18 July 2008

The 1974 Liquidity Squeeze in Australia

Googling for background on the Banking Act for a future blog, I found a paper titled "A History of Last-Resort Lending and Other Support for Troubled Financial Institutions in Australia" (http://www.rba.gov.au/rdp/RDP2001-07.pdf).

I had an unnerving déjà vu experience when reading Section 10 (except the bank run part, maybe that is next). Below are some extracts.

"Section 10 The 1970s

Following the comparative calm of the 1950s and 1960s, the growth of non-bank financial institutions fuelled a property boom in the early 1970s. The 1974 liquidity squeeze brought the boom to an abrupt end. The failure of a number of property financiers precipitated runs on building societies in several states, particularly South Australia and Queensland. Building societies in Queensland also experienced difficulties in 1976 and 1977. Weakness in the property market brought down the Bank of Adelaide later in the decade. The Reserve Bank provided some liquidity support in each of these cases, although it did not lend directly to non-banks.

10.1 The 1974 Liquidity Squeeze

Following a boom in lending by banks and non-bank financial institutions, the Reserve Bank tightened monetary policy in 1973. This was accompanied by a drain in liquidity resulting from a deterioration of the balance of payments and a government budget surplus. As interest rates soared, property prices began to collapse triggering the failure of several property development companies.

On 30 September 1974, the property financier Cambridge Credit went into liquidation. The failure of two other substantial property developers (Home Units Australia in July and Mainline Corporation in August) preceded Cambridge Credit’s closure. While those failures prompted sharp falls in the share prices of other property developers, finance companies and banks, Cambridge Credit’s failure saw public nervousness spread directly to other financial intermediaries. The following day, runs developed on building societies in NSW, Victoria, Queensland and South Australia. While the runs in NSW and Victoria were comparatively small, the runs in Queensland and South Australia were far more severe.

...

Although the Hindmarsh Building Society in South Australia was financially sound, it was subject to the most severe run. The run, based on rumours the society had lent to failed property companies, continued, little affected by the Acting Treasurer’s statement. The run exhausted the society’s cash reserves. The National Australia Bank lent the society cash until the National also ran low. On 3 October, the South Australian Premier, Don Dunstan, addressed customers queuing outside the Hindmarsh’s offices, assuring them that their funds were safe. The run subsided the next day."


For "youngsters" like me (I was only 5 years old when this liquidity squeeze occurred) I would also recommend reading "Appendix A: Financial Disturbances in Australia – A Chronology". Runs happen. Interesting question is whether the public these days would be comforted by a statement by a politician that all is OK. Maybe they will be, is there any proof that society has gotten any smarter? If anything one could argue they have gotten stupider and more greedy and are just as invested in keeping the system going so will want to believe there isn't any fundamental problem with the system. Coming soon to a theater near you: The F-Files: I Want to Believe in Fiat Currencies.

I also found some other interesting comments about legal tender gold backed notes in the paper:

“High-powered money consists of those forms of money that are directly exchangeable for real goods (i.e. commodity money, such as gold coin, and instruments declared to be legal tender). While, up until 1910 the notes issued by banks and backed by gold were also highly liquid, the fact that their widespread acceptance relied on public confidence in the banks that issued those notes indicated that they were one step removed from high-powered money.”

“In 1910, the Federal Government’s legal-tender note issue was introduced. Initially, it was required that the government’s gold reserve cover one-quarter of the value of notes issued up to £7 million. For any note issuance above £7 million, one-for-one backing was required. In 1914, however, the gold reserve provision was relaxed so that the required gold reserve was one-quarter of the value of notes on issue regardless of the size of the total note issue.”

“The bank [Commonwealth Bank] was required to maintain a minimum gold reserve of 25 per cent of the notes on issue (although the required gold reserve was reduced to 15 per cent in June 1931). Although Australia went off the gold standard at the end of 1929, it was not until the introduction of new banking legislation in 1945 that the gold reserve requirement was completely abandoned.”


I like the term "high-powered money". I wonder if this is some defined academic term or just made up by the authors? History lesson for today - get hold of some high-powered money!

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