Category: Economic policy

Time to guarantee Oz bank deposits

John Quiggin27 Comments

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

The smartest guy in the room?

John Quiggin57 Comments

One thing that really puzzles me about the great bailout plan is the almost universal acceptance that Paulson should be the one to run it, at least until the next Administration. More generally, I’m surprised by the kid-glove treatment he’s been getting in public discussion, even from people highly critical of the plan.

Let’s stipulate that he’s a smart guy. He wouldn’t have risen to the top in Wall Street if he wasn’t. And, of course, if having smart guys running the show was sufficient to ensure good outcomes, Wall Street wouldn’t be in its current mess.

Looking back at the record, plenty of people have observed that, at least in his public statements, Paulson repeatedly underestimated the severity of the crisis. And there’s nothing in the ad hoc shifts between cash infusions, bailouts and bankruptcies to suggest that he has much more of an understanding of what’s going on than anyone else. As Paul Krugman has said, he’s making it up as he goes along, just like the rest of us.

But the bailout plan is something else. The possibility of a meltdown like this has been talked about, increasingly seriously, for the last couple of years. Yet Paulson responds with a three page document saying “I need $700 billion, no questions asked”. Wasn’t there a contingency plan? Or worse still, was this the contingency plan?

Either way, Paulson should be sacked forthwith.

The one-hoss shay (repost)

John Quiggin25 Comments

I thought I’d repost this piece from March readers can make the necessary adjustments.

The Fed’s bailout of Wall Street investment bank Bear Stearns has, unsurprisingly, been discussed in terms of the domino theory. A more appropriate metaphor is The Wonderful One-Hoss Shay . This was a carriage constructed on the theory that a system always fails at its weakest spot.

The way t’ fix it, uz I maintain, Is only jest T’ make that place uz strong uz the rest”.

On the Fed’s current approach, the system is unbreakable, provided that “too big to fail” protection is extended to every significant firm in the system. The result of this protection is that the kind of crisis where the failure of one firm leads to a cascade of failures elsewhere is prevented. But then

First a shiver, and then a thrill, Then something decidedly like a spill,– And the parson was sitting upon a rock, At half-past nine by the meet’n’-house clock,– Just the hour of the Earthquake shock!

–What do you think the parson found, When he got up and stared around? The poor old chaise in a heap or mound, As if it had been to the mill and ground! You see, of course, if you ‘re not a dunce, How it went to pieces all at once,– All at once, and nothing first,– Just as bubbles do when they burst.

That didn't last long

John Quiggin47 Comments

Two days after the US authorities made much of standing firm against calls for a bailout of Lehman, the Fed has announced an $85 billion rescue of insurance company (and large-scale counterparty in all kinds of derivative markets) AIG. There’s none of the ambiguity surrounding Fannie and Freddie in this deal. AIG is not a federally regulated entity, and the insurance subsidiaries are regulated at the state level to ensure their ability to pay out on claims. This is, purely and simply, a case of a speculative financial enterprise that’s too big to fail.

Having reached this point, it’s hard to see how the US can turn back from a massive extension of financial regulation, starting with the derivative markets where AIG got into so much trouble, notably those for credit default swaps (CDS). Along with winding up the affairs of AIG, Lehman and others, the authorities will need to oversee an orderly unwinding of the transactions in these markets which they are now effectively guaranteeing. More generally, it’s time for a partial or complete reversal of the financialisation of the economy that took place after the breakdown of the Bretton Woods system back in the 1970s.

BTW, if you happen to have cash parked in a US money market fund, you might want to read this. (Insert disclaimer about financial advice)

UpdateBrad Setser has the same reaction.

A new payments and savings system?

John Quiggin19 Comments

With US banks, and even brokerage firms like Bear Stearns, being bailed out on a massive scale, and the rating agencies largely discredited, it’s unsurprising that the question of whether governments could do a better job of some of the tasks now assigned to financial markets is being raised again, after a long period when any such suggestion was taboo. Nicholas Gruen had an interesting piece in the Fin, reproduced at Club Troppo, on the possibility of governments mobilising bonds as a liquid asset and using them as a basis for a payments and saving system to compete with private banks. I haven’t had time to think through the details, but the proposal is certainly worth a hard look. Certainly, the kind of knee-jerk anti-government reaction that used to come from the finance sector and its supporters is no longer tenable since their sudden conversion to soci@lism (at least when it comes to rescuing banks).

Carbon taxes vs emissions trading

John Quiggin98 Comments

Now that nearly everyone is agreed on the need for a market-based policy instrument to reduce CO2 emissions, the biggest unresolved question is whether to implement carbon taxes, tradeable emissions permits or some hybrid of the two.

I support tradeable permits, but I’ve never really spelt out my reasons for doing so. It’s important before doing this to observe that the differences between the two approaches are more limited than most of the discussion suggests. Both ensure the existence of a price for CO2 emissions and both can be set up to distribute the costs of emissions in a lot of different ways.

That said, tradeable permits have some significant advantages in my view.
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Garnaut draft report released

John Quiggin68 Comments

The Garnaut Review draft report has just come out. The site is clogged, but I’ve managed to get a copy of the report and press release (I’ve attached the latter here.

There’s a lot of discussion of the Murray Darling Basin where the worst-case projections are about as grim as they can possibly be. My UQ research group (Risk and Sustainable Management Group) did the economic modelling that translated the climatic projections into predicted changes in land and water use. There are big adverse impacts under most of the ‘business as usual’ scenarios. On the other hand, in the projections where CO2 concentrations are held to 450 ppm things aren’t bad, and even 550 ppm would still allow irrigation to continue.

More soon on the policy recommendations. Whether or not the government ultimately follows Garnaut’s proposed model, there’s no doubt that the Review has shifted the terms of debate substantially. Those (like the Federal Opposition) who are tempted to play the issue for short-term political gain will pay a big price in the end if they succumb to that temptation.

The power of persuasion

John Quiggin27 Comments

That’s the headline for my article in today’s Fin, which follows:

After a messy and unedifying process, the Iemma government has finally reached an agreement with the Opposition to proceed with the privatisation of the New South Wales electricity industry. The price of the deal has been acceptance of the Opposition demand for an inquiry by the Auditor-General, Peter Achterstraat.

In most cases, inquiries into policies on which the government is already determined are little more than rubber-stamps. Whatever the desired result, a suitably distinguished former judge or some other eminent person, with appropriately written terms of reference, can usually be relied on to deliver it.

But Auditors-General are a sturdy breed, among the few groups of public officials who have offered significant resistance to the politicisation of the public service over recent decades.

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Bond insurance and regulatory arbitrage

John Quiggin24 Comments

Readers familiar with the Macquarie Group are likely to have several reactions to the news that Macquarie is considering entering the US municipal bond insurance market. First, if Macquarie is interested, there is almost certainly money to be made. Second, much of the gain is likely to be at the expense of the governments concerned, and will involve some combination of regulatory arbitrage and financial engineering. Finally, given its high-risk business model ( Babcock & Brown, the other leading exemplar of this model is trying to stave off the banks as you read this) isn’t it a bit odd for Macquarie to be guaranteeing the debt of low-risk entities like local governments?

[update: Pressure on ratings agencies to treat public and corporate bonds on the same basis is having an effect]

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