By Gareth Morgan*
It’s decades overdue but at last the government guarantee on deposits at banks has been shown not to be cast-iron.
The decision taken in Cyprus to impose a one-off 7% tax on all bank deposits as the cost of securing a rescue deal from Europe, is intensely unpopular.
Ordinary people somehow think they shouldn’t take responsibility for the decisions they have encouraged their politicians to make.
Why not?
One of the major moral hazards of financial sector liberalisation of the last 40 years has been the guarantee from central banks of the deposits at banks.
That leads people to store their money in the bank with no regard for the credibility of the bank. And then the banks have increasingly disregarded at worst, or not taken seriously the risks they take with their lending.
If you know there’s an implicit or explicit guarantee from the central bank that underwrites the deposits you take in and then lend out, then it follows as night does day that you’re going to be relatively relaxed about credit risks.
This is why we get cycles of systemic over-lending as occurred in the mid-1980’s in NZ to the commercial property sector, and in the early 2000’s to farmers, and has occurred internationally to a major extent culminating in the Great Financial Crisis.
And more worryingly is the over-lending as has been going on for decades with residential property in New Zealand – as the IMF highlighted yet again in its report this week.
That our own Reserve Bank continues to “think about” this issue while the Minister of Finance ponders it publicly nowadays, is testimony to the reality that until a crisis hits nothing will be done. This is the nature of political and central bank leadership.
Central banks rightly guarantee the banks because they don’t want a repeat of the “run on the banks” as occurred during the 1930’s Depression.
But at what cost has come this stream of unfettered credit from central banks to our commercial banks?
Sure it’s all gone swimmingly well for several decades now and while we’ve had booms and busts that profligate credit has sponsored, we’ve used both inflation and taxpayer funds to disperse the costs – or “socialise” the debt as they say.
And along the way bankers have made bigger and bigger salaries as they truly have been on a gravy train courtesy of the central bank guarantee.
Wealth and income disparities across society have burgeoned as a result of credit-fuelled boom bust cycles and the night-after impact of inflation and tax loads on those who in effect fund the profligacy.
We actually know no better way than the infamous “Greenspan Put”.
Well Cyprus just got its come-uppance and the fall guy – when there’s no other line of defence – are not the poor (who inflation roots) nor the suckers (those that pay tax) but those that save – both ironic and somewhat overdue really.
That it takes a country to get itself totally into the crap before the penny finally drops on the public at large, and even then precipitates howling indignation, is enough testimony to the reality that we like to use every inch of rope to hang ourselves rather than untying the knot before the garrotte grips.
Pro-active policymaking is simply not in the repertoire of those whose main priority is to mollify the public (politicians) or ensure tenure (career public-servants).
We get the decision-making we want.
As a society we of course want the good times to keep rolling, no matter how the party’s being funded – and woe betide anyone who stands in the way.
Isn’t it logical then we get the outcomes – eventually – that we should expect?
Meanwhile let the music play.
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Gareth Morgan is a businessman, economist, investment manager, motor cycle adventurer, public commentator and philanthropist. This opinion piece was first published on his new blog garethsworld.com and is reprinted here with permission.
34 Comments
Forget the banks - The whole country is living on borrowed time.
Current account out this am - now up to 5% and rising with the trade balance in deficit which means we are borrowing and selling assets to pay the interest on our ever increasing foreign debt - scheduled to go to 84% of GDP from present 72% by 2015.
Will be the country that needs an IMF rescue !
Deposits are not lend out. Banks create credit at least ten, twenty, thirty? times they take in in deposits. Banks don't care about deposit risk at all, they are in the business of credit creation. Accounting rules and regulation is the only reason they need deposits. Deposits are not risk bearing investments, otherwise they would be bonds or stock. So now all of a sudden the savers are the bad guys and should back the investors/speculators whom are getting the rewards for the risk the deposit holders is taking. Right.
Exactly.
"If you know there’s an implicit or explicit guarantee from the central bank that underwrites the deposits you take in and then lend out, then it follows as night does day that you’re going to be relatively relaxed about credit risks.
This is why we get cycles of systemic over-lending as occurred in the mid-1980’s in NZ to the commercial property sector, and in the early 2000’s to farmers, and has occurred internationally to a major extent culminating in the Great Financial Crisis."
Come on Gareth, surely you know that conclusion is not true? We get cycles of systemic over-lending because banks are allowed to create currency, and create most of it. You're going to be relatively relaxed about credit risks when you make profits based on how much credit you can create.
"That leads people to store their money in the bank with no regard for the credibility of the bank. And then the banks have increasingly disregarded at worst, or not taken seriously the risks they take with their lending."
Gareth, Im having trouble working out the banks most at risk, which banks do you think are safest?
Im worried about BNZ and its dairy lending but then all the banks appear to have done brainless things, and none have a monopoly on stupidity
. So if you could just give me the name of the best of a bad bunch it would be of much relief to me and my family.
ps. don't worry i wont tell anyone else.
It’s a system question not about individual banks. The moral hazard is that there is every incentive on commercial banks not to worry too much about the risk around loans – just to adopt the same risk as every other bank. If they all get in the crap together what’s the Reserve Bank going to do? There’s no choice but to bail out the depositors. The relevant question is how can the central bank discipline the credit system so that such overshoots don’t arise.
Yes to the systemic risk - but as to the relevant question - it's not so much a "..how can..." but rather a ".. why are they not..."?
It is (in my opinion) to a new breed of elected representatives that must withdraw support for the existing power structure.
Certainly any government deciding to do such needs to have properly planned a departure from the status quo, but if we don't do it the IMF will for us. It could even be by the time our receivership comes along - the IMF won't be there either .. so it seems to me the sooner we get onto self-determination type rebalancing the better.
That it takes a country to get itself totally into the crap before the penny finally drops on the public at large, and even then precipitates howling indignation, is enough testimony to the reality that we like to use every inch of rope to hang ourselves rather than untying the knot before the garrotte grips.
It just took an over indebted company collapse before the noose closed round that somewhat starry -eyed but nonetheless iil-informed rugby captain.
"Who would be a banker? You get vilified when you won't lend and vilified when you do."
"Oh, I don't know, you do get to print your own money."
"What? Print your own money? How's that work then?"
"Well it's actually a sort of indulgence that a bank gets when it lends money to its local government.
So, it buys government debt (ie lends money to the government). This counts as Reserves, and it can lend out up to ten times as much as it lent to government by just creating the debit and credit entries on its books. There are a bunch of other rules of course, like it has to borrow some money from individuals and other banks, but that's the gist of it."
"How do I get to be a banker?"
You can do better than that, just RP (repurchase agreement) finance US Treasury bond positions and make ready to deliver to the Federal Reserve - just like stealing candy from the taxpayers.
Thank you. It was just a job for me at the time - I took little notice of what was really involved, the daily action was just too fast and too big to really analyse to what extent and how the bank was engaged with the authorities - only in later years did I realise the enormity of it all.
I am not making excuses,I knew I was being well paid to do this so something was not acceptable to normal human beings - much like a hired gunslinger. Gee it's like a Pink Floyd moment - LOL
My latest speculation was that our mortgage payments were in a sense tribute to the Empire. Fekete's paper seems to fit with that. The argument went something like this:
Mr Bush "We need a war Alan, I'm relying on you to do your bit"
Mr Greenspan "Of course. You just go right ahead and borrow whatever you need Mr President. I'll just put interest rates down so the government won't have to pay a red cent more."
So more credit created by the US government, multiplied by 10 by the US banks, borrowed by French and German banks and multiplied another 4 times and lent worldwide. Eventually we borrow more to buy our houses off each other.
The interest payments then flow from the periphery (yes boys, that's us) to the centre of the Empire in Washington DC via JP Morgan, each step getting to dip their beak along the way of course.
Am I talking nonsense or does that sound roughly right?
Yes, to a degree - A little cynical in as much as I believe the creation of thin air money was not expected to have the impact it did in the way it turned out - Economists seemed not to account for the complete financialisation of the industrial sector. As Fekete points out they never expected the money to run to excess money market making activity - hence bypassing the dirty industrial economy to a large extent within their own borders - clean low civil works involvement leverage took centre stage probably by chance rather than by good management.
My thought process was that the modern system of money and banking was a development of the system developed by the Netherlands and then Britain to fight longer wars. So it was not accidental that it is structured to fund warfare, nor is it accidental that it funnels wealth from the periphery (the colonies if you like, or tributary nations in my model) to the centre of the Empire of the day. The present day Emperor or his accolites don't understand that this is hard wired into the structure, so to them it all appears accidental.
It is these little exchanges that make Interest.co worth suffereing the PI's. I suspect the US is to remain the empire of the day for some time yet. Perhaps diminshed from its peak, but top dog for a while yet. Although Jim Sinclair puts the score at Moscow 1 - Washington DC 0 for the week.
Interesting thing with that Fekete piece is that it largely ties up with (M.V)+i=P.Q. He doesn't like the Quantity Theory of Money, but I would love to see him try my revision. Based on that equation I predicted interest rates would only trend down but that more money would have to keep being printed to balance this. Velocity would also trend lower as purchasing power declines because of the debt burden, necessitating even more money expansion. Where my model starts to diverge(although it is possibly not in the long term) is that it shows prices have to rise to keep the equation in balance. I have been waiting to hear from Zerohedge this year regarding the contraction of shadow banking, as they predicted as that wound up the conventional banking system would have to pick up the slack.
In 1931 Ansalt bank in Austria collapsed, it had loaned over %50 of all bank loans in the country ( a staggering amount of money). The depositor panic lead to the collapse of the German-Danat bank creating a currency crisis for the German government. This created a panic of foreign banks out of German and Austrian assets. German and Austrian banks had $5 billion of short bterm bills all due in 60 to 90 days. German, Austrian and Hungarian trade plunged, hyper-inflation destroyed the currency.
Lets get our banks sorted Mr Wheeler, because if they go tits up it wont just be depositors that lose, will it.
http://www.amazon.com/Gods-Money-Street-American-Century/dp/3981326318/…
http://globaleconomicanalysis.blogspot.co.nz/2013/03/fraudulent-guarant…
A bit about the RBNZ OBR from Mike Shedlock.
"Those without deposit insurance are at least being honest."
I commend the Reserve Bank of New Zealand's policy for precisely the reasons it stated:
"Deposit insurance is difficult to price and blunts incentives for both financial institutions and depositors to monitor and manage risks properly."
nuff said I think... regardsI could agree with you, but not after covered bonds and crazy LVRs backed by our own RB.
A run on a bank would have a knock on effect which could create a panic in offshore investors, destroy our currency, our asset values and our exports.
You think a bank failure would only affect depositors?, what happens when loans get called in?
I dont see covered bonds as a biggee as long as the % is small ie <10%, what that does give the bank is a lower cost to lend and the lender feels very safe, I suspect thats deluded.
Deluded, because the thing I see (disadvantage) about covered bonds is the lender cant get up and withdraw the money overnight if there is an obvious deteriorating situation, they are illiquid. I (at least) as a depositor am highly liquid, I can move all my money via Internet banking in a few hours.. So sure the covered bond holds 10%, but if the depositors holding 90% have all left, whos holding the baby?
Of course the Q is then just where to put the money...it either has to be cash, gold or short term Govn bonds...
I agree with you on the LVRs, its way too high. That however is the action of the bank staff, also if you dont like it, why cannot you walk out with your money? I do think the RB and indeed our Pollies should have locked us to 80% LVR but that would have lost votes, so for me the blame is as much with the voter as the RB and Pollies.
"create a panic in offshore investors, destroy our currency, our asset values and our exports.?"
Indeed....this wouldnt be a NZ only thing though? I think we'd be in a global event, our currency v USD would plumit and be worthless. (would it be that bad for our exporters? hrmm hard Q IMHO)
"when loans get called in" yes and this is my worry even ppl with 10% left to pay could be called in...however the ones at 95% would have long gone.
I would assume that ppl with 10% could easily get a mortgage elsewhere...dunno....a very hard Q. Even if the ppl with 80% get called in and dis-posessed thats a huge wave of homeless for the Govn to deal with....ugly, pretty extreme.
regards
The fundamentals are all wrong. The banks are paying a higher return to shareholders than investors, and yet frankly depositors are carrying more risk. You would be better to convert your investment to shares. Weird thing is that banks would actually be better to buy back capital. Why pay shareholders 7% when they can pay depositors 2%? this defies logic as banks must hold certain levels of capital under basil. RBNZ should be either getting Banks to hold way more capital thereby reducing shareholder return or looking at margins which have become bloated. Either way equity should be much higher to provide a buffer for any unforeseen economic shock - such as drought, or possible foot and mouth outbreak which could decimate our economy. RBNZ is taking some massive risks. What happened to diversification? investment 101.
The problem is (for me anyway) is that,
a) we have a monolithic risk structure and the rating is based on that. By that I mean all of the banks are all majorily exposed to all sectors, so if one bank folds I cant see how the rest wont be far behind.
b) All of them are hugely leveraged...no fat to absorb probable losses.
So Sure the big 4 fold if say the milk market collapses to <$4 a kilo, so would Robbo bank and kiwibank and TSB (say) survive? I doubt it.
regards
I have been thinking of moving my funds to Rabo bank
Really? read article
Stock trucks had already rolled in to remove his 300-cow dairy herd, which could be sold by the receiver to recoup some of the $5.6 million in loans and fees Mr Gray owes Rabobank.
You might wonder why Rabobank let this particular borrower get so out of his depth with debt funded by depositors - you should take advice from the regulator before you subject your savings to a possible haircut courtesy of the RBNZ. - the general disclosure statement will not highlight this sort of lending practice or how deeply it pervades the bank's lending culture.
Gareth is right and Gareth is also wrong.
For most people (unlike Gareth who has umpteen dollars to move all over the place)
a Banks serves only as :
1. A place for money to be parked temporary until it is used to pay bills...
2. a place to keep some savings an earn a bit of interest (nowadays even that is gone) instead of using the same savings to speculate on stocks and shares ...it's a place seen as the lowest risk of investment losses.
3. Nowadays all transaction involving money is electronic, there is no more cash transactions for payroll, taxes etc etc...Tell your Boss to pay you in cash !!
Imagine getting your pay on Wednesday and on Thursday the Banks and RBNZ tells you that the Bank is temporarily closed and when it opens on Friday, your account will be short by 10% or whatever amount because your Bank's management had "stuffed up".
My first thought would be that I should have kept my money under my pillow...or cupboard etc etc.
This is the reason why Goverments give guarantees either explicit or implicit.....Because without it most banks cannot survive and we return to a Cash Only society.....imagine that !!
Goverment guarantee for banks is for the benefit of the bankers...not the depositors !!
It is reasonable therefore that the Banks should be paying the insurance premiums to the goverment....much like EQC levy....the Banks pays levy to the Goverment in case of a Financial earthquake....Depositors has a choice, we can deposit our money with the banks or under our beds....the Banks don't have the same choice.
"We get the decision-making we want."
NO
You are wrong
If an election were held today, what political party is out there that you could recommend to do a good job?
I can't think of any.
Like most people we are forced to make a protest vote because that is all we have to fight with.
It is not the politicians or the poor people that lead to revolutionary changes. It is people like you and others in your class. You must lead the charge SO WHY DON'T YOU?
Is it better to be a moaner than a leader?
Where do you think all this moaning is going to get you?
Why dont you get together some of those really great people out there and start a new party just like Bob Jones did when he was unhappy?
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