Finance and weak governments don’t mix

Monday, 20 October 2008 

Opinion polls suggest Australia is being run by the most popular government since Hawke’s early days. And there is little doubt that handing out $10.4bn will make it more so (this is even after ignoring the latest bounce to Labor in the AC Nielsen which is just a reversal of the mythical Turnbull bounce it reported last time).

Yet popular does not mean strong. Both sides of politics are operating now without their core base. Since Rudd’s arrival, each election and by-election confirms the increasing softness of both sides’ support. Labor not only saw record-breaking swings against it in its Sydney heartlands this weekend but the coalition found one of its own core seats again dropping away to an Independent (by the way, to say, as Turnbull did, that Port Macquarie voters have a tradition for voting for Independents is meaningless, it is more that natural coalition supporters have lost the tradition of voting for the coalition).

It is that weakness under the government’s feet, even despite its popularity, that guides how the government is responding to the financial crisis. The Age’s Shaun Carney was right to contrast Rudd’s crisis summit with business leaders with Hawke’s Summit a quarter of a century ago. It is not just that the unions were not represented last week, but that business didn’t really have any reason to be there either. Rudd is leading the first Labor government not to be able to offer up the unions to help business solve an economic crisis.

It is this core weakness of both parties that is behind the New Sensitivity and the inability of either parties to make an unpopular step. It has now culminated in the Über-Sensitive gesture of the $10.4bn hand-out even before the evidence of the extent of the slowdown is in. But while all the attention has been on what the government is doing about a recession yet to happen, it is the involvement of this government and those around the world in the financial system that is likely to make such a recession more certain.

There are two problems with weak governments moving into the financial markets that stem from it worrying more about their own problems than those of the markets. The first is a basic one; with a crisis of profitability coming, they can’t decide whether to present profitability as a Good Thing or not. Here we had the government bad-mouthing the high profits of the banks one month, backing them up the next and now congealing both positions to formally supporting the profitability of banks but bad-mouthing the ‘obscene’ money-making activity of the CEOs they employ.

Bank-bashing for political reasons makes it harder to take the necessary action to bail them out. Here it has only been a bit of harmless political game-playing as the government hasn’t needed to be too hands on. But in major banking industries like the US and the UK, where governments were aiming to have only part ownership, they are finding their punitive actions on shareholders are leaving them dumped with the lot as investors back off from what is now a lousy industry to invest in.

All of this might just be bad news for bank CEOs and shareholders, but the resulting greater government control over the banking system leads to a second more serious problem over risk. Commentators have pointed out that one of the problems with the government guaranteeing banks’ fund-raising is that it will encourage banks to use the funds for more risky lending.

The real problem is the exact opposite. A myth of this financial crisis is that it is a result of too much risk-taking. In fact the derivatives industry on which it centred is all about off-loading risk. Risk was being passed around like pass-the-parcel with everyone off-loading it but no-one capable of managing it. The credit crunch has hit because banks have become so risk averse that they won’t even lend to each other now that the means of passing off that risk has gone.

Re-building credit lines will involve taking risks. But government policy is likely to encourage less risk-taking than the sort that would be needed to maintain lines of credit, for example, to a small business when a downturn is coming. As the government gains greater control over credit and try to remove risk from the system, it is likely to make things worse. It is why Turnbull was right that the government’s removal of risk for bank fund-raising whether on the whole-sale markets or from depositors, has now choked off the ability of other business to encourage lenders to lend them money.

The financial system has had a blow to its confidence and its willingness to take on risk. Governments that are unsure of their support base have a capacity to instil neither. This applies not just to highly unpopular ones in the US and the UK. Even here, a Labor government with no union base to call on has nothing to offer business but more state intervention. And this will be on risk-averse terms that will be more about protecting its own credibility than those of the financial markets. Right now this may appeal to individual business leaders who are now looking for security, but it is unlikely to be favourable to business as a whole.

Posted by The Piping Shrike on Monday, 20 October 2008.

Filed under State of the parties

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