Doorstop Interview

Treasury Place, Melbourne

Friday, 10 August 2007

12.20 pm

SUBJECTS: Developments on international markets, interest rates, Peter Andren

TREASURER:

The Australian Stock Exchange has opened 2½ per cent down this morning as a result of international developments principally started in the United States.  Those developments relate to the home lending market in the United States where there has been a significant default in the significant part of the market known as the sub-prime market.  Let me make the point that even after the fall on the stock exchange this morning and falls in previous weeks, the Australian Stock Exchange is still over 6 per cent up through the course of the year.  And what this illustrates is that this is a correction off a very high base.  That is, even after the correction that we have seen today you are seeing Australian Stock Exchange All Ordinaries which is up over the course of this year alone over 6 per cent.

The sub-prime market in the United States is a lending market to people who have an impaired credit history.  That is, people who have a pervious default or have previously been bankrupted or have an adverse credit history of some kind or another.

The sub-prime market in the United States represents about 15 per cent of the market.  In Australia to closest analogy that we have is what we call non-conforming loans which are generally aimed at borrowers who have a poor credit history.  In Australia that is about 1 per cent of the market.

So the Australian exposure to non-conforming or sub-prime loans is about one-fifteenth what it is in the United States.  In the United States the delinquency of 90 days of more on the sub-prime market is about 10 per cent.  In Australia the delinquency of 90 days or more on the non-conforming loans is about 6½.  So it is a smaller proportion of the market and the delinquency rate is less.

Overall in relation to the market, in Australia the delinquency rate of 90 days or more in arrears is about one-sixth what it is in the United States.  And the delinquency rate is about 2½ per cent in the United States.  It is about 0.4 per cent in Australia, one-sixth.  So you have nothing like the exposure in Australia that you do in the United States to sub-prime borrowing.  You do not have the same delinquency rate and you do not have the same overall effect.

This is a shakeout in the United States which has been caused by a very large exposure to sub-prime borrowing, an exposure that Australia does not have.  Nonetheless, the reality is that this has affected the US stockmarkets and through that other stockmarkets around the world including Australia.  The exposure of Australian financial institutions as I have just illustrated to this kind of loan is very low and the exposure of Australian institutions to the US market is also very low.

There is no reason at all to believe that this instability in the US market, the borrowing market will be replicated in our own.  But this instability will affect US stockmarkets and through that stockmarkets around the world including the Australian stockmarket.

Australia’s financial system is well regulated.  I believe the best regulated in the world with our prudential regulator.  It is regularly stress-tested to make sure that it is not over exposed to bad high levels of non-performing loans.  The system is very secure, very profitable and well capitalised with the low exposure comparative to the United States as I have just explained.

JOURNALIST:

Treasurer, do you have any concerns that Australia is going to be caught up in the liquidity pull-back that is happening as a result of the sub-prime crisis around the world?

TREASURER:

Well there is no reason why Australia should be adversely affected, except through the knock-on consequences of equity markets and world bond markets.  That is, we don’t have an exposure of anything like the dimension of the United States.  The exposure in the United States will affect stockmarkets and because it affects the US stockmarket, that has knock-on effects.  You may see the exposure in the United States affect the spread on bond markets.  That is that people will start pricing risk higher and that those people that have lower credit ratings may well have to pay a bit more of a premium for risk in bond markets.  But it will not affect Australian financial institutions nor will it affect Australian Governments.

JOURNALIST:

Do you think the Reserve Bank, other central banks around the world have been boosting liquidity in the market overnight, should the Reserve Bank of Australia be doing the same?

TREASURER:

No, I have been in contact this morning will all of our regulators and it is operations as normal in Australia.

JOURNALIST:

I heard some information this morning the Reserve Bank has doubled its (inaudible) from around $2 billion to $4 billion, is that not your understanding?

TREASURER:

There was a report this morning that there was excess liquidity in the system but the Bank reports that this is normal operations and normal procedures.

JOURNALIST:

How much (inaudible)?

TREASURER:

Well, when there was a question as to whether this was excess, the Bank said no, this was normal operations, that there is not anything out of the ordinary being done in relation to liquidity.

JOURNALIST:

(inaudible) to that fact that you have got a $5 billion (inaudible)?

TREASURER:

No, as I said earlier there has been nothing out of the ordinary, nothing different, this is just normal operations.

JOURNALIST:

Can you explain what you call normal operations?  Can you explain what has happened this morning and what the Reserve Bank…?

TREASURER:

Nothing that it doesn’t normally do.

JOURNALIST:

Treasurer, did the Bank give you any explanation as to why they increased liquidity as they did then?

TREASURER:

No, it is normal operations today.

JOURNALIST:

Would you describe more that doubling as a normal procedure?

TREASURER:

No, I don’t say that there was anything different.  They are just doing today what they normally do.  Nothing different at all.

JOURNALIST:

Not in reaction to…?

TREASURER:

No.  And as I said, the exposure in the Australian financial system is minimal.  Australia doesn’t have a sub-prime mortgage market of anything like the dimension of the United States.  In the United States it is something like 15 per cent.  In Australia it is 1 per cent.  In the United States the default rate is higher than it is in Australia and in the United States the exposure to non-performing loans is something well over six times that of Australia.  So in the Australian financial markets there is hardly any exposure to this.  There is no reason why any Australian financial institutions will be exposed.  The only effect in relation to Australia is, as you would expect, if the world’s largest economy experiences downturn, or if the equity markets in the world’s largest economy have a decrease, that has knock-on effects to other capital markets.

JOURNALIST:

Treasurer, financial markets place an additional risk premium on bond spreads, wouldn’t that have some flow on effect for domestic interest rates?

TREASURER:

As I said earlier, I think that this will lead to a premium being built in for risk.  Yes, I agree with that.  And risk of course is in relation to low credit ratings below investment grade, and those people – or companies I should say – who are borrowing on non-investment grade bonds would expect that the interest rate will go up.  But this would not affect any of the known Australian companies and certainly would not affect any of the governments because they are all rated at investment grade or above.

JOURNALIST:

Could it affect the flow-on through (inaudible)?

TREASURER:

Look, one of the consequences of this would be if you are a person who has a bad credit history you will find it harder to get a non-conforming loan; or if you do, you may have to pay a bit more of a premium.  Now, we are talking here about people who have been bankrupt or defaulted on a mortgage or have an impaired credit history may find it harder to get a loan and may have to pay a bit more of a premium.  That is because the premiums that were being charged weren’t high enough.  So there may be a correction in that respect and if there is a correction in that respect, it would be no bad thing.

JOURNALIST:

How much will the interest rate rise affect housing affordability?

TREASURER:

Well, the fact that standard variable mortgage interest rates have moved by a quarter of one per cent will tighten family budgets for those people who have a mortgage and are paying off a home.  The fact that the standard variable mortgage interest rate has increased by a quarter of one per cent may actually restrain the growth in prices.  So some people are actually concerned about the growth in prices, this may have a positive effect for them in that regard.  Other people who have already purchased and are in the market will find that it strains their family budgets.

JOURNALIST:

Have you been in contact with the US authorities and do you have any feel for if they have identified the extent of the problem with the lenders?

TREASURER:

Well I had an extensive discussion with Deputy Secretary Kimmet from the US Treasury at the APEC meeting last week in relation to this.  We discussed the nature of the sub-prime market, the effect that it would have on the US economy and any knock-on effects.  The view of the US Treasury is that this is a correction in the market.  It will lead to re-pricing of risk.  And if it does lead to re-pricing of risk in relation to some of these sub-prime borrowings that would be no bad thing.

JOURNALIST:

Treasurer, are you concerned that as the knock-on effects of this reverberate around the world and we don’t know how long it is going to go for, that this will inevitably put pressure on interest rates generally to go up in Australia?

TREASURER:

No, what this will do is it will put a premium on risk.  That is, if you are below investment grade or you have got a bad credit history there will be a higher premium that you will have to pay.  And that is because the market has been underpricing risk.  What a correction like this illustrates is that in the United States there was far too much lending to people with bad credit histories.  And as a consequence, when those people got into trouble there has been very large default.  And in the future if people want to make those loans they should be pricing them at a much higher rate.  That is the message from this.  Now, this doesn’t affect bank loans in Australia.  Bank loans in Australia are not made to people who have impaired credit history.  There is, as I said, only about one per cent of the market in Australia that would be comparable to a sub-prime loan.  And the message from this is in relation to that market, the lenders will have to be more careful and they will have to price the risk the better.

JOURNALIST:

Are the authorities confident the exposure of hedge funds and other investment funds’ exposure to these types of debt has been clearly identified?

TREASURER:

Well when you are talking about global hedge funds – most of which are actually US hedge funds – they don’t have onerous reporting standards under US law.  It is a matter I have discussed with the US authorities over a long period of time.  I actually think they should make better disclosure.  It is something I have urged the US regulators to do on numbers of occasions.  But the way in which they generally look at their exposures through counterparties, and from my discussions as recently as last week with the US Treasury, they believe that they know pretty well what the exposure is.

JOURNALIST:

Treasurer, how concerned are you that the volatility we are seeing on the market now and a further 2.6 per cent drop, how that is going to affect the status-quo (inaudible) shareholders?

TREASURER:

Sure.  Well let me make this point.  The Australian stockmarket has fallen 2½ per cent.  That is a very large correction.  But bear in mind, even after that fall the market is still up 6 per cent over the year.  So you are seeing a correction off a very high base.  What the developments in the United States illustrate is there is a lot of uncertainty in the global economy.  This is the world’s largest economy.  You are seeing a high default rate in relation to a substantial part of its housing market and the impacts, because they affect the United States, will affect countries around the globe.  This is why economic management is difficult and hard and it takes a lot of experience.  And never let anybody say to you that there are no problems in the global economy or the national economy at the moment.  There are.

JOURNALIST:

So you would urge Mum and Dad investors in Australia to sit tight and not to panic?

TREASURER:

Well I don’t give investment advice and if I did I would require a licence and if I gave it without a a licence I would be breaking the law.  But what I would say is this: that there is a correction going on in the market – the market has fallen 2½ per cent – but after that correction the market is still up 6 per cent over the year.  You must bear in mind where it is starting from before you assess the impact of this correction.

JOURNALIST:

Can I just ask you about something different?  Independent MP Peter Andren has announced today that he has cancer.  Did you know him quite well?

TREASURER:

Look I know Peter reasonably well as a fellow Member of the House of Representatives.  I was very sad to hear the news that he has been diagnosed with cancer.  I have seen his statement today that he is not going to run at the next election and that he is having treatment and I wish him all the best.  It is a terrible thing to have and I wish him all the best in relation to his treatment.  Okay, thanks.