Economic policy

What I thought about deposit guarantees in 2006

John Quiggin11 Comments

Here’s a piece I did for the Australian Institute of Company Directors in 2006 (actually, in 2005, but it came out later). I think it covered most of the main points that have arisen in the debate over deposit guarantees.

Embarrassment alert Thanks to a system failure, the link wasn’t saved but reader Tintin found it here. Before that, SJ found a piece from 2002 which has (ahem) a bit of overlap with what I published in 2006. The second piece does have some refinements, notably explicit support for narrow banking, but I didn’t learn an awful lot on this topic in the intervening four years.

11 thoughts on “What I thought about deposit guarantees in 2006”

  3. I predict that he said something like:

    But the medical insurance panic would be nothing compared to what might happen if, in the midst of a liquidity crisis at a major bank, one of our socially responsible talk-show hosts suddenly discovered that there was no government guarantee for bank deposits. This happened on a small scale in the 1970s, forcing NSW Premier Neville Wran to take a loudhailer into the streets to stop a run on a building society.

    Once a panic of this kind is under way, any equivocation on the government’s part is fatal. Once again the disastrous experience of state regulated building societies provides an example. When the Pyramid group got into trouble in Victoria in the early 1990s, the Cain Labor government tried to hedge its bets on whether deposits would be guaranteed. The resulting climate of panic helped to bring down both the government and the Victorian economy. And, in the end, the government had to pay out anyway.

    Even with a prompt and unequivocal response, situations like this raise the question of where lines are to be drawn. If ordinary bank deposits are guaranteed, what about certificates of deposit? If certificates of deposits are included, what about the share parcels marketed by banks? What about the ‘Mum and Dad’ shareholders of the bansk themselves? The only way to prevent panic is to spread the safety net as wide as possible, and far wider than would have been required with an explicit, and explicitly limited, guarantee.

    Many of these problems would arise to some extent even in the presence of an explicit system of deposit insurance. But nearly of the problems with deposit insurance, such as moral hazard, apply in spades to the implicit insurance in force in Australia.

    The real reason we do not have deposit insurance is that the big banks are unwilling to pay for it. The main cost is not the premium but the more intrusive regulation that would obviously be justified once the government was explicitly identified as an insurer.

    One might ask how such a situation could arise, given that the whole system of prudential regulation was reviewed by an eminently-qualified commitee (the Wallis committee) as recently as 1997. In fact, the Committee’s 1996 Discussion Paper did suggest looking at deposit insurance, but the idea was howled down so effectively that it made no appearance in the final recommendations.

    In principle, a deposit insurance scheme could be run either by the government, as in the United States, or by a private insurer, as in Germany. For expert advice on the options, I spoke to Ian Harper of Melbourne University, Australia’s leading banking economist and a member of the Wallis committee. Harper’s view was that private deposit insurance could play a useful role as a ‘front-line’ of defence against minor problems, particularly those affecting smaller institutions. However, the Big Four banks are too big for reinsurance, and too few in number for mutual insurance on the German model. Hence, the system must ultimately be guaranteed by government.

    In the current atmosphere of global financial crisis, a banking panic could emerge with very little warning. The sooner Australia moves to an explicit system of deposit insurance, the better.

    Which is what he said in 2002.

  5. Regarding the “embarrassment alert”:

    There’s no cause for embarrassment, John, apart from the trivial one of the missing link.

    You said something sensible in 2002, said the same sensible thing in 2006, and now here we are in 2008, dealing with the problem you said should have been dealt with in 2002.

  6. deposit insurance is morally wrong. are we a capitalism, or not? of course we are.

    no wishy washy socialism here. plenty of randomly applied patches on the raddled face of our glorious free market economy, though. that’s (democratic) socialism: “power to the people!”, furry faces, and bandaids on the rotting corpse of capitalism, aka ‘law of the jungle’ in economic mode.

    ah, current head concubine has delivered my morning cup of coffee. i will soon be able to smile at humanity’s utter inability to run a rational, stable, fair, and sustainable society.

  7. I suppose, al loomis, the society is run ‘rational’ if it satisfies your preferences.

  8. No, no, no,
    ernestine.

    A society is rational if and only if it has citizen-initiated referenda.

    If you disagree with Al on this you are a mindless slave groveling at your master’s feet and begging for the privilege of licking his boots.

  10. ernestine, and damocles: i do believe you are catching on. please be a little more measured in your agreement though, as i have suffered from parody, satire, irony and simple monkey laughter, leading to paranoia.

  11. Wasnt the old AIDC a guaranteed deposit system run by the government? (Australian Industry development Corporation)I do know capital was guaranteed and it was like a bank.

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