QED

Swan gong when wrong


What do Lehman Brothers and the Treasurer Wayne Swan have in common? Both of them have won a magazine award for financial management and neither saw the GFC coming.


To mark the third anniversary of the collapse of Lehmann Brothers, the Treasurer, Wayne Swan, in question time last week claimed that “when the world went into the global financial crisis the unemployment rate in the United States and Australia was the same. It is almost twice that now in the United States.”

He’s been going on about his alleged economic prowess like a vuvuzela at every opportunity in question time since. Little did anyone know that he was just warming up for his acceptance speech for winning Euromoney Magazine’s “Best Finance Minister Award”. Itmay not be as prestigious, perhaps, as US President Barack Obama’s Nobel Prize for “encouragement” but the Treasurer is chuffed just the same.

And Swan’s in good company: Lehman Brothers took home a Euromoney prize in 2006, the year before it began to stumble badly; Paul Keating got his gong just before he drove the economy over a cliff while the rest of world suffered a flat tire.

Given that Swan was responding to a Dorothy Dixer, you could be forgiven for assuming that he would have adequately prepared his answer – to show he got the ‘big calls right’ – because he was wrong on both counts. Not that Obama is likely to call him out over his chest-beating when he visits in November.

The US unemployment rate at the time of the Lehman collapse in September 2008 – when the sinews holding the global financial system together began to snap – was 6.3 per cent compared to 4.3 per cent in Australia.

US unemployment is now about 9 per cent versus 5.3 per cent in Australia where it is trending up despite the Treasurer’s May budget prediction – when he promised to create 500,000 new jobs by 2013 – that it would be trending down to 4.8 per cent. (It seems Swan now has a jobs promise deficit to add to his growing debt and recurring budget deficits.)

The number of Australians looking for work has risen over 23 per cent and Australia’s economy has registered two quarters of negative growth – though not consecutively. And there are parts of the economy in stagflation – that is, experiencing inflation and recession concurrently. But Australia has avoided the worst of the GFC – thanks to the reforms of the Hawke, Keating and Howard governments as well as China’s continuing appetite for nearly everything beneath our feet.

Maybe Swan was thinking that the global financial crisis actually began earlier, when the US unemployment rate was lower – say in mid 2007 – when there were worrying signs. But if we cut him some slack on the small call of comparing unemployment rates, then Swan got the big call on the biggest post Second World War recession wrong.

A review of a timeline of events leading up to the Lehman collapse and the GFC, prepared by the University of Pennsylvania’s Wharton School of Business, compared against the statements and actions of Swan and Kevin Rudd show they didn’t appreciate the impact on Australia of the deepening GFC and coming recession until they panicked in the midst of it – and perhaps not even then.

In the first half of 2007, banks in Europe and the US including HSBC, Merrill Lynch, JPMorgan Chase, Citigroup and Goldman Sachs began to report huge sub-prime mortgage backed securities losses and the US Federal Reserve started lowering interest rates as the economy began losing puff.

Despite central bank interventions in Europe, the US, Canada and Japan to increase liquidity and provide emergency funding support, the German Landesbank and Britain’s Northern Rock faced collapse. Others soon followed.

By September 2007, the US Federal reserve had cut its interest rate to 4.75% and the interbank loan rate jumped to 6.75% as banks became concerned that counterparty banks could fail. Some banks simply refused to provide any funding, creating a widening credit crunch. The Bank of England also cut its cash rate and stepped in with liquidity guarantees for Northern Rock as customers literally ran to the bank to withdraw their deposits like a Depression era newsreel scene.

In Australia meanwhile, the Howard Government expressed reasonable concerns about the economic storm clouds gathering on the horizon. Then Treasurer Peter Costello warned: “I think the fall-out from the US sub-prime market has a considerable way to go. It is not yet entirely clear who is holding all of the risk on these defaults. There will be different financial institutions around the world which will identify losses and in the interim financial institutions as between themselves are restricting credit or driving the price up. That is going to put a lot of pressure on the international economy.”

Costello went on to warn that though Australia was well prepared, the crisis gripping the financial markets could infect the real economy and that the US and other economies were at risk.

What was the concern of Rudd and Swan while the global financial system began to melt down? They were busy portraying themselves as economic conservatives, running a scare campaign over inflation – which had nevertheless been close to or within the RBA target band even as China’s big dig began to gather steam – and claiming that the Howard Government was itself hyping the crisis enveloping the global financial system. Oh, and did I say inflation?

Swan accused the Coalition of running an economic scare campaign and "putting upward pressure on inflation, and when you put upward pressure on inflation, you put upward pressure on interest rates". A Labor Government would, he said, have "a disciplined budget strategy".

Julia Gillard didn’t hold back: “[Howard] owes [those suffering “mortgage stress”] an apology, he should say sorry, he should express regret; he should beg forgiveness. The words he uses should be all of the above because Australian working families are owed it. This isn’t a day to be looking in the Oxford dictionary, this is a day for Mr Howard to be looking inside himself and thinking to himself, ‘Did I tell Australians the truth?’."

Notwithstanding the higher home loan rates in 2007, they were by historical standards incomparably lower then the double-digit rates under the last Australian treasurer to take home the EuroMoney prize. Perhaps Gillard has taken a moment since her no carbon tax pledge to avail herself of a copy of the OED.

And who can forget the TV ad where Kevin07 portrayed himself as Milton Friedman’s lovechild: “A number of people have described me as an economic conservative. When it comes to public finance, it’s a badge I wear with pride”, Rudd said. Just who those people were will remain an eternal mystery.

As the crisis metastasised at the end of 2007 and early 2008, bourses around the world suffered their biggest falls since the September 11 terror attacks. The US Federal Reserve and other reserve banks around the world intervened again and again, cutting interest rates and providing unprecedented liquidity support. At the time, the International Monetary Fund warned the financial markets crisis was likely to spread to other sectors of the global economy and estimated subprime losses could be as high as US$1 trillion. Losses have since been estimated to have been several multiples.

In the months that followed the Rudd-Gillard “New Leadership” election win and the financial crisis deepened still more, the subprime mortgage contagion leapt from Wall Street to Main Street as foretold by Costello in the dying days of the Howard Government. Credit was withdrawn, US business and mortgage defaults grew, layoffs began and consumer and business confidence plummeted.

With recessionary alarm bells going off in finance ministries around the world, the take-home message from Swan’s first budget in May 2008 was that an increase in unemployment was an essential part of the strategy to rein in inflation. In other words, it was the unemployment we had to have.

Yet Swan’s first budget was nearly inoperative before the ink dried. Within months, Lehman employees were packing up their desks and the global economic rout had begun in earnest. In September, Swan provided unnecessary guarantees to the big four banks, which created more problems.

But it wasn’t until February 2009 that the Government responded in any meaningful way, and then over-reacted after Rudd, Gillard, Swan and then Finance Minister Lindsay Tanner resurrected every non-productive government budget-busting boondoggle never to have seen the light of day in a desperate, panicked bid to stave off a technical recession. The hard won Coalition budget surplus and billions more were shoveled out Treasury’s door — pink batts, school halls, green loans, cash for flatscreens or whatever you like, from Botox to Bali holidays, were given the tick with scant regard for oversight or long term economic productivity.

By then the Rudd-Gillard government had shed its conservative fiscal suit for something different but familiar, when Rudd opined in The Monthly that, “The time has come, off the back of the current crisis, to proclaim that the great neo-liberal experiment of past failed, that the emperor has no clothes… is the culmination of a 30-year domination of economic policy by a free-market ideology that has been variously called neo-liberalism, economic liberalism, economic fundamentalism, Thatcherism or the Washington consensus … The political home of neo-liberalism in Australia is, of course, the Liberal Party.”

Of course, Howard was never a neoliberal and the economic reforms, championed by Ronald Reagan and Margaret Thatcher, have become mainstream economic orthodoxy; and hardly extremist ideology as Rudd implied.

The reality is that, Australia’s economy was able to sale over the shoals of the GFC due in part to the China resources boom and to the macro and micro economic reforms of the Hawke, Keating and Howard Governments – if apparently repudiated by Rudd – and the 11-year economic stewardship of Peter Costello, who repaid $93b of Labor debt and bequeathed Swan a budget surplus.

But don’t expect to hear those facts in Swan’s award acceptance speech when he caps off his self-celebration of his Euromoney award. As for that other Australian Treasurer who took home the prize, when Euromoney tracked him down for comment, he reportedly offered a travel tip.

Alan R.M. Jones was an adviser in the government of John Howard.

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