paid as a result of failure. We have not had failure of Australian financial institutions. With some of the so-called bonus share arrangements in the United States we saw appalling behaviour by executives who knew the institution was going to go under, sold off their shares and the poor old employees who held shares—often in their pension fund, which Australian law does not allow, fortunately—were left holding their shares that had crashed in price, either directly or through their pension funds. The executives got out before the company collapsed, because they had insider knowledge. Australian law does not allow that sort of behaviour, fortunately. But the Prime Minister has advocated fundamental reform in this area. (Time expired)

Question agreed to.

Bills read a second time.