Tricky question of getting better banking

by Crispin Hull on September 22, 2017

THE chair of the Australian Competition and Consumer Commission, Rod Sims, has always championed competition as the friend of the consumer. In the past few years he has been especially critical of state-owned utility monopolies and privatisations that lead to monopolies and structures that hurt consumers.

This week, with the interests of consumers at heart, he questioned the “four pillars” policy that prohibits mergers among the big four banks.

He said it could be argued that the “four pillars” policy gives the big four an advantage because they are seen as “too big to fail” and would be bailed out by the taxpayers if there was a crash, so they get higher credit ratings and can borrow at lower interest rates. Against that advantage it might make it harder new banks to enter the market to give consumers a better deal.

Alternatively, Sims suggests, the Government should look at extending the no-merger rule beyond the four big banks to all banks to stop the big four swallowing up smaller banks which can offer consumers a better deal.

Yes, it is a good idea to look at the banking system to see if the rules are still serving consumer needs, but we should be very careful. The stability of the financial system is more important than whether banks are serving consumers. It will not help consumers if the financial system is made less stable.

Australia has been pretty well served by its financial system compared to other countries, as the history of the global financial crisis attests. Sure, we have had our scams and incidents of unethical behaviour, but we dodged the bullet that hit the US and Europe.

A book by Obama’s first Treasury Secretary, Timothy Geithner, called “Stress Test: Reflections on Financial Crises” is quite instructive on how important the financial system is to the well-being of everyone. It also busts some myths on the 2008 crisis and points out some lessons which have still not been learnt in the US, and probably not in Australia either.

Geithner was head of the New York Federal Reserve under Bush and was one of the first to express alarm at the growth of the derivatives market which was one of the main causes of the crash. Finance companies bundled up mortgages into derivatives and sold them. The ratings agencies foolishly gave them AAA ratings, but when the housing bubble burst, the derivatives were near worthless and a chain reaction began.

Geithner wanted a classic Keynesian response: for the Government to push money into the economy, as was done by the Rudd Government in Australia under Treasury advice. But Geithner was delayed by Congress.

Geithner and Obama did a good job of preventing the US from sliding into a big depression. They were greatly handicapped by the Bush Administration’s earlier squandering money on the military and tax cuts for the rich.

In Australia the Howard Government had at least built up some surpluses, even if they squandered quite a bit on tax breaks for the rich.

Anyway, Geithner argues that the US was handicapped by not having enough regulatory tools and by having too many agencies sometimes with conflicting agendas supervising the financial sector.

Australia has more regulatory tools than the US, but it still suffers from a plethora of agencies with supervisory roles: the Australian Prudential Regulatory Authority; the Reserve Bank; the Australian Competition and Consumer Commission, the Australian Securities and Investment Commission and the Financial Services Ombudsman.

The ACCC’s aim is to promote competition which in turn makes things better for consumers. But if you have a whole lot of small competing banks, Economics 101 tells us that some of them will go out of business because they are less efficient or less competitive.

APRA’s aim is to make sure the banks remain liquid, so that they do not get into trouble by lending too much long-term in a way that jeopardises their capacity to repay short-term debt. Many consumers and businesses, on the other hand, like easy credit.

The Reserve Bank’s aim is to keep inflation between 2 and 3 per cent to ensure monetary stability. Sometimes that means higher interest rates which consumers and businesses do not like. And in some ways the Reserve’s monetary policy works better if there are fewer banks, which reduces competition.

ASIC’s and FSO’s aims are to make sure all financial companies behave themselves.

Australia was lucky not to have a huge shonky over-rated derivatives market in 2008. Looking back, many people in the US were angered that a lot of the people who caused the crash rather than going to jail continued to get high salaries and even bonuses.

They are also angered that some of the big banks became even bigger after getting government help, and that their managers have not learned the lessons of managing risk. Indeed, knowing they will be bailed out again they will take even bigger risks.

Geithner, however, makes a couple of myth-breaking points.

First, when you are putting out a fire it is likely that you will inadvertently save some arsonists as well as innocent bystanders – a collateral rescue. That is a price worth paying.

The Obama Administration was condemned by Democrats for not making Wall Street pay and hounded by Republicans for not letting market forces take their toll and letting banks burn rather than prop them up with taxpayers’ money which was tantamount to socialism.

But the let-them-burn policy would have resulted in a depression, not a recession and millions of innocent people would have lost their jobs, houses and security. The Administration avoided that.

Geithner also points out that the taxpayers did not pay. In fact, the Government made substantial profits because it bought shares in banks and car-makers at the low point and sold them after the recovery.

Further, he says that “too big to fail” is a myth. The fact is that if any bank or financial institution fails, even a small one, the knock on effect can be so profound, that Governments move in to protect all remaining banks that pass a stress test with guarantees, mergers or purchase of equity.

So in Australia rather than remove the four-pillars policy, we could remove the big banks’ advantage stemming from “too big to fail” by the Government guaranteeing deposits in all banks up to, say, $100,000. The banks would then pay for that guarantee with a levy that could be used if bail-outs ever became necessary. Then all banks would benefit from a “too big to fail”.

The ACCC and ASIC could then concentrate on weeding out unscrupulous practices and fee and interest gouging.
CRISPIN HULL
This article first appeared in The Canberra Times and other Fairfax Media on 23 September 2017.

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