Debating bank solvency in the crash of 2008

The facts of the solvency, or otherwise, of one or more of the four major Australian banks at the peak of the financial crisis in October 2008 is a topic generating some heat over the last day or so.

Ross Garnaut and David Llewellyn-Smith in their book The Great Crash of 2008, and published in the last week, wrote as follows:

"In the early days of October 2008, money poured into the big four Australian banks from other financial institutions. But life was becoming increasingly anxious for them as well.

"One by one they advised the Australian government they were having difficulty rolling over their foreign debts. Several sought and received meetings with Prime Minister Rudd.

"The banks told him that, if the government did not guarantee their foreign debts, they would not be able to roll over the debt as it became due. Some was due immediately, so they would have to begin withdrawing credit from Australian borrowers.

"They would be insolvent sooner rather than later."

This is no clips job. Rather, it is Ross Garnaut's own investigations and reporting on the events of one year ago.

Garnaut, who worked as economics adviser to a prior Labor prime minister in the 1980s, remains well connected (for example, through his recent work on the review of policy on climate change).

A lot of the (guarded) reporting at the time of the crisis focussed on selected regional banks and also some foreign banks.

The subsequent (elective) guarantee on wholesale and retail liabilities was largely reported, at the time, on the basis of the issues facing those smaller banks, and also placed in the context of the worldwide rush to guarantee bank liabilities.

So, the Garnaut reporting is new, and relevant.

Then there's the question of whether Garnaut's reporting is accurate.

The Australian Bankers Association responded, in a media release yesterday, that "the evidence is that the Australian banks were not insolvent and the wholesale funding guarantee was introduced as a means of ensuring banks could maintain lending growth, not to restore the solvency of banks."

The ABA argued that the guarantee of wholesale liabilities "was introduced as a response  to similar guarantees introduced by other countries, starting with Ireland. This  development fundamentally changed international debt markets by creating a new AAA-rated security for investors.

"These developments overseas threatened to constrain the ability of banks in Australia to  rollover funding."

The ABA also noted that "there has never been any commentary or report from the  Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Treasury, senior economic ministers, banking analysts, the International Monetary Fund, the World Economic Forum or other reputable commentators that Australian banks were insolvent.

"There is no doubt that the introduction of the Government's wholesale funding guarantee assisted banks in maintaining overseas funding at a reasonable price.

"We will never fully know the stress that the system may have come under without the guarantee."

Melbourne University Press is the publisher of The Great Crash of 2008.

Note: Ian Rogers helped steer David Llewellyn-Smith through sources of banking statistics during research for the book, and also helped fact-check the fourth chapter on financial innovation.