Analysis & Opinions - Australian Financial Review

How We Staved Off Recession and the GFC

| Sep. 13, 2018

Lehman Brothers' eye-watering $US612 billion collapse was the single largest bankruptcy in US history. Global financial markets panicked, within 24 hours global capital flows literally froze and for the next month the world teetered on  the brink. These were white-knuckle times as we entered not just the Global Financial Crisis, but also the "great global recession" that followed. These were the events that would dominate the entire history of our government.

In Australia we successfully navigated the GFC without losing a single financial institution – although we came perilously close in a number of cases – and without a single citizen losing their saving deposits. We also became the only major developed economy  to come through the great global recession unscathed.

And despite the ocean of opportunistic conservative political commentary that has followed, we did so with among the lowest debt-to-GDP and deficit-to-GDP ratios in the Organisation for Economic Co-operation and Development, evidenced by the fact that through the GFC, the global recession and the years that followed, Australia maintained AAA credit ratings with all three global ratings agencies. None of this happened by chance. It required careful financial and economic management.

In Australia, together with the Treasury, we had been carefully working on contingency plans for the previous six months, since just before the bailout of Bear Stearns in March that year. By May, the Council of Economic Regulators – made up of the Treasury, the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission – had produced an internal "Memorandum of Understanding on Financial Distress Management", our own contingency plan for dealing with any Australian financial institution that found itself in crisis.

We had also been concerned about the security of people's bank deposits given that Australia was one of the few countries  without a bank deposit insurance scheme. That's why in June 2008 we announced we had also accepted the advice of the Council of Economic Regulators to introduce a scheme, previously rejected by the Howard government, to protect the first $20,000 in individual deposits.

Contingency plans

Immediately following the Lehman's collapse, I travelled to New York for meetings with US President George Bush and the president of the New York Federal Reserve, Tim Geithner. I had earlier spent time with US Federal Reserve chairman Ben Bernanke and the US Treasury Secretary Hank Paulson on their own contingency plans. Whatever we did in Australia would be useless unless we could anticipate the timing and content of US sovereign interventions in the crisis, particularly the Targeted Asset Recovery Plan (TARP).

I also lobbied President Bush on bailing out the global insurance giant AIG once I discovered the scale of AIG's presence in the Australian insurance market. Had AIG failed, the consequences for us would have been catastrophic.

When financial markets collapsed again on "Black Friday", October 10, we convened an urgent meeting of the cabinet's Strategic and Budget Committee over the weekend. By then, the panic had well and truly spread to Australian financial markets. We feared a run on the banks as the global contagion set in. It was a sobering meeting. After a full day's deliberation, we agreed to provide a sovereign guarantee on all inter-bank lending to sustain the liquidity of our own banks; as well as a similar guarantee on all savings deposits.

Maintaining confidence was essential. And it had to be done before markets opened on the Monday. It's a sobering thing standing up and announcing to the nation a $2 trillion plus guarantee when it's your own signature on the bottom line! Nonetheless, it worked.

The other half of our weekend focused on the impact of the GFC on the real economy. Treasury warned us that recession was almost inevitable. I asked what could be done if recession was to be avoided. That's when Treasury Secretary Ken Henry famously advised: "Go hard, go early, go households."

Stimulus measures

We had already spent half a day on what Treasury had learned from mistakes made in the response to the 1991 recession when stimulus measures were delivered too late to be of material benefit to the recovery. So we agreed on the first tranche of stimulus payments to families adding up to 1 per cent of GDP. We had to get it into the economy by Christmas if we were going to keep retail afloat and give employers a reason to postpone any decisions on staff reductions until the following year.

That's where the second stimulus package of February 1 came. We knew from incoming economic and financial data that we were staring at a contraction of more than 5 per cent of GDP. That's why we decided on a further package of 4.2 per cent of GDP including further cash payments, the trebling of the First Home Owners Grant to boost residential construction, a 50 per cent temporary investment allowance to boost private fixed capital investment and a $15 billion school modernisation plan to build state-of-the-art school libraries across all the nation's primary schools. This was designed to spread stimulus across multiple sectors and to stagger its effect across 2009-2010 to keep the economy out of a confidence-destroying recession – when all other major economies had already gone under.

The bottom line is that our fiscal stimulus strategy worked. We avoided going into recession in 2009, albeit by the skin of our teeth. And Australia, as a result, has now completed 27 years of continuous economic growth. Another OECD record.

All four of the measures we took – the two financial guarantees, and the two stimulus packages – have been relentlessly attacked by our conservative opponents, either then or since. What conservatives have never had the intellectual integrity to do is ask themselves the simple counter-factual: what would have happened had our government not taken these decisions? Subsequent detailed technical studies by the Treasury have demonstrated that without both stimulus packages, we would have gone into recession.

As for the impact of the stimulus on the budget deficit and net debt, what the conservatives never admit is what would have been the combined impact of more than $100 billion in revenue losses irrespective of what decisions were taken on stimulus; before adding even greater revenue losses arising from a further collapse in economic growth if stimulus was not deployed; coupled with escalating social security payments through a near-doubling in unemployment rates. Instead we kept unemployment under 6 per cent, the second lowest across the OECD.

Australia dodged two bullets after the Lehman's collapse: financial implosion and a long, deep, debilitating recession of the type that unfolded in every other economy around the world. Our response was not perfect. We made mistakes. But from the evidence, we did absolutely the right thing by the nation.

For more information on this publication: Please contact the Belfer Communications Office
For Academic Citation: Rudd, Kevin.“How We Staved Off Recession and the GFC.” Australian Financial Review, September 13, 2018.