Hedging bets on the future

IN 1985, I was a very junior lawyer in a blue-ribbon Sydney law firm. Over expensive cocktails at a function, the head of an overseas bank – the recipient of a freshly minted banking licence – flashed his gold Rolex and boasted that he had ‘plenty of money' to spend and his company would revolutionise not just Australian banking but the whole country. Later, the party continued back at his harbourside penthouse, but I was tired of him and went home. He was an obnoxious, materialistic little man. Little did I know that the city would soon be full of them.

That year, Treasurer Paul Keating had granted sixteen foreign banking licences. Suddenly, Sydney was bursting with expat bankers and foreign capital. Australian businesses no longer had to go cap in hand to their local bank to get money to expand; they had a choice. The city, thanks to the reforms implemented by Premier Neville Wran, was already changing – and this new money, which arrived with the Keating-led program of financial deregulation, was the accelerant that transformed it.

While Melbourne has taken pride in being a sober, serious city, Sydney has always been in love with fast money and good times: its ethos came from convicts and the Rum Corps; even now, its government depends on the revenues from the hoteliers and registered clubs stuffed with poker machines. Gambling and gaming is in its DNA; former premier Robert Askin and chief magistrate Murray Farquhar consorted with known criminals. It's a city known for its love of bending the rules.

Like the local crims, the Australian banking system had always functioned as a cosy cartel, but by the time Neville Wran entered the New South Wales Parliament, in 1970, it had begun to open up. It's hard to imagine now, but the first credit card, the now-superseded Bankcard, was launched in the mid-'70s and for the first time people could buy things they didn't have enough cash for without applying for a personal loan. A young Paul Keating, the opposition spokesman on minerals and energy, called for the introduction of foreign banks, because the local banks were ‘unresponsive' to the challenges and rewards of the mining industry. TheAustralian Financial Review approved his stand. In late 1977 it quoted him and called for an inquiry, describing the current banking system as ‘quasi-socialist in that it is effectively run by the Reserve Bank but retains the worst features of oligopolistic capitalism'.

Keating had first-hand experience of the workings of banks. In 1965 his father's company, Marlak Engineering, won a contract from the Malaysian government to build a bridge, but the local banks would not lend against the contract and the loan application was rejected. Marlak lost its chance and Paul Keating found a mission. He told me: ‘That was the way they were. Deadbeat institutions run by deadbeat executives.' In Keating: The Inside Story (Viking, 1996) his former economics adviser John Edwards attributes Keating's fundamental understanding of markets and prices to his involvement with his father's company. Thanks to the rigid banking rules, Marlak missed the opportunity to expand and was sold to ANI eight years later.


PAUL KEATING LOVES his home town, declaring with characteristic bravado in 1993, ‘If you're not in Sydney, you're camping out.' He claims credit for the city's massive demographic changes – as a result of the reforms he implemented, Sydney split into two cities: the affluent, internationally focused suburbs that cling to the harbour and the sprawling tracts of suburbia beyond.

In 2007 he said, ‘When I was Treasurer, I made Sydney the financial capital. Before I opened up the financial markets in 1984, there was a $30,000 limit on borrowing, and even then you had to crawl to the bank manager. Now, any two butchers can go across the road, buy five blocks, develop them and sell off the plan. In a world awash with liquidity, anything buildable is bankable.'

Being the nation's financial capital has a downside in a global financial crisis. When Lehman Brothers collapsed the global banking system ground to a halt, and within a week its Australian branch was tipped into voluntary administration, owing up to $800 million. Immediately, local financial institutions – spooked for much of the year as companies including Allco, Rubicon, and Babcock and Brown hit the credit wall – started shedding staff; within weeks there was a panic sufficient to force the government to guarantee all bank deposits, and profoundly change the finance sector.

If you want to see what life is like when the finance sector is no longer at the top of the tree, head to Double Bay, five kilometres east of the CBD: there are dozens of empty shops; many of those still operating are free of shoppers, though plastered with sale signs; if you hang around long enough, someone will sell you their car. Postcodes 2027 and 2028 still report the highest incomes in Australia, but when the financial tsunami washed over Wall Street, the wave did not take long to hit.

For the first time in decades, Sydney house prices led the market down. In the residential heartlands of the banking and finance sectors, in the harbourside eastern suburbs and lower north shore, prices fell through the parquetry. Australian Property Monitors reported that prices in Double Bay dropped by a quarter in the year to the end of March 2009 on a low turnover. For the first time in recent memory the most expensive houses recorded the biggest falls. ‘The top end of the market has always been seen as a bit of a safe haven and has generally been immune to downturn,' the RP Data senior research analyst Cameron Kusher said, but the global financial crisis ‘really impacted hard on high-income earners'.

Everyone knows someone who has been affected, but trying to find one who will talk publicly about it is not easy. John McGrath has been selling top-end houses for decades: ‘There has definitely been an increased number of people electing to sell below the radar. They either want to save face or don't want people to know that they are in trouble.' The saving grace is low interest rates, which have ‘enabled people to rearrange their debts and avoid too much forced selling'.

Since the mid-'80s the gap between the top and the middle has widened in Sydney, skewing the local ecology. Whole suburbs are now at the mercy of one sector, and when that goes down it takes almost everyone with it. In the past year 20,000 local jobs in banking and associated industries have been cut – high-paying jobs that demanded degrees, devotion and long hours. These in turn financed an ancillary army of service providers: decorators, builders, cleaners, trainers, caterers, hairdressers and nannies.


ONE OF THE biggest problems for Sydney is that the state economy is reeling. In May 2009, Access Economics reported that unemployment would hit 9 per cent by the end of 2010. The one-time Premier State has gone backwards since the 2000 Olympics on the key indicators of growth, investment, jobs, home building and wages. It now contributes less than a third of the country's economic production. An exodus of people means its population share has also shrunk below a third, and it accounts for only 15 per cent of new home building. New South Wales receives just under a quarter of new business investment, down from a third at the beginning of the century.

Sydney split into a global city and a local one, urbane and suburban, fast and not-so-fast, in a process that started in the late '70s but received a great boost during the era of deregulation. Australia had started tentatively on that path in 1979, when Prime Minister Malcolm Fraser established the Australian Financial System Inquiry under the stewardship of Keith Campbell, the chairman of property company Hooker Corporation Ltd who examined the banking sector, tax, stock exchange and foreign exchange.

Campbell, like Paul Keating, had learned from personal experience the limits of the highly regulated Australian banking system. The ALP historian and former minister Rodney Cavalier has written extensively about Campbell in his Southern Highlands Branch Newsletter: ‘In the 1960s a weak balance sheet denied the Hooker Corporation a loan from any Australian bank, locked in (as they were) to rigid matrixes of assets and liabilities, income and repayments. Campbell raised the funds for the survival of Hooker by selling options and warrants over Hooker shares, a true first for Australian finance.'

When the Campbell Report was released in 1981, it was ‘praised as a blueprint for the future', according to the business writer Edna Carew. It ‘broadly recommended that the banking and financial markets be freed of government controls so that interest rates and the exchange rates would be determined by the markets and not by authorities such as the Reserve Bank, the Treasury and government,' she wrote in Keating: A Biography (Allen & Unwin, 1988). ‘The Australian banking system, which (with one exception) had not increased in numbers since the 1940s, should be expanded to include new and foreign banks.'

A recession sent unemployment soaring to new highs, and the Campbell Report languished until after the election. Cavalier noted, ‘The impact of an inquiry depends on its political context. There is nothing so powerful as an idea whose time has arrived. When the report is substantive and the chairman persuasive, it will nonetheless go nowhere if it lacks a champion. That champion is necessarily the minister of the moment or the leader of the government. The Campbell inquiry lacked a champion in John Howard, it found one in Paul Keating. The champion was one who had changed his views on economics and regulation. Like any convert, he was a zealot as born anew.'


AFTER THE 1983 election, Hawke and Keating's victory celebrations were short-lived. The day after the poll, they were told by Treasury Secretary John Stone that the projected budget deficit for 1983/84 was $9.6 billion, $3.6 billion more than expected. Hundreds of millions of dollars had flowed out of the country just before the election. The two leaders had agreed that the old way of looking at things in Australia had run its course. Yet when Keating entered the former Treasurer John Howard's office for the first time he found one copy of the Campbell Report sitting on a filing cabinet, yellowed and faded by the sun. ‘That said so much for Howard's attitude to it,' Keating recalled. ‘When I came to office, there was a momentum for deregulation. Howard had let the Campbell Committee report die and I appealed to Vic Martin to do a report on that. It had to be done by someone who believed in the rationality of the markets.'

Dr Don Russell was a principal adviser to Paul Keating in the 1980s and '90s. He recalled that those unwelcome pieces of news dictated the pace of change – it had to happen quickly. On the Tuesday after the election Keating devalued the dollar, stopping an unprecedented capital outflow. Russell said they grasped that ‘Australia had major economic problems. Inflation was high and we had just lived through a second wages explosion which had led to a collapse in corporate profits and an awful budget deficit...after a decade of failure there was a serious concern that the country might be incapable of fixing the problem. Australian manufacturing industry was in a shocking shape and the old philosophy of regulation, industry assistance and high tariffs no longer appeared to have the answers. Hawke and Keating came to the conclusion that they had to make Australia more competitive, which meant opening industry up to international competition.'

Finally, Campbell's time had come. He made the keynote speech from the private sector at the Economic Summit convened by the new government in April 1983. Cavalier noted that he ‘won the confidence of the mainstream of Labor when he enunciated that high levels of unemployment were unacceptable as an instrument in fighting inflation. Within the week, having pushed himself beyond endurance, Campbell suffered a fatal heart attack.'

At the end of that year Hawke and Keating floated the dollar and removed exchange controls. Russell said this was a ‘watershed philosophical decision', and subsequent moves to deregulate the finance sector and cut tariffs flowed from it: ‘if Australia was to become internationally competitive then the controls had to be removed from the banks,' Keating said at the time. ‘We, can change the financial system in a way which the so-called businessman's party never could, or never had the guts to do. I always thought it's the job of the Commonwealth Government to run the private economy well. And if you're going to do that you've got to sit down and work out where all the impediments are. Then you tick them off, clear the decks...A lot of the Labor Party is about the politics of envy. Well I don't have any of that shit in me.'

In 1984 there was another election, followed by a Tax Summit to canvass reforms, and the next year Keating was ready to announce sixteen new licences for foreign-owned trading banks. ‘And they said it couldn't be done,' he boasted.


MELBOURNE HAD LONG jealously guarded its reputation as the home of the banks and the largest companies in Australia. But while the government intended that the new banks would be spread around Australia, most came to Sydney. Keating had not made a conscious decision in deregulating the financial system to make Sydney the leading financial city, according to Don Russell – but within a decade it was Australia's undisputed financial capital, the glamorous international magnet. ‘Given its existing infrastructure and competitive strengths, Sydney was a natural beneficiary...It's just the way it turned out. They took the controls off the financial sector and this is what happened.'

Sydney became one of the burgeoning fields in a new global gold rush, as international bankers scrambled to set up operations. By the mid-'80s, it was becoming an exciting, cosmopolitan city. The Wran government was elected in 1976, and implemented ‘reforms across the board on social measures, loosening laws on Sunday trading, hotels open on Sunday, cafés spilling onto footpaths, demands for a higher-quality bread, anti-discrimination laws, investing big in the arts and collecting institutions (new wings for the Art Gallery, the State Library), heritage laws, anti-censorship, support for the arts and arts festivals. There were tax breaks and incentives to get business here.' These were changes that enabled the city to ‘express itself', Rodney Cavalier wrote.

By 1988 the city was booming. In Sydney: Biography of a City (Random House, 1999) the former Lord Mayor Lucy Turnbull noted that the ‘federal funding to pay for public works to commemorate the two hundred years of European settlement', combined with Wran's transformation, meant that when the city took centre stage it sparkled; Sydney had ‘shaken off its dull grey provincial mantle'.

The new bankers brought plenty of cash with them. As Mitchell Moss, a professor of urban policy and planning at New York University, puts it, ‘Until the late 1970s, banking was a career choice more akin to being a corporate lawyer or a doctor than a high-flying hedge-fund manager. Wall Street became a high-margin business because of the deregulated environment. You basically had a casino culture operating in the financial-services industry.' And Sydney, with its love of gambling, was an ideal base for a new kind of gaming.

Some of the contracts the financial markets wanted to trade were close to the legal definition of wagers, which are unenforceable – at least by legal methods. In the early '80s, the lawyer Michael Eyers had a standing brief to review for Hill Samuel (now Macquarie Bank) the legal status of its forward financial contracts. Senior Counsel's advice was regularly sought on whether these ran the risk of being struck down as unenforceable wagers – and whether Hill Samuel could then have recourse to linked contracts and margin calls. Not until the mid-'80s did corporations legislation remove this threat from derivatives.


A CENTURY EARLIER the Victorian government had given tax breaks to companies setting up headquarters in Melbourne, and although the NSW government considered offering similar incentives to the foreign banks, they were not necessary. There were many reasons why bankers wanted to come to Sydney, and the greater number of direct international flights made the decision easier. ‘People come out to Australia to set up a branch and go back to the US or the UK five times a year, and there are more flights through Sydney', the demographer Bernard Salt argues. ‘Melbourne flights add hours to the journey – that's a major deal-breaker.'

The Reserve Bank director Jillian Broadbent, who was working in merchant banking at the time, concurs, adding that this gained momentum because the ‘anchor' institutions such as the Australian Stock Exchange, the Sydney Futures Exchange and the Reserve Bank were all located in Sydney. The foundations of the boom which lasted until 2008 were laid down at this time. According to Michael Eyers, ‘By the end of the 1980s, through deregulation and the emergence of financial markets in response, and because Australia has a world-standard banking regulatory system and a secure commercial and legal environment, and not least because technology developed to support – or permit – modern markets, the ground was laid for the twenty-year boom that followed the recession [in the early '90s] that perhaps we really had to have.'

Sydney made an easier transition from a manufacturing to a service economy than Melbourne during this period. Over the past twenty-five years, employment in the finance sector in Sydney grew by more than 7 per cent a year. Paul Keating argues that the competition in the banking sector reinforced the growth of the high end of the service economy. ‘It created a new cohort of middle-income executive people who lived within the financial-services economy. Larger salaries and emoluments and so-called success fees created a new class of individuals who expanded their wealth by using the financial assets of financial institutions.'

The international bankers brought a new pay structure as well. On top of their huge salaries, they received large bonuses. This affected Sydney's housing market, as bankers borrowed increasingly large sums of money to buy trophy homes, knowing they could pay off a big chunk of the mortgage with the next bonus.

Bernard Salts argues, ‘The ability to continually trade up to a higher-priced house is part of the bonus culture... they became addicted to that and built a lifestyle around that which drove property prices in Sydney, London and New York.'

In the mid-to-late '80s, the Sydney property market rose exponentially. John McGrath recalls that at the end of the decade, ‘the market went up 50 to 60 per cent – that was unprecedented in my lifetime. The rich got richer and bought into the higher-quality areas and homes. The gap between the top and the middle increased – it was the Macquarie Bank factor; people were earning money that they had never earned before, and houses became a status symbol.'

But the effects were not confined to those at the top of the income scale. Dr Glen Searle, a professor of planning, saw this first-hand. ‘Sydney grew faster than Melbourne and the growth of the financial sector was a major contributor...Bankers traditionally had lived on the north shore, but you started to get the financial sector living in Paddington...I was trying to sell a house at that time [in the inner east] and in that price bracket, $130,000 to $150,000, prices were going up a thousand dollars a week.'

The economist Graham Larcombe, who is a director of Strategic Economics, also closely observed the changes. Global corporations ‘nurtured the property markets and the asset bubble'. Once deregulation started, the ‘role of the financial sector was much more central to the running of the economy...Sydney emerged as a global financial cities such as London, New York and Tokyo as well as Munich and Singapore became conduits for capital flows in and out of ­economies. Sydney was a beneficiary of that, in an economic and an ­employment sense.'


UNTIL THE 1980S, Wall Street accounted for only about a fifth of all corporate profits in America, but by the peak of the bubble in 2007/2008 it had grown to an astounding 41 per cent. These numbers masked the reality that it was growth based on debt. Larcombe argues: ‘The type of globalisation which emphasises financial globalisation is flawed, as it is associated with growth in activities which were not sustainable in the long term.' He is concerned that household indebtedness as a percentage of Australia's national income had risen from 25 per cent in the 1980s to 160 per cent by 2007. ‘That growth in economic activity and employment is driven by debt. The more the boom went on, the more speculative activities became. The extraordinary thing is that mainstream economic policymakers did not think that instability could occur. They argued that business cycles were a thing of the past.'

Now that credit has dried up and the regulation of global finance is up for grabs, the pain is being felt not only in top-end house prices in global cities. Even in well-regulated and comparatively well-insulated economies like Australia's, there is a lag in what happens to employment, consumption and production. ‘The real impact on Australia is yet to come. The future is more uncertain than it has ever been. We still have not gone through the shock of the impact on the real economy, the effect of unemployment on household incomes.' This time, however, as Larcombe notes, it is ‘not just the westies' who have borne the brunt of it.

John Maynard Keynes has been here before. ‘A "sound" banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.'

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