Lose control of your car in the wet, and you suddenly become the model driver — no speeding, no tailgating, and no running red lights. Your risk of an accident remains the same, but your harrowing, adrenalin-charged memory ensures you no longer tolerate even the tiniest risk. In a few days or weeks your old habits gradually return. Perhaps you drive even worse now, foolishly believing a lucky escape has lowered your chances of another mishap.
Reactions to the GFC have been similar. Amidst the economic gyrations of late 2008 and 2009, regulators and commentators evinced a steely ‘never-again’ mentality. But almost three years on, little has changed and lessons are not being learnt.
Take the housing market. The American government’s effective subsidisation of mortgages, through its feckless mortgage backers Fannie Mae and Freddie Mac, ultimately poisoned swathes of the world financial system. Government inevitably ends up buying or guaranteeing the mortgages the private sector does not want to have.
Yet as recently as April the Australian government indicated it would buy another $4 billion of residential mortgages. This mortgage-subsidy programme began with $8 billion in late 2008 to “reinvigorate” the Australian mortgage market. It was supposedly “a temporary initiative that responds to highly unusual conditions” — as temporary as the decade-old first home buyers’ grant it seems.
It is neither right nor prudent to use taxpayers’ money to facilitate housing loans to people who could not otherwise get a loan. If people cannot yet borrow from private lenders they should wait until they have a bigger deposit.
The financial crisis was also a reminder that large banks, unlike other large companies, enjoy a government guarantee against failure. This means they can borrow more cheaply, and have an incentive to engage in risky activities. Large profits accrue solely to the employees and shareholders. Large losses, on the other hand, are met by taxpayers and the resulting credit crunch reverberates throughout the entire economy.
To deal with the implications of big banks, global financial regulators have this month finalised a new set of capital standards, known as Basel III. Far from wholesale reform, however, the new standards are largely tweaks of the existing arrangements. And their full implementation is a leisurely eight years away.
The 8% minimum capital ratio, which stipulates how much money banks must keep aside as a buffer in case of bad times, won’t be changing — although what counts as capital will be better defined. It will, however, be augmented by an additional “countercyclical capital buffer”, which national bank regulators will adjust according to the “state of the credit cycle”.
In reality, a nebulous unobservable concept like “the credit cycle” will be of little help in working out how much extra banks should keep aside. And regulators will face a political backlash if they decide to increase the capital ratio: ‘working families’ would be ‘punished’ with fewer loans or higher interest rates. It would have been better to permanently increase the capital ratio at the outset.
The elephant in the trading room — that many banks are too big to fail — looks set to drift off the agenda. Yet it is the most fundamental problem with the existing financial system. And it is not only a foreign affliction. It is patently obvious that Australia’s four major banks are too big to fail, which means Australian taxpayers subsidise them, including their more risky proprietary-trading and speculative activities.
Publicly guaranteed private companies should not be part of a free market. As both Mervyn King, governor of the Bank of England, and Alan Greenspan, former chairman of the Federal Reserve Board in the United States, have suggested, if banks are too big to fail, then they are too big.
Ideally, the government’s promise not to rescue banks would be credible. Unfortunately, in a democracy, it never will be. The free-market solution is therefore to offset the benefits to private banks from their guarantee and try to curtail the perverse incentives created by it.
It is therefore ironic that Adam Bandt, a Greens MP, is calling for a “too big to fail” levy on Australia’s major banks. How any such a levy were designed would be crucial. But given Australia’s major banks do not even pay a fee for the government’s $1 million deposit guarantee, some scope exists for some type of compensation for taxpayers.
The most likely outcome, however, is that little will change. For Australians the GFC was a foreign spectacle more than a genuine economic crisis. That is unfortunate, because the problems created by explicit and implicit subsidies are no less real simply because they do not manifest themselves at a particular time.
The reason we have 4 big banks who are too large to fail is that everyone else fell off the face of the earth during the GFC. The idea of the government buying billions of Residential Mortgage Backed Securities is so smaller lenders like Credit Unions and the like can at least try and compete with them and try to bring back some form of competition to the banking industry.
They let Commbank swallow Bankwest and 1/3 of Aussie home loans. They let Westpac swallow St George, Bank SA, RAMS and others. Short of forcing a de-merger I think them stimulating the RMBS market is about as positive as it gets.
By the way nobody ever said these loans were to people who can’t afford them – sub prime loans don’t exist in Australia.
The concept of a punitive (possibly scaled to % market share above a certain level) levy on banks has some merit to remove some of the financial incentive to grow to a massive percentage of the market. If nothing else it means that the goverment ie taxpayers get some benefit for footing the risk of having to bail out the ‘too big to fail’ banks.
It would be much easier to legislate than to try to legislate for demerging the banks down to a certain percentage of market share and could be phased in to reduce impact when it is introduced.
Of course, the big banks would just say that they have to pass on those new costs to their customers… but at least then it is the customers paying via their products rather than as taxpayers indirectly by tax. And the little banks, if they exist, should have an advantage by not having those costs to pass on.
Possibly something that should be considered for other industries where the collapse of a major player would have major economic repercussions and be a candidate for a bailout. Consider the car manufacturers in the US, bailed out I assume because of the massive unemployment that would occur if such large manufacturers went bust.
Companies are consolidating in all industries, we should consider the risks of having players larger than a certain size.
Don’t demerge the Big Four, just require them to split the gambling industry from the banking industry.
The private desks and anything too complicated for a Y12 student to understand can belong to the shareholders, win, lose or draw. The basic banking, including the home loans business, would go the other way, share splits, new boards and all. The Government has no interest in standing behind the former, only the latter.
If the Big Four (or even one or more of the Big Four) don’t like that arrangement, then they can stand on their own feet.
Of course, the incumbents will squeal like stuck pigs. They would lose control of all that nice safe domestic and housing money which is currently the foundation for the gambling (“investment”) operations which are used as justification of the CEO’s huge salaries, while the branches are downsized and hollowed out.
Adam Creighton attempts to pin the blame for the GFC on the US Government backed Fannie Mae and Freddie Mac. This despite the inconvenient truth that the major US private lenders experienced far higher default ratios on their sub-prime books than did these two institutions. The relevant statistics were publicised some weeks ago by Paul Krugman; Creighton should widen his reading.
@IAN BROWN – You are correct. That information has been “out there” for some considerable time, but you wouldn’t know any of that from the reporting of our MSM. They have been busy demonising the US Govt backed lenders, the Clinton Administration, and just about everyone else except the main culprits – the private banks in the US. Creighton appears to be following the incorrect line.
BTW, I read somewhere recently that the UK Govt have set up a system where the private banks pay into a mandatory fund – ? controlled by the government – which will be used to bail out any future bank excesses. Can’t remember all the details, but it seemed to be a “once bitten, twice shy” type of contingency. Don’t think the UK government has any intention of bailing any of them out again after the cost of doing so during the GFC.
Perhaps our government should look at this scheme?