Both Ireland and Greece have now moved to guarantee all bank deposits, while the US bailout bill increases the FDIC guarantee to $250 000 for individual accounts at any institution (meaning that anyone willing to hold accounts at four different banks can have $1m guaranteed).
I’ve never seen the merit in the RBA stance of refusing to give an explicit guarantee, while allowing everyone to think that bank deposits are unconditionally safe. I suspect an explicit guarantee will be needed before long, and that it would be better to announce it now, before it is needed.
The quid pro quo, necessary for a whole lot of other reasons in any case, ought to be a tightening of regulation on anything a bank might do that would increase the risk of default. That includes owning high-risk subsidiaries, participating in innovative derivative markets, and taking on off-balance sheet contingent liabilities, among the factors that have contributed to recent collapses overseas.
Updated In the spirit of laissez-faire, I’d be happy to allow for competing unregulated and unsupported deposit-taking institutions. To avoid the danger of moral hazard, I’d require the following
(i) There should be a legislative prohibition on any form of support for these institutions from the government or regulators
(ii) Publicly guaranteed banks should be prohibited from having any dealings (loans, shareholdings, bond purchases and so on) with unsupported institutions
(ii) Customers should be required to sign and regularly renew an agreement stating that they are aware that there is no possibility of a bailout of deposits with these institutions
John Quiggin 
CBA, and I’m sure all the others, hold a shipload of derivatives ($1.4T) which they class as assets – a couple of nasty surprises could see them short of capital
Ironically the situation to date would suggest that relative to the Americans the RBA has done a better job in the stances that it chooses to take.
People possibly think that deposits are unconditionally safe because we have a government run central bank. It might help if we got rid of the central bank. Barring that the RBA could advertise the situation better. It could require the banks to hand out a pamphlet from the RBA every time somebody opens a bank account which outlines the fact that deposits are not government guaranteed and like any investment there is a risk involved.
I’ve wondered for decades how you managed fiat money without actually supporting it — you know, by fiat and guarantee and regulation — at your central bank for borrowing money from.
If you’re going to have a money supply supported by fractional reserve banking, how do you do that without actually — being there? Obviously, by leaning on someone else’s currency.
But you’re a serious country now. You’ve got Russell Crowe, Tim Flannery, Rupert Murdock. Have your own currency and support it. Rock the boat.
Gave us yanks a run. I’ve noticed you’ve got a lot of sun per capita. What does solar power actually look like? Can you make that work?
/ehj2
Just an old guy hoping somebody new will have some sense.
ehj2,
You’d reckon the way we like to big note that we could guarantee bank deps.
However, the “Pacific Peso” is acting more like the “plugged peso” of late.
BTW if wind power is mainly air, solar power is mainly hot air.
CO2 polluted, of course.
TerjeP says, “It might help if we got rid of the central bank.”
This is akin to saying, “A tall ship would sail better if we got rid of the mainstays and let the masts stand or fall on their own.”
No doubt the ship would chart a better course if we also got rid of the captain, the navigator and the helmsmen whilst simultaneously downsizing to a skeleton crew which could only suffice in the finest and fairest of weathers.
The captain and all officers with their store of sailing knowledge could be replaced by a board of know-nothing generic mangerialists who would draw double pay and talk obscurantist nonsense during endless meetings round the captain’s table. The ship would soon go down with all hands… like the good old USS Lehmen Bros for example.
The charge of British depositors back to state owned banks (newly state owned due to state rescue) shows that there is not only a place for state guarantees for deposits but also a place for a state owned back.
This collapse won’t be all bad news if it leads to the re-nationalisation of the Commonwealth Bank… and Telstra… and the Post Office… and all power generation and infrastructure. It’d be a good outcome and put us into a position to tackle the coming energy and climate crises with strategic assets and strategic planning and action capability back in the hands of the democratically elected government where it belongs.
Then at least we might reclaim our country as a true Commonwealth, a common-wealth run for the common weal. Let us hope that the coming crisis destroys corporate capitalism before corporate capitalism destroys us (and the world). A more responsive and restrained capitalism with proper democratic oversight and strategic planning control will serve us better. We gave the corporates their head and they failed us utterly.
Guarantee Bank Deposits?
Grrrrr! not likely. If economists propose a ‘free market’ mechanism, or ‘freemarket’ economics, then this is high hypocrisy.
The ALP and Libs both privatised the Commonwealth Bank, and every(?) State Bank. This was the act of betrayal that university academics of the era all proudly cheered and clapped.
To now divert taxpayers funds to mend a broken bank flies in the face of all previous public policy by our previous generations of suited ‘hollow men’.
Australia needs a fundamental rethink of economics and, instead of feather-bedding corporate banks, we should look to reinstating government guaranteed deposits in a publicly owned and regulated institution, and then let customers decide where they want to bank.
Australia has developed new banks when required (devfelopment banks, rural banks etc etc), so it can be done now.
Given a dogmatic capitalist economy and given the freedom they had to pay executive salaries and dividends to shareholders, it is now morally impossible to subsidise their, debt ridden, broken balance sheet. Free marketeers have to learn the lesson of the market.
You cannot have one economic theory for the good times, and the opposite for the bad, particularly when the good caused the bad.
A new public funded, government guaranteed institution would be a much better solution.
Chris Warren
“The ALP and Libs both privatised the Commonwealth Bank, and every(?) State Bank. This was the act of betrayal that university academics of the era all proudly cheered and clapped.”
Not all, I think.
http://www.google.com.au/search?client=firefox-a&rls=org.mozilla%3Aen-US%3Aofficial&channel=s&hl=en&q=quiggin+privatisation+commonwealth+bank&meta=&btnG=Google+Search
Fair enough. But at least give the consumers a transparent system where the rate of return on their deposit gives an appropriate signal of the amount of risk involved. The recent failures of the free markets have been because the risks were not properly assessed and signalled. Ultimatley free markets are doomed if they are built on lies and deceptions.
Fair enough, but, in effect – all.
I am sure there are exceptions – Bruce MacFarlane, Ted Wheelwright, Pusey, Langmore, Stretton …
There were a few others scattered about the (now defunct New Left Party), eg Hamilton, Stilwell, and a few graduate economists in some Departments.
but – in effect – privatisation was the policy of the profession and the dogma of the discipline.
John Stone’s article “The Critics of economic rationlism” in “A Defence of Economic Rationalism” (Allen and Unwin, 1993) is worth re-reading.
Chris Warren: That is an excellent post.
The idea of a low return , no risk, government backed bank would appeal to many people.
Older people for instance might be interested in depositing their money in such a place on the proviso that it was lent out to young people starting out.
Both Ireland and Greece are in violation of EU law.
The Greeks have pulled back to a “political commitment” and the Irish are under a ton of pressure to modify even from within, as all the cash piling into Irish banks is UK Stirling which makes the tiny Irish nation underpinning a larger nation with a different currency.
As for the rest, I heard of voices of complaint from the Governments when the banks where sending massive tax cheques their way. Maybe casue they were in on it too.
To be a little clearer, Chris W., I put forward precisely this idea here
http://www.uq.edu.au/economics/johnquiggin/JournalArticles01/CBAPrivatisation01.html
Very good. Was this an example of the Left winning the argument but loosing the battle?
“we should look to reinstating government guaranteed deposits in a publicly owned and regulated institution”
Hmmm..sounds very interesting Chris Warren. What real rate of interest would you suggest I get on my savings bearing in mind presumably I would be able to redeem the capital I lent in real purchasing power too. Is that what you mean by ‘Govt guaranteed’, bearing in mind that the RBA deliberately target a 2-3% annual purchasing power reduction in any money lent out at present. If I decided to deposit it with another non-guaranteed institution, would I only pay tax on any real gains there too?
Or is it really a case of swings and roundabouts if my capital and returns are real ‘Govt guranteed’ and I find my taxes continually rising to ensure said guarantee. A bit like the US Govt overseers of the value of all things monetary past and present. By my reckoning that US$810bill bailout err.. Govt guarantee, is now an immediate tax liability of $6600 per private sector worker (122.7mill of them) when their average weekly wage is $610.51 or $31746 pa now according to average hours worked and average hourly rates. There are of course around 353 mill Americans to be fed, albeit some of those are self funded and don’t need to raise a sweat.
Acrually we’d call private sector workers here-
http://www.bls.gov/news.release/empsit.nr0.htm
private sector employees. From the figures I doubt employees will be footing that bill. Rather it will be the self-employed and self-funded as usual by the looks of those figures. As I said, swings and roundabouts, no doubt.
Not even slightly akin.
What I said was that people might be less inclined to imagine that their deposits are government guaranteed if there was no government run central bank. Which is akin to saying that people might be less inclined to imagine that the ship over there is going to sail one day if you took down the mast.
Observa
Interest rate should be sustainable. In other words it should reflect some appropriate share of the growth rate and should be set by an umpire, not by credit-drenched bidders.
In theory this would work in a closed economy, so other issues naturally arise.
I reckon most savers would just settle for their savings maintaining their purchasing power Chris, without considering any real return for the time use of consumption forgone.
Until recently a few years ago, I figured all bank deposits were “safe”. It’s amazing to find that in Australia there is no govt guarantee of banking deposits. The UK have just increased theirs to 50,000gbp and that is not enough (though people will probably open multiple accounts and spread their money around).
Here in Australia I reckon most folk thing that banks are as safe as … houses. It’s ironic because most of us are probably aware that the housing market doesn’t have a rosy future here.
Thankfully there is a precedent of deposit “bailouts” by state govt – in the case of Bank of SA and Pyramid Building Society. I am not sure if there was a cap on deposits “insured”.
Unfortunately, the govt recently announced that it was contemplating a $20k deposits insurance scheme for Australia. They reckon it would cover 80% of account balances. This is not nearly enough to prevent panic. In addition, by merely mentioning that perhaps up to $20k will be safe in the future, it only makes it clear to savers that their deposits are currently at risk.
We don’t have anything like NS&I or Northern Rock here in Australia. The closest I know about is govt bonds. It’s the only way I know of to “bank” with the govt.
I feel nothing but protected! As all of my deposits are negative, I would be only too pleased to see them disappear.
Guarantee of OZ bank deposits” almost says, of course without saying it to avoid a bank run, “people its OK to leave your money in any bank even the insolvent ones because our government guarantees your deposit. You no longer have to think about which bank has the safest deposits because of course your are not capable of understanding the banks complex funding structures. Balance sheets and P & L’s no longer provide you with the true complete picture of the banks financial position. Life at the bank is much more complicated than could possibly be explained by a Balance Sheet or P & L.”
The banks of course love the guarantee. They no longer have to justify there solvency to its depositors. Even the poorly run banks are backed by the government guarantee so that means individuals have less cause to find the best operating banks. Meanwhile the poorly run banks continue to rot the financial system. Of course if I thought a bank was insolvent I would remove my funds to a better operator except my deposit is underwritten and the interest on my funds are greater then with the more conservative solvent banks.
A government backed guarantee on deposits is a Moral Hazard.
In regard to Laizzes-fair banks (L-F-b) running side by side with GSE banks. Why would you bother. The US financial system has collapsed on the back of the biggest moral hazard of all time, Fannie Mae and Freddie Mac.
Here are a few scenarios.
A L-F-b sets up in the same market place as a GSE bank. To compete in the mortgage market the L-F-b must provide at least the same competitive rates and services as the GSE. Of course in this market the people will avoid the L-F-b because their money deposits are not guarateed. If the L-F-b goes ahead and decides to compete directly with the GSE anyway it will be difficult to scource capital as no investor in his right mind will invest in it knowing GSE have special government privileges and oversight. It is quite a risky proposition. So JQ cannot accept this warped Laizzes fair offer.
But how about a L-F-b with boutique services. It charges more fees but in return the customer is rewarded with service and greater more secure returns. The L-F-b Targets well informed individuals or companies who are astute enough and interested enough to get the most out of their money. The bank provides innovative financial services and low risk investment models. The bank has transparent books and understands that its products, services and solvency are critical to its success and profitability. This bank continues to grow on the back of its quality products and services as well as its trasparent books.
One day, it dawns on the GSE banks that they are loosing business to the L-F-b. The collective scream with envy “how come we can’t give the same services as the L-F-b customers do”. So with government backing the GSE provides the same services but of course with special government priveleges and oversight. The L-F-b is no longer profitable as it cannot compete. The moral Hazard is back with a vengance. The GSE tends to hide the business risk/cost asscosiated with boutique banking and secondly the risk is borne by the government employees who are unlikely to pay the same price as those in a private enterprise.
I don’t think it would be possible under many circumstance to run an L-F-b in a market place were GSE coexist. The intrinsic moral hazard of GSE reduces the possibilty of a true L-F-b ever co-existing with a GSE.
Ubiquity,
If the govt guaranteed deposits across the board, then it wouldn’t create an unfair competitive advantage for what you are calling “GSE” bank.
The problem is that there used to be an implicit understanding that all deposits were guaranteed here in Australia but, with the govt recently announcing that it was contemplating a $20k deposits insurance scheme, that implicit understanding cannot be relied upon any longer.
Unfortunately, I am completely in cash now so I am pretty concerned :). I wish I just had debts like BilB :). They’d have to be old debts over some decent assets though!
I guess I have the answer to my question about CBA. Per comment #1, CBA apparently also has some 1.4T of “nasty” derivatives.
The idea of a ‘deposit insurance’ is still around, I hear. Isn’t it obvious by now that the only ‘agent’ who can provide deposit insurance is the society at large as represented by the government. Specifically, every $1 deposit lost by private banks is replaced by $1 issued by the monetary authority.
Good post – agree deposit guarantees are going to become more important. But your point about counter-party risk is critical, guaranteed institutions need very tight regulation so they do not risk public funds unnecessarily. Nationalising the banks (again) is a big step for us as a country.
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