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Chapter 2
A Brief History and Implicit Guarantees
A short history of federal government involvement with state borrowings
2.1
The May 1923 Premiers' Conference agreed to form a voluntary Loan
Council, under which the federal government would borrow on behalf of the
states but the Council would set limits on states' borrowings. In the 1950s, the federal
government effectively agreed to underwrite state borrowings. However, during
the 1970s and 1980s the states started borrowing outside the Council's limits.
In 1992 it was agreed the states could borrow in their own name. The 1993
Budget Papers characterise this as being 'to enable the individual states to
assume responsibility for managing their own borrowings and to be accountable
to financial markets for their actions'.[1]
2.2
Treasury have noted:
...the Australian Loan Council do still meet following the
Ministerial Council on Federal Financial Relations, and they consider the
aggregate borrowing requirements of all Australian governments. I would
anticipate that, should there be borrowings at levels that are ringing those
sorts of alarms, that would be the forum at which those issues would be raised
and dealt with.[2]
2.3
The only time a default by a state has been an issue was in NSW under
Jack Lang during the Great Depression. Two successive federal governments
(under Prime Ministers Scullin and Lyons) covered overseas interest payments on
the NSW government’s behalf, with Prime Minister Lyons introducing legislation
which allowed the Federal Government to recover money directly from NSW revenue
and establishing that the Federal Government would take responsibility for
meeting foreign interest payments by the states. Lang challenged the
legislation in the High Court and lost. Shortly after, Lang was dismissed by
the state governor and defeated at the subsequent election.[3]
An implicit guarantee?
2.4
This example demonstrates the high price that a state government is
likely to pay for defaulting on debt. Some point to this example as evidence of
an implicit federal guarantee of state debt. The argument is that no federal
government would be willing to allow a state to default on overseas debt
because of the potential damage to its own reputation and credit rating and
that of other Australian states and other borrowers.[4]
2.5
Mr Peter Jolly, Managing Director of nabCapital, agreed that
historically the market has factored in some sort of implicit Commonwealth
guarantee of state debt in the bond markets. He pointed out that, before the
collapse of Lehman Brothers, state bond markets were attractive to investors
because of their relative stability and typically higher returns:
Markets do to a degree work on the basis—people who buy semi‑government
bonds probably feel they are implicitly guaranteed by the Commonwealth. Rating
agencies to a degree rate the Commonwealth itself on some assumption of
liability for the states and others.[5]
2.6
Ms Sue Vroombout, General Manager of Treasury's Commonwealth-State
Relations Division, said:
...credit rating agencies have indicated that they believed
there was an implied assumption that the Commonwealth would step in. But the
Commonwealth never expressed that view.[6]
2.7
As each state has taken increasing responsibility for their own fiscal
position and borrowing programme, it could be argued that any implicit
guarantee has eroded over time.
2.8
The Treasurer’s press release states that the Commonwealth guarantee
will only cover securities which the states choose to make subject to the
proposed guarantee.
2.9
In discussing that point, Mr Jolly pointed to the fact that, although
the market may factor in some sort of implicit guarantee in times of greater
liquidity, the difference between state debt issued bonds that are subject to
this guarantee and those that are not will certainly be obvious.
In a practical sense, it is neater for the market if all the
lines are the same. In a sense, they are fungible. If some states choose not to
guarantee their existing loans and some do, then we may end up with something
of a two‑tier market. It is manageable but there would definitely be a
difference in pricing.[7]
2.10
This assertion that explicitly guaranteed debt will be priced
differently from other debt indicates that there is less than total confidence
in any implicit guarantee.
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