Matt Nolan

If we have a bank tax, make it a deposit levy

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I argue the deposit levy point (as a form of insurance) here.

The only point I have to add is that some may say “why charge poor old depositors”.  I’d note here that we need to think about the “incidence of tax” – if it is true that depositors have no market power, then the entire burden of the tax will fall on banks and borrowers.

This is all part of a broader debate on deposit guarantees (here, here) – if we rule them out, we rule out the justification for a levy as well.  I’d add there is a big issue I haven’t touched – what is our ability to limit deposit insurance given concerns about “bank stability”, and what do we do when banks are just too big (think Ireland and Iceland).  My real desire is to see transparent, and credible, ex-ante policy … and to be honest about the trade-offs we are facing and accepting.

Either way, my focused has switched back to methodology issues as I’ve realised I need to intensify work on my NZAE paper this year (posts here and here) … in case they actually decide to accept the abstract I’ve just submitted.  As a result, when I next get a chance to sit down there are two posts I want to write about assumptions, and then I might start blogging some of the background material I’ve already written about for the paper.

However, knowing me I’ll just start ranting about whatever I see in the paper instead 😉

Will Taylor

Looking for stock advice? Buy a cat…

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Via @NBR I came across this awesome article on the Guardian about a cat named Orlando that was pitted up against some investment professionals and students in a stock picking challenge. How did the cat pick stocks?

While the professionals used their decades of investment knowledge and traditional stock-picking methods, the cat selected stocks by throwing his favourite toy mouse on a grid of numbers allocated to different companies.

And the results? Orlando the cat unsurprisingly (to anyone who has studied finance and whose job isn’t giving investment advice) earned more money than the professionals.

At least the kids didn’t beat the pros, that would be embarrassing if they did….

jamesz

Anomalies and market efficiency

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Tim Harford points to a paper on the EMH showing that:

…after an anomaly has been published, it quickly shrinks – although it does not disappear.

The anomalies are most likely to persist when they apply to small, illiquid markets – as one might expect, because there it is harder to profit from the anomaly.

It’s always good to remind ourselves that all anomalies are only fully priced in equilibrium, and we’re probably never in equilibrium. The process of moving towards equilibrium involves market participants seeking out those anomalies and exploiting them. So the continued discovery of new market anomalies isn’t evidence against market efficiency: it’s merely observation of the normal equilibrating process.

Matt Nolan

Careful what you wish for

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In a recent column Bernard Hickey suggested the following:

Taxpayers still face the risk of seeing bank losses socialised in future while today’s profits are privatised.

A more honest solution would be for the Government and the Reserve Bank to openly state that a bailout would not occur. Term depositers would demand a higher return to compensate for the higher risk, and it would remove the moral hazard that currently subsidises the profits of Australian banks.

Now lets be a bit careful here.  Yes there is an implicit government guarantee of banks – in fact the way to look at it is through the lens of a deposit guarantee, when it comes to the big banks the New Zealand government will not allow depositors to lose out.

The logic behind this is the fear of a bank run.  The reason we hadn’t had a financial crisis  on a global scale between the Great Depression and 2007 was largely due to the implicit deposit guarantees that soveriegn nations had put in place during the 1930s.  Even if these were not always “explicit” they helped prevent runs on the banking system, which engendered confidence and prevented financial crises.  One key reason for the GFC during 2007-2009 was the sudden change in behaviour by governments – where they were showing themselves suddenly unwilling to provide this insurance on the basis of “moral hazard”.  It is true that issues of moral hazard had helped to drive risky lending, but it was confusion around where the burden of debt fell and a lack of clarity around who was “implicitly insured by government” that led to a run on wholesale financial markets and the financial crisis.

The “solution” to any perceived issue in our banking system is not to get rid of deposit guarantees, and it is not to remove the implied subsidy that this may provide to the New Zealand banking system.  It is to ensure that banks in turn face this cost during the rest of the cycle.

The RBNZ’s desire to set up the OBR is based on a desire to prevent bank runs, while also making who bears the burden of a bank failure “fairer”.  They are trying to ensure that we don’t have a financial crisis, while minimising the cost associated with “moral hazard”.  This is preferable to forgeting the lessons of the Great Depression and GFC, which is what we would be doing if we were to completely pull away from the implicit back stop of the banking system.  Trust me, I don’t like implicit insurance for industries myself – but financial markets are one area where such things need to take place, and as Hickey says they have to take place in a transparent manner.

Matt Nolan

A summary of credit creation

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This post on VoxEU gives a neat summary of the credit creation process, and the ways that collateral chains have had an impact on the process.

I’m not going to reiterate the post – as it is concise, and if you are interested it would be a good idea to go and read it.  However, what I will say is that this is akin to the standard view of credit markets – essentially at a given point in time assets and liabilities match across the market, but the more convoluted the chain, the more vulnerable financial markets are to an uncompensated change in asset prices.

Matt Nolan

Sigh, more like SCF?

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So this isn’t what I wanted to hear:

Mr Key also warned that other finance companies may go under and the government would continue to look after investors by keeping the guarantee on investments in place.

I think he meant:

Mr Key also warned that other finance companies may go under and the tax payer would continue to take on all the risk for investors by keeping the guarantee on investments in place.

Look.  I had no problem with the idea that we needed to do something in wholesale markets during the credit crisis to prevent an effective “bank run”.

But the two problems with keeping this going now is that:

  1. This problem is gone now,
  2. Given the fact that funds flooded into risky assets after the guarantee there is a definite case that we should have done less.

Contrary to what Kiwiblog said that “It is easy in hindsight to say that one should not have had the guarantee scheme, but in late 2008 the wordl financial system was on the brink of possible collapse, and pretty much every OECD country did much the same as a stability measure” I think it is perfectly fine to critique the scheme.

Why?  Well we KNEW there were issues with our finance firms, and we stuck them into a scheme rapidly without doing due diligence on a whole lot of the stuff.  And we made this f’ing critique AT THE TIME – so we are allowed to make it now 😉

Lets just think here for a second.  Effectively government was taking on all the risk, so why weren’t the insurance premiums insuring that all the return also went to government?

If it is hard to observe the price, couldn’t we have just said that people who entered the scheme couldn’t increase lending – this would have allowed the scheme to protect deposits without leading to the “increased risk taking” that has taken place.

Bah.