Gillard's secret rates weapon

Assuming Julia Gillard throws off the latest Kevin Rudd challenge, she has at her disposal a weapon to substantially lift the popularity of the Labor government. In the unlikely event that Kevin Rudd becomes PM in the next few weeks he has the same weapon.

It's simply a question of whether they will use it. I believe there is close to a 50 per cent chance Gillard will use the weapon and in the process lower home mortgage interest rates and greatly stimulate the non-mining sector of Australia. If Morgan Research is right about what is happening to Australian unemployment (Sharp turns ahead for employment, February 20) it could become the government's key weapon.

I write this because last night I found myself in the company of a bunch of top bankers including one of Australia's experts in overseas wholesale funding by banks. In recent weeks I have been tentatively suggesting it's silly to have Australian banks go onto the overseas wholesale banking market and be held to ransom by global institutions. (Breaking up a rates ruckus, February 14).

The banks are forced to pay high interest rates overseas which in turn boosts our home mortgage and business borrowing costs. Australia's home mortgagees are in fact hostages to the Greek crisis – a situation that Australians do not understand. The solution is that the government should use its Triple A credit rating to undertake the overseas borrowing and pay about two per cent less than the rate the banks can borrow. The government would advance the money to the banks taking a profit along the way.

I always thought I was missing something. It was too simple. But the bankers tell me they have been following my writings and it is a simple process. They suggest a variation which is used by Canada to achieve the same end – a bunch of bank mortgages can be wrapped in a triple A government guarantee and marketed with the triple A rating which amounts to exactly the same thing. There will be other variations to achieve the same end.

The bankers did point out that if the government insisted the banks use the money to lower housing interest rates then it amounted to a subsidy to the housing industry akin to what happens in the motor sector. But there was no doubt the government could do it and housing interest rates would fall, say, half a per cent or more over time. An alternative suggestion is that the government simply charges the banks a market rate – which would not alter home mortgage rates. This would enable the government to pocket far more money so reducing the deficit without the nasties.

Clearly Treasury does not like the idea and indeed the Commonwealth government has stepped back from offering banks guarantees. Treasurer Wayne Swan has instead been engaged in brutal bank bashing which has helped no one because the public then does not understand the problem. Meanwhile, the current suggestions out of London that we don't have a problem would mean that all bank CEOs are misleading the stockmarket. It's just not right.

With the Greek crisis subsiding it is likely that the cost of wholesale borrowing offshore will continue to fall but it is still well above what it was a year ago. Moreover it is likely that as the year proceeds there will be a few more Greek crises which will boost funding costs. Alternatively, Australian retirees are beneficiaries because the high cost of bank borrowing overseas keeps local term deposit rates high.

The bankers point out that it is much cheaper for companies like BHP or Woolworths to borrow overseas than our banks.

At the moment Australian local deposits are funding more than 60 per cent of most bank loan books. If confidence returns some of that money will return to the equity market and demand for loans will rise which will reduce local deposit funding closer to 55 per cent of the bank books. The bankers fear that if that happens the rating agencies will downgrade Australian banks even though in previous decades they have accepted a 55 per cent local deposit contribution. Times have changed.

In other words to fund the nation's growth and its banking system is going to require government intervention. If Julia Gillard does not take up my suggestion I am sure, if he becomes prime minister, that Tony Abbott will do so because in the longer term it is the only way out. And he too will find it a magnificent way too painlessly reduce the deficit.

Of course too much government borrowing will affect our Triple A rating which means you can't run big government deficits and back the banks.

My previous commentaries on this subject are:

Swan song for the RBA (February 13)

Australia is asleep on the jobs (February 10)

How a rate hike could save the bank(February 9)

The Aussie dollar goes for gold (January 25)

Facing off against a jobs raid (January 24)