A time to hasten slowly amid market volatility

The Australian 12:00am November 12, 2016

John Durie

The late Mario Cuomo once said: “We campaign in poetry but when we are elected we are forced to govern in prose.”

It’s a lesson Wall Street seems to have forgotten in its enthusiasm to back the hoped-for Donald Trump agenda in pushing stock prices to a new record high.

It is as though the property developer is a latter-day Ronald Reagan but, as economist Saul Eslake notes, without a few items: such as the fact over the course of Reagan’s presidency the US Federal Reserve cut rates from 17.5 to 6 per cent, the US debt-to-GDP ratio rose from 20 to 40 per cent and is now 75 per cent, and the US working population age increased by 1 per cent a year against 0.2 per cent now.

The magic wand is missing, as is some magic potion. No wonder, when asked yesterday, Australia’s financial regulators were unanimous in their warning that “it’s too early to tell what Trump will do”.

RBA deputy Guy Debelle did warn the FINSIA luncheon: “I wouldn’t be selling any volatility insurance too cheaply any time soon.”

The expectation before the Trump victory was that his presidency would herald a wave of volatility in markets but so far heading into last night’s opening it’s all been one-way traffic going higher.

ASIC boss Greg Medcraft, commenting on Trump’s reported desire to wind back US financial regulation, said “global fragmentation is a very worrying trend”.

What worries the chief plod is an increase in countries taking different regulatory routes, which makes it difficult to regulate.

He noted US financial institutions get reciprocal trading rights from the Dodd-Frank rules so any repeal of the law could limit their ability to work in other markets.

Byers noted the market needed to see what was in the Trump proposals because some of the Dodd-Frank exemptions applied only to organisations with a leverage ratio of 10 per cent or more. “I don’t know how many banks would accept that requirement,” he said.

By way of example, Australian banks, which have big housing loan balances, are on 5.1 per cent in the case of ANZ, 4.6 per cent for CBA, 5.3 per cent for NAB and 4.9 per cent for Westpac.

The lower the rate the more debt you have outstanding, but as noted, the Australian banks have relatively safe balances with home loans whereas the US banks securitise them off balance sheet.

Debelle outlined progress in the global code of conduct for foreign exchange dealers which he is leading and is due to be released in May next year. He noted it was principle-based, which from a regulatory viewpoint is far better because rules are easier to arbitrage than principles.

“If it’s not expressly prohibited or explicitly discouraged, then it must be OK seems to be the historical experience. Moreover, the more prescriptive and the more precise the code is, the less people will think about what they are doing,” he added.

APRA’s Byers warned that in the present low-return environment the danger of excessive risk is magnified.

He said that “a strong risk culture within financial institutions that gives appropriate weight to both sides of the risk-return trade-off” was more important than of the rules he was putting in place.

“Rarely will an organisation consciously decide to ‘roll the dice’ and significantly raise its risk profile in order to bolster profits.”

It happens “in small incremental steps, and each individual step will not be seen to materially change the organisation’s overall risk profile”.

ASIC’s Medcraft warned that “there is a new world and companies have to understand they need to act to keep their social licence”.

RBA’s Debelle said it was a matter for management to understand where the returns are coming from in their organisation and understand what is happening in the organisation.

“A lot of institutions have got close to losing their social licence to operate,” he warned.