Profit in the eye of a banking storm

Commonwealth Bank chief executive Ian Narev has used a pretty reasonable argument to 'defend' his bank's striking $7 billion profit – namely that the treasure chest will largely be returned to Australian households by way of dividends and capital returns (if its shareprice holds, that is).

Narev pointed out that 60 per cent of the bank's share register was made up of "800,000 Australian families" with direct holdings, and a further 20 per cent was accounted for by institutional investors looking for a good home for Australian superannuation dollars. All true.

That argument will not impress younger Australians, however. With approximately a third of Australians holding mortgages, a third renting, and a third having paid off their mortgages, CBA's $7 billion party will mostly be attended by grey-haired Australians.

In itself, that financial landscape is far from offensive – far from being a gross exploitation of the Australian people by wicked exponents of financial capitalism.

That won't stop the ignorati calling for government to do more to curb bank profits, or more particularly to force banks to pass on reductions to the RBA cash rate – but most of that chatter will fall on deaf ears. As comedian Steve Coogan once told me, answering critics who claimed he'd 'gone commerical': "I'm prepared to live with that, because it means I can buy a Ferrari."

However, the story that our banks are 'profitable businesses offering good, but not excessive, returns to Australian investors' is only one side of the coin. Because a little less than four years ago bankers were driving their Ferraris into underground carparks, killing the ignition, and just sitting in the dark wondering how their bloated loan books would make it to the end of the week.

Lest we forget. It was the bank deposit guarantees, rapidly announced by the Rudd government, that saved those bankers the indignity of driving second-hand Holdens and parking them, like most Australians, in the street.

Rudd announced the guarantees in October 2008 at a time he described as "the economic equivalent of a rolling national security crisis". The government guaranteed around $700 billion of deposits, which in turn supported loans books heavily skewed towards housing mortgages.

The bank balance sheets held, the property market largely held, and the banks began reducing their exposure to the volatile wholesale funding markets. They have made a small amount of progress in reducing the near-40 per cent of their liabilities sources abroad, but not nearly enough given the still perilous situation in Europe. Domestic deposits are expensive to attract, even during a phase in which cautious consumers are changing their consumption/savings patterns.

As Stephen Bartholomeusz explained yesterday, CBA's result yesterday was primarily driven by reasonably constrained costs and a 15 per cent decrease in impairment charges. Not, as used to be the case, by a rapid expansion of volumes or margins – the two parameters that might indeed provide grounds for the accusation of 'reckless financial captialism' (Victorious CBA passes on the champagne, August 15).

So it's tough to raise money at a decent price and tough to sell it again to borrowers at a decent margin. And hanging over the whole picture is the cloud of another potential shock emanating from Europe.

Recent signs of hope in the US economy, and in the negotiations to reform the European banking and sovereign debt situations must be put in perspective: just a month ago Adrian Blundell-Wignall, the OECD's deputy-director of Financial and Enterprise Affairs warned Australia that our financial sector was still at great risk of a housing price slump devastating the banks.

Blundell-Wignall told reporters: "That's the major threat for the banks today – that Australia gets dragged down by the whole Europe-Asia-US issue and then unemployment starts to go up. Whether house prices are too high or not depends on whether you've got a job or not. If you don't have your job, you just can't pay your mortgage and then you become a bad loan problem."

Right now, as Treasurer Swan gleefully reminds us daily, most people have a job. And it would take a pretty hard landing in China to change that.

So why worry, eh?

The main reason to look beyond Commonwealth Bank's strong profit to the potential need for future bailouts is simple – that we could ill afford such bailouts again. When Rudd helped CBA and the other big four out a hole (remember that small banks were charged more for the same favour), national debt was virtually non-existent.

Four years later, after two rounds of stimulus spending (which this columnist supported) and later budget blowouts (which I did not - see Swan's dangerous debt game, May 10), the federal government is standing on far less solid financial ground.

The obvious retort is that a 'guarantee' is not the same as a direct injection of public funds – the kind of 'bailout' seen in the UK, US and across Europe.

However, the banks are not the federal government's only risk if the global picture deteriorates. Moody's yesterday reminded us that the states all have major debts problems of their own, and the federal budget is the safety net for services and infrastructure when the states bugger things up.

Australia has a debt problem.

Household debt is still too high, and still over-reliant on the big four borrowing on global markets.

Federal public debt is too high, and the Gillard government must be held to account for doing too little to reduce it when the essential phase of its GFC stimulus spending was complete.

State debts are too high, and the two Coalition-held states attempting to reduce public debt, New South Wales and Victoria, are learning how difficult politically it is to address the problem.

Running an economy with this much debt spread across the federal, state and private sector balance sheets is like driving a car with no brakes through a twisting stretch of freeway – after each bend, the Treasurer, or indeed bank shareholders, whoop with joy that "nothing can stop us now". And if nothing ever gets in the way, it's tempting to conclude there was never a problem.

But would you run your business like that – with no thought for risk mitigation?

It's too soon to forget the strain a sudden traffic hazard – be it GFC phase I, II, or the current III playing out in Europe – will cause not only Commonwealth Bank, but also our debt-laden governments.

When you find yourself pumping the brake pedal, it's too late to stop.