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Due Credit

You’ve probably seen his name in the business pages. Malcolm Wood talks to David Tripe, Director of Massey’s Centre for Banking Studies.

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Dr David Tripe

There is a term David Tripe is fond of using these days when people ask about the origins of the global financial crisis. It is ‘disaster myopia’, the very human tendency to severely underestimate risk. It comes, he tells me, from a paper coauthored by Richard Herring, a former visiting scholar at the Reserve Bank. Herring, Tripe recalls, was fond of ending his talks to local audiences with the snide comment, “but of course the bankers tell us that this time it is different, there won’t be a problem, nothing can go wrong”.

Nothing can go wrong.

During his career Tripe has seen many shifts and ructions within the banking world. He joined the industry in the 1970s with an honour’s degree in economics just as international exchange rates were being floated and the banks were making their first forays into foreign exchange trading, “some making quite spectacular losses by the standards of the day”. Later he would watch with growing disbelief the behaviour of the markets in the lead-in to the 1987 crash. “There were people lending money on the smell of the smell of an oily rag. When you saw it being done, you thought, ‘well this is a recipe for disaster’ and, of course, it was.”

He witnessed too the aftermath of the crash: the reluctance of banks to lend for commercial property development – an inherently risky activity, he says – and the fateful rise, in response, of private finance companies set up by commercial property developers.

But he also saw good things happen, particularly as the banking system was deregulated. “In the mid ’80s you had to queue to get to a lender to get a mortgage for a house and you needed four or five mortgages and all the rest of it. By the mid ’90s it was so much easier for the consumer.”

By the time he departed the commercial banking world to join Massey’s Institute of Banking Studies in 1994, he had developed an utter fascination with the industry he had entered for no better reason than “it paid better than a government job”.

It shows. In conversation over a cappuccino in Wellington Library’s Clark’s café he leans slightly forward, talking with enthusiasm, explaining and expanding.

If a banking expert can be locally famous, then Tripe is that expert. Newspaper reporters seek him out; their coverage of the current crisis is punctuated with Tripe’s typically matter-of-fact commentary. So I have been curious to meet him, if only to see what happens when banker turns academic.

Impressions? I can imagine he must be a compelling lecturer in Palmerston North, but he also has the sort of besuited well-groomed presence that might equally be at home in Wellington’s policy-making circles or the boardrooms of Auckland, which is where most of the banks are locally headquartered.

But there are individual touches as well: his jazz-instrument-themed tie – though he tells me his inclinations are more classical – and the pocket watch he pulls out white-rabbitishly to consult once or twice.

Just as the 1987 sharemarket crash was, in retrospect, clearly predictable, he tells me, this time round the signs that a financial bubble was building were evident long before it burst. The flood of cheap credit, the comfortable belief that property could only rise in value, the herd behaviour – all of these were signs the market was riding for a fall, says Tripe, who has made no secret of his views over the past few years.
Indeed, he wasn’t the only one to express doubts But the industries whose self-interest was tied up with the rise in property and pushing out cheap credit were not interested in naysayers.

“There were a lot of people who had a commitment to it as a one-way bet, because if it was a one-way bet it was going to make them rich, or it gave them a job, because they sold services to the people who bought houses.”

In New Zealand a smaller-scale reckoning came with the collapse of a number of finance companies, beginning in May 2006, while internationally the first significant signs that all was not well – the beginnings of the catastrophe – came with the August 2007 announcement by BNP Paribas, a commercial bank in France,that it could not fairly value the underlying assets in three funds as a result of exposure to US subprime mortgage markets. Like many other major banks, Paribas had unwittingly taken on so-called toxic debt in the form of the bundled and securitised packages of mortgages called Collateral Debt Obligations (CDOs).

These in themselves are a useful financial instrument, according to Tripe.

“CDOs were established to address the problem that when you bought a pool of mortgages you didn’t know when you were going to get your cashflow. With a CDO you would know when you would get your cashflow – say within two-to-four years or four-to-eight years – and in principle that is a good thing for investors.”

Similarly, a financial instrument some journalists have taken to describing as a weapon of mass financial destruction, the Credit Default Swap, is far more useful than not. “Suppose you are a bank wanting to make a large loan to the New Zealand government but you don’t necessarily want that much [risk] exposure to the New Zealand government on your books. What you do is make the loan then sell off parts of the exposure. Not having too much of a credit concentration with any particular borrower is just prudent.”

Where the fault lies, he says, is not with the instruments, but with how they have been used: the push to sell mortgages to people who could not afford them; the misleadingly secure ratings given to CDOs that were anything but; the rush to onsell those CDOs to institutions around the world; the overlay of financial complexity; and the miscalculation of risk. He comes back to disaster myopia. Those outside-chance events – the ones so unlikely no allowance is made for them – do happen, and much more often than the models allow for.

So what happens now in our patch? New Zealand’s small open economy faces some very serious problems. Although the exchange rate may offer some buffer, the overall demand for our products is still likely to decline as global demand diminishes; credit has already become more difficult to come by; and the downturn will cast an unforgiving light on the New Zealand economy’s fundamental problem: the nation has been consistently spending beyond its means, making up the difference with debt.

For a number of years New Zealand has been running a current account deficit of between 8 and 10 per cent of GDP (Gross Domestic Product), accumulating a net international debt that stood at $165.9 billion at the end of September 2008.

Paradoxically that brings with it some reassurance, he says – overseas investors are to some extent hostage to New Zealand’s economic success – and some risks.

“Of that $160- or $170-billion odd of foreign indebtedness, banks have net foreign indebtedness in New Zealand dollars, or hedged in New Zealand dollars, of around $110 billion,” explains Tripe. “So they have a very big chunk of it, which means someone somewhere else in the world is holding net New Zealand dollar positions that have been falling in value as the value of the New Zealand dollar has declined. There is a real concern that they will get uncomfortable with that and want to exit their New Zealand dollar positions, and that could cause a dramatic decline in the value of the currency.”

However, Tripe is reasonably comfortable that the local – read Australian – banks, although leveraged (“they all meet the standard capital rules of 8 per cent equity, but in practical dollar terms when the risks are unweighted we are effectively looking at between 5 and 8 per cent”), will accommodate the changing environment.

“When it comes to the crunch, I am not of the view that the banks are going to lose huge amounts of money. Most of their lending is secured with loans for housing and loans on small businesses, and most people will have been sensible in their borrowing, and the banks have some margin. Even if someone loses their job and housing falls by 20 per cent, in many cases the house can be sold without a loss, and even where there are losses, some of these will be insured.”

He is less sanguine about what will happen to the New Zealand economy generally. “To spend at the level of our income we are going to have to reduce the proportion of the nation’s income being spent on retail and housing by 8 to 10 per cent. That means some excess capacity that is going to have to be drafted into some other use, which means that current levels of employment are nowhere near what they are going to reach. The official government figures seem to be unduly optimistic.”

Nor is the world soon going to be back to what it was anytime soon. Although Tripe is resistant to the idea of being classified ideologically, in general he favours free market solutions over the alternatives and he is no fan of nationally owned banks, which tend, he says,towards inflexibility.

Yet for the foreseeable future a number of landmark international banks will now have major government stakeholdings.

“The French took the best part of 20 years to unnationalise the banks that they nationalised in the early ’80s – and they took up most of the market’s appetite and capacity for buying banks. When you have the US and the UK and the Europeans all trying to denationalise banks [in the same period], that is going to take lot more.”

The blanket retail bank deposit guarantee schemes now in place in many countries also disquiet him.
 
However necessary, these schemes introduce ‘moral hazard’: with the government carrying the risk there is less reason for financial institutions to act with proper prudence.

Will the crisis mean that banking qualifications now become more sought after within an industry whose upper echelons – it emerges – are largely full of people who have come in from other disciplines?

Tripe isn’t sure. There has, in the past, been a tendency for the banks to see themselves as all-knowing and no one has held them to account – bank customers seldom ask their bankers about their qualifications.
Perhaps, he says, they should.
 

Changing the face of banking?

One of the more interesting phenomenons in recent years has been the arrival of the NZPost-owned Kiwibank, which launched in June 2002 and, as of September 30 2008 had slightly more than 2 per cent of the New Zealand market share but more than 10 per cent of the New Zealand customer base. *
 
But is the playing field level? In December 2008, former BNZ chairman Kerry McDonald suggested that the over-the-counter business in PostBank branches was being used to cross-subsidise the banking business.
Tripe does find aspects of Kiwibank’s business model “a bit challenging”, making it almost impossible to determine how well it is doing. “Kiwibank’s cost structure is way higher than the other banks. It has a bigger branch network and assets that are a tenth of the size of the bigger banks. The costs allocated to Kiwibank by NZPost should be those of the additional banking activities of the branch. But how do we test that? We can’t.”
He also wonders about the long-term future of a bank that relies on having a costly physical presence in any community of some size. “If we look 20 years ahead are banks going to want branch networks as large as they have now? The answer is no. The only functions you need now are to deposit small business takings and to open an account. In Australia some of the information brokering for opening new accounts has been brokered to AustraliaPost, but they can do that because AustraliaPost isn’t a banking competitor.”

* Combined with the TSB and SBS, this brings total New Zealand-owned share of the banking market to between 3.5 per cent and 4 per cent.

 

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