Matt Nolan

A run on finance companies – but not in the direction you’d expect

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So investors are “rushing” to finance companies to invest money.  One of my economist friends just told me he tried to invest money in a finance company, just to be told that they were “over-subscribed”.

I have two concerns stemming from this:

  1. Moral hazard:  Finance companies will invest in higher risk ventures to get the return – knowing that there downside is covered by the government.
  2. Bank funding:  Given suggestions that banks may face a funding crisis, a movement of funds from banks to finance companies can’t be a good thing 😛

I suspect that Bank’s decision to charge a premium based on the quality of investments will have some impact – however, is the premium high enough to solve these problems?  I guess we will know once we see the new set of deposit rates that finance companies come out with.

Matt Nolan

Random statement of the day

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This from the Minneapolis Fed:

Thus, roughly 80 percent of such business borrowing is done outside of the banking system. The claim that disruptions to the banking system necessarily destroy the ability of nonfinancial businesses to borrow from households is highly questionable

There are two ways I can read this quote, one that I agree with and one that I dispute. The first way is that “this isn’t the end of the world” – I agree with this, and I still think that people too closely linked to the financial markets are expecting worse outcomes for the global economy than will actually occur.

However, I think the Minneapolis Fed’s paper overplays it a little and suggests that there is no credit rationing element – only a risk-price element.
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Matt Nolan

Does the Bank see petrol prices as anti-inflationary?

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According to their recent official cash rate decision they might:

The reduction in domestic spending will be partly offset by the depreciation of the New Zealand dollar over the past few months, falling oil prices (emphasis added) and the recent loosening of fiscal policy

Now I have no problem with this view – hell we have discussed the ambiguous nature of oil prices on inflation before (here, here, and here).  However, our conclusion was that the net impact would be zero – not the negative relationship the Bank is implying here.

This is consistent with the RBNZ’s strong focus on the “demand” side of the economy ahead of any “supply” side effects – and indicates that any sharp increase in retail sales (given recent declines in oil prices) could put the Bank back into pausing mode.

I think this is actually a fairly substantial point – it tells us that as well as watching the labour market numbers, we need to watch retail numbers in order to get a handle on future movements by the Bank.

Matt Nolan

Arnold Kling rips into economists

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Over at Econlog Arnold Kling takes to task virtually all mainstream Macroeconomists for there “description” of the current economic crisis. This combined with my reading last night on reductionism in economics (I think it was Robert Frank Kevin Hoover – although I have now forgotten as it was an essay in a larger book) currently has me on the back foot – even though I’m a strong methodological (and even an ontological) individualist there are obviously issues with the current application of reductionism in economics.

However, let met put down some of the key bits from the Kling.

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Matt Nolan

We now have insurance based on risk!!

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Thanks goodness – they have changed the deposit insurance scheme such that the premium depends on risk!!!!

We have discussed that here (*, *, *, *).

Also they have capped the amount you can insure at $1m – very good.

The one concern left is the wholesale market. With no wholesale insurance available the wholesale market for funds is threatening to dry up. With many other countries doing it we have a problem – because of other nations choice to insurance wholesalers domestic credit for banks could dry up.

However, I would like to point out that there is unlikely to be a “bank run” on wholesalers, and as a result if they were willing to pay market rates for private insurance I’m sure they could get it – as a result in of itself government wholesale insurance is not a good idea. As a result, the only reason for doing it would stem from this “international prisoner’s dilemma” – something the Bank must not see as a sufficient threat.

Matt Nolan

NZ Rate Cut October 2008: 100 Basis points

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So the OCR is now down to 6.5%. This was in line with market expectations given recent credit market turmoil.

According to the statement “ongoing financial market turmoil and a deteriorating outlook for global growth have played a large role in shaping today’s decision” – consistent with the view of the market

Although I was unimpressed by this statement:

With weaker short-term growth and sharply lower oil prices we now expect that annual CPI inflation will return to the target band of 1 to
3 percent around the middle of 2009

Given that a drop in CPI growth as a result in a fall of tradables does NOT imply that the Reserve Bank is achieving its mandate, they partially made up for it with this:

However, we still have concerns that domestically generated inflation (particularly in labour costs, local body rates, electricity prices and construction costs) is remaining stubbornly high

Non-tradables is a problem – we have had a recession and they haven’t declined. The Bank does need to ensure that non-tradable inflation goes below 3% before it can be confident about heading into easing territory.