Serious vulnerability in the Australian banking system

May 23rd, 2010

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Last week, we witnessed one of the most rapid falls on the Australian dollar (AUD). In a matter of a couple of weeks, the AUD fell around $0.10 relative to the US dollar (to a low of above US$0.80).

There were many reasons offered for this rapid depreciation- one of them blames the Rudd government?s resource super-profit tax (see Why Rudd?s mining super-profit tax will encourage more commodity speculation). In reality, there?s probably no specific reasons why AUD fell so quickly for this specific instance. As we wrote in our report, How To Foolproof Yourself Against Salesmen & Media Bias, the desire to pin-point a specific reason is part of the human trait of falling for the narrative fallacy. The simplest explanation laid the blame on ?hedge funds? and ?speculators.?

In any case, in the minds of most lay-people, the AUD is seen as a barometer for the health of the Australian economy. If the AUD goes into a free-fall, many people will see it as a sign that the Australian economy is in trouble. Conversely, if the AUD appreciates strongly, it is seen as a sign of a ?strong? economy. In reality, the foundations for the strength/weakness of the economy has been set long before the currency appreciate/depreciate. Nowadays, with the rise of lightening-speed money, the currency exchange rate is more as a result of capital inflows/outflows from money shuffling and less as a result of the fundamentals of the economy.

For Australia, we are getting more and more nervous about a currency crisis someday (see Will there be an AUD currency crisis?). Jimmy Rogers concurs with our worry. As he said in a recent interview,

If the Australian economy keeps taking on debt, the next time there’s a bear market, the Australian dollar will collapse. And he sees a bleak future for any currency backed by massive debts. Top of his list of bad currencies is the once mighty greenback.

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The only disappointment I’ve had is that your politicians are as bad as the ones in America. If the Australian government keeps running up such gigantic debts, the lucky country is going to run out of luck.

However, he reiterates his belief Australia will not be prepared for the next economic shock and for a commodities bear market if it keeps taking on debt.

One thing you have to note is that Jimmy Rogers is probably not talking about Australia?s government debt. Relative to basket case countries like US, UK, Japan and the PIIGS in Europe, Australia?s government debt is tiny. The problem for Australia is its private debt, which is reflected in the foreign debt. As long as foreigners wants to invest in Australia, it will be fine. But the moment foreigners change their mind, Australia will be in trouble (a crashing AUD will be one of the symptoms).

We believe Australia has a serious structural problem that can easily turn this lucky country into an unlucky country very quickly. Recently, we saw this presentation (that explains the problem) making its round around web sites:

How to Profit From the Coming Aussie Property Crash (and Banking Crisis)

Please note that we:

  1. Are not making any investment advice based on this presentation.
  2. Are not making any predictions based on this presentation (see Failure to understand Black Swan leads to fallacious thinking to understand what we mean).

There?s one point made in this presentation that we have not covered in this blog- there are AU$13 TRILLION worth of off-balance sheet liabilities in Australia?s banking system (you can see the figure yourself from the link to RBA?s web site). Inquiring minds should be asking questions about what these liabilities are all about. Does the Australian regulators and central bank (and perhaps the banks themselves) fully understand what sort of hidden risks the Australian economy is subjected to from these ?off-balance sheet? liabilities?

For us, the basic point to take away from this presentation is that:

  1. There is a serious vulnerability in Australia?s banking system.
  2. This vulnerability is simply too colossal to be bailed out by the Australian government (hence the threat to the AUD).

We are not trying to scare anyone here. But these are the sorts of questions investors have to ask.

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  • Matto

    Hi guys, just been doing a bit of background stuff on the aussie banks. previously you discussed the aussie banks exposure to residential property losses and i have been thinking about this re lenders mortgage insurance. Assuming one of australia's big risk exposures is to a rout in property prices LMI would cover aussie banks for any losses here, the two main LMI's are run by QBE and Genworth Financial who have fairly broad geographical and financial product diversification. These guys also are the providers of LMI for CBA, ANZ and i believe NAB too.
    However, both WBC and previously SGB insured their LMI in-house. Since the take-over, WBC now has exposure to its existing LMI portfolio and st George's as well.
    I havent found any figures on their total exposure and provisions as yet but i'll keep digging and see what i can find.
    I'll keep you posted.

  • Thanks Matto!

    When TSHTF, we wonder how much of the LMI will be able to honour their contingent liabilities.