However successful the Government has been at managing the short-term effects of the economic crisis, it has failed to use the last twelve months to drive significant reforms in the banking sector that will deliver long-term outcomes. And, perversely, its obsession with stability might end up providing the conditions for a systemic failure.

The collapse of competition in Australian lending was an inevitable consequence of the financial crisis. The Government didn’t help by waving through the takeovers of Bankwest and St George by the Commonwealth and Westpac, but the virtual cessation of cheap credit was always going to pose an existential threat to any role in mortgage finance by non-bank lenders and the regional banks.

The policy issue for the Government was how it responded.

Now, yes, the Government did move early to provide additional liquidity to the residential mortgage-backed securities market, offering first $4b and then another $4b in the wake of the financial crisis, but that was a small fraction of the home mortgage market. And the wholesale borrowing guarantee gave the big banks a huge competitive advantage by enabling them to access the Government’s AAA-rating anyway.

In April, Christopher Joye urged the Government to adopt the Canadian approach of guaranteeing mortgage and commercial property (that fitted appropriate criteria), thereby re-opening the securitisation market. He was backed by what was left of the non-bank sector (since vanished). At the end of June, Shadow Treasurer Joe Hockey made a similar call, although it was lost a bit in the silly kerfuffle over whether Hockey had bagged Howard Government spending levels.

Since then the issue has vanished without trace as the major banks, and in particular Commonwealth and Westpac, have taken their dominance of the residential lending market to nearly 75%.

As ACCC Chairman Graeme Samuel said, it is hardly a healthy state of competition.

In the long-run, as Joye has noted, a banking system ever-more dependent on four big banks means that, whatever risks those banks may take offshore, their health and solvency are absolutely critical to the baseline integrity of the Australian economy. In the event ANZ’s offshore ventures into Asian finance go seriously awry (think NAB and Homeside in the US) — as history suggests they may well — Australian Governments will have no choice but to bail ANZ out — much like many foreign governments have had to bail local banks out that have had big US sub-prime exposures (like the Swiss and UK governments).

“We’re creating a giant experiment in moral hazard here,” Joye says.

“The bankers would have us believe that they are private companies. But the incontestable truth is that they are not conventional private companies. Since all the major banks borrow short from at-call depositors and short-term wholesale finance providers and lend long through, for example, 30 year home loans, their businesses are based on a massive internal conflict: if depositors withdrawn their money (as happened with Northern Rock in the UK) or wholesale funders refuse to roll-over their debt (as happened to the global banks throughout the GFC), the banks become insolvent.

“This is precisely why the major banks needed deposit guarantees and wholesale funding guarantees in order to survive. Put differently, the banks’ business models are not in the long-run viable without these explicit and implicit guarantees.

“In addition to all of this, people forget that the banks get the luxury of borrowing anytime they want from the publicly owned bank, the RBA, that was originally established to provide them with liquidity as a so-called lender of last resort during times of crisis. Importantly, banks can borrow from the RBA during these times of crisis at demonstrably below-market rates, as Challenger’s CEO has noted. I cannot think of many private businesses that get the luxury of all this taxpayer support.”

Joye is also critical of the banks’ unwillingness to accept the fact that they are not like normal companies.

“You hear the bankers trot out this claim that they paid for the taxpayer guarantees, and there were therefore no subsidies. This is a complete fiction. First, the banks paid nothing for the deposit guarantees for accounts of less than $1m. Second, the only counterparty on the face of the planet willing to guarantee the banks’ liabilities was the Australian taxpayer. The truth is that taxpayers could have charged considerably more for the guarantees had they wanted to. Described differently, the Australian taxpayer was the banks’ lender of last resort.”

A credit market that is almost a pure oligopoly also moves power to business from regulators. In banking, that can have major economic implications. The banks have retreated from business lending to lower-risk mortgage lending, slowing the supply of credit to employment-generating businesses. And with virtually no competition, the major banks can make out-of-cycle interest rate rises with impunity, with only the wrath of Wayne Swan to fear. And while the RBA can take out-of-cycle rises into account in its own interest rate determinations, it loses control of their timing.

On 28 July, Glenn Stevens described a key factor in the RBA’s future interest rate decisions. The RBA Governor rarely gives direct policy advice to governments, but his words were significant:

A very real challenge in the near term is the following: how to ensure that the ready availability and low cost of housing finance is translated into more dwellings, not just higher prices. Given the circumstances — the economy moving to a position of less than full employment, with labour shortages lessening and reduced pressure on prices for raw material inputs — this ought to be the time when we can add to the dwelling stock without a major run‑up in prices.

If we fail to do that — if all we end up with is higher prices and not many more dwellings — then it will be very disappointing, indeed quite disturbing. Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over‑leverage and asset price deflation down the track.

Stevens did not say either that there was a housing price bubble developing, or that the RBA would “lean against” such a bubble if it did. But supply-driven house price inflation would inevitably feed into general inflation, placing upward pressure on interest rates.

Courtesy of the economic downturn, housing affordability has dropped down the political agenda. It was a major issue in 2007 and one of Kevin Rudd’s chosen areas of policy differentiation from the former Government. Instead, the Government has focussed on boosting the high-employment construction sector through both direct funding of social housing and weighting the First Home Owner’s Boost toward new houses.

That is, as they say, a good start. But neither will address the long-term problem that Australia isn’t building enough houses for the people who want to live here, which Stevens was urging governments to get cracking on. We came into the downturn with an undersupply of housing and we’re going to emerge with an undersupply of housing — just in time to resume a high-immigration, high-growth economic trajectory that will further strain housing supply and drive prices up.

The problem will be particularly acute in NSW, where development is mired in the sort of political-legal swamp that Frank Sartor wandered into at Catherine Hill Bay and the word “developer” is taking on the same connotations as “racing identity”.

This is another area where the long-term decline in the performance of the NSW Labor Government will have serious national economic consequences. And it is not an area particularly amenable to Federal Government intervention.

Banking regulation, however, very much is. Two months ago Joye and five other of Australia’s best and most influential economists — Joshua Gans, Nicholas Gruen, Stephen King, John Quiggin and Sam Wylie — called for a new inquiry into the Australian financial system, and proposed a range of issues that needed scrutiny, including the impact of the emerging international regulatory framework on domestic regulation. The call was lost amidst criticism of the “people’s bank” idea which was one out of dozens of issues meriting consideration. No evidence in the last eight weeks suggests the need for an inquiry has diminished — quite the opposite.

This is also a space that Malcolm Turnbull and Joe Hockey should be able to successfully operate in. Hockey has already moved on the RMBS issue, and Turnbull can draw on his success in the finance sector and his greater freedom to criticise the major banks. There is far more opportunity here than in criticising the stimulus package, which simply reminds voters of the Government’s successful handling of the crisis.

*Listen to yesterday’s Canberra Calling, “The Steve Fielding podcast, spelt P.O.D.K.A.S.T“