Nationalising the banks

This week is a big week for the banks in Australia being the annual reporting time when they are forced to disclose the remuneration packages that they pay out to their management. The banks have been under attack – again – for gouging their customers with spurious arguments about rising costs and falling margins. While some of their costs may have risen from the rock-bottom levels before the crisis, the evidence does not support the narrative that the banks are now presenting to the public as a precursor to further gouging. The big debate though – which is simmering – is about the purpose of banking in a monetary economy. Essentially, banks are public institutions given they are guaranteed by the government. But there is a tension between their public nature and the fact that the management of the banks claim their loyalty lies to their shareholders (and their own salaries). This tension has led to the global financial crisis and its very destructive aftermath. However, while the real economy still languishes in various states of decay, the financial sector has bounced back under the safety net of the government’s socialisation of their losses. How long will all of us citizens tolerate this? The solution to the tension is to socialise both the gains and losses of the banking sector. In that sense, nationalisation of the banking system is a sound principle to aim for. This would eliminate the dysfunctional, anti-social pursuit of private profit and ensure these special “public” institutions serve public purpose at all times.

I have noted in recent weeks the claim emerging that the leading proponents of Modern Monetary Theory (MMT) appear to adopt contradictory positions in terms of the juxtaposition between the responsibilities they ascribe to government (full employment, public purpose etc) and the fact we do not advocate curtailing the capacity of banks to create loans (out of thin air).

I have found that a curious argument and also one that reflects a less than complete reading of our body of work. But as a teacher I should always realise that if someone is not “getting it” then the first question I have to ask is whether I have explained it clearly enough. Then I have to ensure I have provided enough reference material to support the pedagogy and if all that fails and I am sure that I have communicated clearly then I will conclude that the student is the problem.

So this blog is about banking. Not a complete story (given I am short of time today) but an account of what I think should happen to banks and banking. Note that this account is interpretative rather than a statement of MMT principles. It reflects my preferences based on my understanding of those principles. But equally, someone with a similar understanding might choose a different policy path.

At the outset let’s cut to the chase – I would nationalise all private banks.

In doing so I would be eliminating the largely unresolvable tension that exists in the current system where banks occupy a special protected place and are not really allowed to fail by dint of government support (implicit or otherwise) yet at the same time behave just like risk-taking entrepreneurial firms, paying exorbitant executive salaries and skewing their operations to the interests of their shareholders.

The tension between the public nature of banking and the intrinsic social role they play and the greedy pursuit of private profit – or the privatisation of profit and the socialisation of loss – is palpable and unsustainable.

Socialisation the profits and loss and steering the activities of banks 100 per cent towards the advancement of public purpose would go a long way towards eliminating the worst features of the banking system which culminated in the global financial crisis.

The crazies will argue that this is the first step towards communism. Perhaps it could be but the nationalisation of banks doesn’t imply that at all. It just means that a key social institution is serving only one master – the public rather than compromising its public charter to line the coffers of their private owners.

An Australian government tried to nationalise the banking system in 1948 but the legislation was challenged by the Bank of New South Wales. The challenge – Bank of New South Wales v The Commonwealth (1948) 76 CLR 1 – which was also known as the Bank Nationalisation Case was decided upon by the High Court in Australia. The court ruled that the Government’s plans were unconstitutional.

The High Court ruled that the nationalisation of private banking would violate an individual right to engage in particular types of trading and commercial activity. Under section 92 of the Constitution, there is deemed to be constitutional freedom of interstate trade and commerce. The Court ruled that the banks had a right to engage in interstate banking which would be lost if there was nationalisation.

Interestingly, this interpretation of section 92 of the Constitution has now been overturned in the Cole v Whitfield case in 1988. So the old grounds for opposing bank nationalisation are now no longer available.

The High Court also ruled that there was a failure in the proposed legislation to provide “just terms” for compensation to the private owners. This was deemed to be in violation of section 51(xxxi) of the Constitution which says that government would provide adequate compensation for compulsory property acquisitions. So this finding did not find that nationalisation violating any principle – it was just a case that the specific legislation was not generous enough.

You can read the full decision of the High Court HERE.

So it is entirely possible from a constitutional perspective for the national government to nationalise the private banks. I recommend it. I also note that many banks in other nations have effectively been nationalised as a result of the crisis. It is clear that once the banks can trade profitably again the government will allow them to privatise the gains after bailing them out of the losses. I find that an obscene aspect of the government intervention.

A classic demonstration of how the commercial banks in Australia work against public purpose is to be seen in the current debate over mortgage rates. Traditionally, the banks have passed on the policy rate changes proportionately. In recent months, the banks broke that tradition and hiked their rates more quickly, citing rising funding costs.

The evidence does not support their claim and rather supports the fact that these government guaranteed institutions are gouging their customers. There is a long history of prohibitive charging by the banks following deregulation.

Indeed there is a huge class action underway at the moment which seeks to make the banks repay all the fees they have illegally deducted over the last six years, plus interest. The case is likely to succeed. I am part of that class action along with 230,354 other account holders.

There was an excellent article in the Sydney Morning Herald last weekend (October 23, 2010) by Ian Verrender – Other side of big banks’ sob story doesn’t add up – which challenged the notion that the banks are nothing more than bloodsucking institutions that do little to advance public purpose.

Verrender (who is a financial commentator) demonstrated why the bank’s claimed “need to raise mortgage rates over and above the Reserve Bank official cash rate” which is based on the alleged higher funding costs from offshore borrowing is flawed. He notes that only “half their funding comes from Australian sources” which is thus exposed to the higher domestic rates and cannot then justify increasing rates above the RBA hikes.

He concludes:

The other way of looking at it is that by passing on the full rate rise they actually are gouging the hell out of their customers. By passing on the full 0.25 percentage points they are more than making up for any increase in offshore funding costs.

He also cites research by the Treasury and the Reserve Bank (RBA) which shows that bank margins are “the healthiest they’ve been in years” and that the banks aren’t “telling the truth at all about their funding costs and the supposed need to raise rates”.

He cited evidence provided to Senate Estimates last week (Economics Committee) by a Treasury official (one Jim Murphy). Murphy noted that he thought the GFC had reduced competition in the Australian financial services sector with the Commonwealth guarantee providing advantages to the big four banks. The financial services industry was cast as an oligopoly.

Murphy’s Treasury off-sider told Senate Estimates:

We saw the exit of some key players, particularly foreign players in the market; securitisation froze over which made it more difficult for smaller players to come into the market and compete with the larger banks.

From page E141 of Hansard you can read the conversation turned to whether the banks were behaving themselves given their market power. Murphy said that while statements made by the Treasurer “about the banks justifying their actions” were “not welcome” by the banks but did exert “some form of discipline on the banks and their actions”.

But it remained that the banks had been making statements recently (claims by the CEOs of the leading banks that rates had to go up because of increased funding costs) which Murphy said:

I think they are testing the water on how the public would react to above rate rises. The difficulty in the whole thing is a dispute as to the real facts of the situation.

The following exchange between one senator and Murphy followed:

Senator BUSHBY-In terms of the costs of their funds and things like that.

Mr Murphy-Yes. The Reserve Bank and Treasury do not believe the view put by the banks that they still need to put up mortgage rates higher than the movement in the cash rate, to recover funds-to recover the past losses.

Senator BUSHBY-Presumably, Treasury is aware of the power, in section 50 of the Banking Act 1959, to control interest rates by way of conferral upon the RBA-a power to promulgate regulations with the Treasurer’s approval?

First, the government (Reserve Bank and Treasury) think the banks are lying about their need to push rates higher.

Second, once again you see the claim that there is central bank independence in Australia is a contrivance. There is no independence. The elected government can overall the central bank board whenever it see fits. The central bank is, in fact, part of the consolidated government sector and its transactions with the non-government sector are equivalent in their impact on net financial asset positions as treasury transactions.

Third, what the Treasury officials didn’t tell the hearing was that the big four are reaping in the profits at the moment as a result of the appreciating Australian dollar. Around one-third of their funding comes from medium-term foreign sources (three and five-year notes) and given the AUD has moved from the mid US60c to nearly parity in the last few years then it doesn’t take much to work out that this will work in the bank’s favour.

Even taking into account that funds are now probably being priced more accurately (and hence more expensive given that the risk is being reflected more reasonably than before the crisis), the appreciating dollar is a major cost saving for the banks and this is not being reflected in the rates that the banks are charging local citizens.

The Reserve Bank also considers the claims by the private banks that their rising funding costs are forcing them to hike interest rates above that indicated by the cash rate changes to be exagerated.

In the March 2010 RBA Bulletin article – Recent Developments in Banks’ Funding Costs and Lending Rates – the RBA say:

Most of the increase in banks’ lending rates over the cash rate since mid 2007 has been due to their higher funding costs. For the major banks, however, there has also been an increase in their net interest margins (NIMs), which in late 2009 were about 20-25 basis points above pre-crisis levels. The major banks’ higher NIMs have supported their return on equity, partly offsetting the negative effects of the cyclical increase in their bad debts expense and the additional equity that they raised during the downturn.

The conversation in the Senate Estimates hearing sought to clarify the question of bank costs. A senator noted that the annual reports of the banks showed they avoided the financial crisis and have increased their profitability. He asked:

Does Treasury concede that it is the right of the banks to maintain their profits and their margins at the expense of other businesses and individuals – Australians generally – or is it happy to allow the banks to wear the consequences of implementing monetary policy, rather than the RBA? In some circumstances, when the RBA is considering increasing the cash rate, if the banks have been independently increasing their rates at a faster level it may well negate the need for some adjustment in the cash rate. Is it about allowing the banks to do a little bit of monetary policy? Are you quite happy to sit back and allow them to get away with it rather than wearing the consequences of an RBA decision which may reflect on government?

The Reserve Bank has said in its minutes of past meetings this year that one reason it has not kept pushing rates up is because the private banks have hiked their mortgage rates disproportionately (breaking historical precedents). In that sense, the private banks are now running monetary policy.

The Treasury official (Murphy) replied that the banks now claim “that their mortgage rates are not keyed off the cash rate; they are keyed off the cost of their funds”. He then said in response to a question that the “Treasury and the RBA do not necessarily agree with that”:

No, what I said was that the RBA and Treasury do not agree that the banks’ cost of funds has reached a stage whereby they need to increase their margins to, in effect, pay for moneys that they have paid out previously on more expensive funding … They are arguing that their
funding rates have gone up and that now they have to reconstitute that funding and recover their funding costs. We question that … If there are increased costs, should … [the banks] … be absorbing them at this time? Everyone else had to face the global financial crisis … They are operating in the community and they are largely operating with the goodwill of the Australian public. They have to take note of that. That is what the Treasurer is trying to stress. They are accountable to the public; they are not just accountable to themselves or their shareholders.

The last point the Treasury official made is telling. Banks occupy a special place in society and cannot be considered as purely private profit-seeking institutions. This is why the neo-liberal push to deregulate their activities which led to the crisis (in part) is a denial of the essential nature of banking.

Verrender takes up this issue and rejects the recent claims by populist politicians that the government should seek to control all interest rates. Verrender says:

Instead, the debate should be about the role of our banks in society. Given they are now a protected species, unique in that they will never be allowed to fail, should they be allowed to behave like risk-taking entrepreneurial ventures, trying to conquer the world and deliver fabulous returns to shareholders and executives?

[The government] … now underwrite their activities. We guaranteed their offshore borrowing. We guaranteed their deposits. We banned some forms of selling in bank stocks. We stood behind them and declared that banks will never fail.

Should they be out there taking on bigger risks by expanding into Asia and trying to push more loans into Australia when almost everyone agrees that companies and individuals should lighten their debt loads?

He also notes that while Australia is “in the midst of the biggest resources boom in history” the CEO of one of the “world’s biggest miners” is paid considerably less than the CEO of the Commonwealth Bank of Australia who has shocked the nation with his “$16 million-plus salary”.

Verrender says that “(t)hat should tell you everything there is to know about Australian banking at the moment”.

By evading their public purpose charter the banks are able to justify pushing ever more credit onto the population so as to increase revenue and profits. But at the same time the increased risk involved in this greedy push is socialised. This makes the banks special. Verrender says that:

There needs to be a debate about the role they play in our community and about redressing the balance of power they hold. They’ve essentially become utilities – government guaranteed utilities at that. Perhaps it’s time banks became boring.

In this article (April 6, 2010) – Let’s see the flip side of bank funding costs – an Australian banking academic who also has connections with the Indian central bank challenges the bank’s claims about the impact of funding costs in international wholesale money markets on their margins.

The writer Milind Sathye says:

Nothing could be further from the truth. International wholesale funding constitutes only about 26 per cent of total bank funding. The cost of this funding has in fact declined below pre-crisis levels.

He produces various statistics to demonstrate his case. For example, he shows that the spread between the London interbank offer rate (LIBOR), “which is based on the rate banks charge other banks to borrow money without security, to the overnight indexed swap (OIS) rate, which is derived from the central-bank-defined overnight rate” fell “below pre-crisis levels” at the same time the banks were claiming increasing funding costs.

He also shows that the total “interest paid by banks on deposits declined from $74 billion (June 2008) to $70 billion (June 2009)” while “outstanding bank deposits rose from $1.4 trillion (June 2008) to $1.6 trillion (June 2009)”.

He says that (of the period that the bank’s were claiming funding problems):

… the best indicator of overall cost of funding is what banks actually pay for wholesale borrowing. The overall cost of funding measured by the proportion of total interest expenses to total liabilities fell from 5.29 per cent to 4.30 per cent, using statistics published by APRA. And the Reserve Bank study on bank funding costs, published in its June 2009 bulletin, has a graph of major banks’ average funding costs that shows a clear decline in overall funding cost.

The stark reality in Australian banking is that the banks under the watchful support of the Australian government concentrated their market power – largely because the smaller banks were disadvantaged by the crisis and did not enjoy the benefits of the bank guarantee introduced by the federal government introduced to save the banks as the crisis unfolded.

As a result of reduced competition, the commercial banks have been busily gouging their customers and reaping increased bank profits as a result at a time when the world was in crisis.

Milind Sathye shows that while bank profits soared their efficiency did not (the “ratio of operating expenses to total assets … remained unchanged” over the last two years). These profits were a direct result of the bank guarantee.

One option that has been suggested recently which does not involve nationalisation would aim to beat the big banks at their own game. Someone said the other day that the Australian government just has to utter two words – Australia Post. See this article (October 23, 2010) – One sure way to knock the banks into line – for more discussion on that idea.

Australia Post is still a government agency and has offices in every neighbourhood. It could easily be transformed to offer banking services which would force some competition on the big four private banks.

In this Melbourne Age article such a plan is discussed. It would “inject competition into banking, as well as providing an alternative future for Australia Post branches as their traditional postal business declined”.

One element opposing this option is that “If [Australia Post] becomes a bank, it then becomes a government-owned bank and the government would have to capitalise it”. So what? The Australian government could always ensure there is enough capital for its bank. The reality is that the Government stands by to guarantee the private banks anyway – no major financial institution in Australia will be allowed to collapse.

Given the Australia government is sovereign in its own currency it faces no financial constraints in either respect. The question is not whether the government can afford to bail out or underwrite private banking but rather whether it should.

Financial stability as a public good

To advance the case for bank nationalisation I note that the fundamental responsibility of government macroeconomic policy is to maximise real national output in a way that is sustainable (social, economic and environmental). In a monetary economy this requires aggregate spending levels such that all those who wish to work have that opportunity.

Further, the population demands price stability as a matter of fairness and thus accept it as a legitimate political goal.

The political priorities of the Australian government in the post World War II period are listed in the Reserve Bank of Australia (RBA) Act 1959. Section 10, Subsection 2 says:

It is the duty of the Reserve Bank Board … to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and … will best contribute to:

(a) the stability of the currency of Australia;

(b) the maintenance of full employment in Australia; and

(c) the economic prosperity and welfare of the people of Australia.

These economic goals fit with my conception of public purpose. I thus consider the banking system in terms of how it promotes the achievement of these macroeconomic public policy goals.

The current financial system is linked to the real economy via its credit provision role. Both households and business firms benefit from stable access to credit.

An economy’s financial system is stable if its key financial institutions and markets function “normally”. To achieve financial stability two broad requirements must be met:

  • The key financial institutions must be stable and engender confidence that they can meet their contractual obligations without interruption or external assistance.
  • The key markets are stable and support transactions at prices that reflect fundamental forces. There should be no major short-term fluctuations when there have been no change in fundamentals.

So stability in our financial institutions requires that they can absorb shocks and avoid potential widespread economic losses.

Financial stability requires levels of price movement volatility that do not cause widespread economic damage. Prices can and should move to reflect changes in economic fundamentals. Financial instability arises when asset prices significantly depart from levels dictated by economic fundamentals and damage the real sector.

Collapses brought on by injudicious speculation that do not affect the real sector or that can be insulated from the real sector by appropriate liquidity provisions are not problematic.

The essential requirements of a stable financial system are:

  • Clearly defined property rights.
  • Central bank oversight of the payments system.
  • Capital adequacy standards for financial institutions.
  • Bank depositor protection.
  • An institutional lender-of-last resort when private institutions refuse to lend to solvent borrowers in times of liquidity crisis.
  • An institution to ameliorate coordination failure among private investors/creditors.
  • The provision of exit strategies to insolvent institutions.

While some of these requirements can be provided by private institutions, all fall in the domain of government and its designated agents. As a consequence there is nothing intrinsically “private” that has to be present in the banking system for these requirements to be met.

Private goods are traded in markets where buyers and sellers exchange at prices that reflect the margin of their respective interests. At the agreed price, ownership of the good or service transfers from the seller to the buyer. A private good is ‘excludable’ (others cannot enjoy the consumption of it without being party to the transaction) and ‘rival’ (consuming the good or service specific to the transaction, denies other potential consumers its use).

Alternatively, a public good is non-excludable and non-rival in consumption. Private markets fail to provide socially optimal quantities of public goods because there is no private incentive to produce or to purchase them (the free rider problem). To ensure socially optimal provision, public goods must be produced or arranged by collective action or by government.

In my view financial system stability meets the definition of a public good and is the legitimate responsibility of government.

While advocating bank nationalisation, I do not support 100-percent reserve banking. I discuss that debate in full in this blog – 100-percent reserve banking and state banks.

If you have a mixed economy (government and non-government enterprise) then I think it is important the business firms can gain access to credit to expand their working capital.

I don’t support banks engaging in betting behaviour between themselves in pursuit of profit. My vision of banking does not include profit-seeking behaviour unless we are going to include broader social benefits as being part of our conception of “profits”.

In these blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks – I introduce some of the reforms I would make to the financial system to ensure it served public purpose.

In terms of operational guidelines for banks, I offered the following ideas. I am working on a paper at present which aims to flesh these out some more.

If you think about these guidelines (constraints) you can hardly conclude that I advocate bloodsucking or irresponsible behaviour from the banks.

Remember also that I advocate using fiscal policy (taxation and social housing provision) to discipline housing markets. I don’t see it is an effective policy response to attempt to choke specific asset class price movements using movements in the policy (cash) rate. The bluntness of the instrument is a problem as is the uncertainty of its outcome.

I have also noted before that the distributional issues involved in interest rate transmission mechanisms (the way the rate changes influence aggregate spending) are too uncertain. Creditors gain from a rise in rates, borrowers lose – net effect?

Reflecting on our conception of a bank – the only useful function that a bank should perform is to facilitate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk. In part, the aim should be to avoid some of the Minskian fluctuations in credit availability over the business cycle.

How might we begin to regulate the commercial banks to ensure their operations more closely satisfy our conception of social/public purpose?

First, they should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets. This would stop all third-party commission deals which might involve banks acting as “brokers” and on-selling loans or other financial assets for profit.

It is in this area of banking that the current financial crisis has emerged and it is costly and difficult to regulate. Banks should go back to what they were – providing financial intermediation. Banks should not be permitted to speculate as counter-parties with other banks.

Second, banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully. One of the factors that led to the financial crisis was the increasing inability of the banks to appraise this risk properly.

Further, the foreclosure scandal unfolding in the US at present would not have occurred if these stipulations were in place.

Third, banks should be prevented from having “off-balance sheet” assets, such as finance company arms which can evade regulation.

Fourth, banks should never be allowed to trade in credit default insurance. This is related to whom should price risk.

Fifth, banks should be restricted to the facilitation of loans and not engage in any other commercial activity.

Sixth, banks should not be allowed to contract in foreign interest rates nor issue foreign-currency denominated loans. There is no public sense achieved in allowing them to do this.

The upshot of these suggestions would be to render a huge raft of transactions that are currently considered part of normal banking these days illegal.

The libertarians will scream state control. But if you think about it we succumb to micro management of our daily affairs by the state in the name of public purpose and largely agree with that because we can more easily see the consequences of a failure of state regulation. For example, only the most extreme rev-heads will not support speed limits on our roads. In most cities, the speed limits are even getting more stringent (which is good for our natural environment by the way). We can easily see that excessive speed causes carnage and wrecks lives.

I could document a myriad of such laws where the state prevents us from doing things which we readily understand to be injurious of others or ourselves. The level of comprehension of the consequences allows us to accept the state intervention. The articulation of public good or public purpose is easy for us to make in these cases.

I thus consider nationalisation to be the best option. But I would also restructure their management to include representatives of the community and their workforces (similar to the community banks now in Australia). The operations of the nationalised banking system should not replicate the profit-seeking model of the private banks.

The “market” and what can be gouged out of it should not determine how the banking system allocates credit. Instead social and environmental criteria would become central along with job quotient and considerations of the working conditions that business borrowers provide their workforces. Yes, a new world.

Conclusion

Given that financial stability is a public good, the structural changes that I advocate for the banking system are probably best achieved by outright nationalisation. It is clear that they could also be achieved with the private banks being maintained.

But the essential advantage of nationalisation is that the tension between public purpose and private profits is resolved. At present, that tension has pushed the banks into very anti-social behaviour which has generated the financial crisis. A properly regulated system of state banks would not allow such a crisis to emerge in the first place.

As Ian Verrender says:

Perhaps it’s time banks became boring.

I am travelling today and so have run out of time. Must fly!

That will have to be enough for today!

This Post Has 45 Comments

  1. I like nationalization, but I don’t want MMT to be the ones in charge if it happens 🙂

    You guys would set borrower cost of funds too low, requiring only that the funds be repaid, effectively allowing anyone to marshall resources even if they add no economic value.

    They would just be required to not destroy value, in nominal terms.

    Depending on who gets access to credit, that may result in a bidding war for resources, but even if you can control for that by rationing credit, then still there will be enormous waste and real GDP growth will fall.

    Maybe it would be fine if you had arbitrary credit rationing and simultaneously restricted the activities that banks fund to an extremely narrow range — e.g. student loans, residential (but not commercial) housing, lending to businesses with less than $X in revenue, qualified charities, etc.

  2. Bill,

    Some interesting points, although personally I would never support total nationalisation of the banking system.

    However, you are off the mark with you comment about offshore funding. You said:

    “Third, what the Treasury officials didn’t tell the hearing was that the big four are reaping in the profits at the moment as a result of the appreciating Australian dollar. Around one-third of their funding comes from medium-term foreign sources (three and five-year notes) and given the AUD has moved from the mid US60c to nearly parity in the last few years then it doesn’t take much to work out that this will work in the bank’s favour.”

    Where is your evidence to support this claim? The treasury officials wouldn’t tell them that because it’s not true.

    I can tell you that domestic banks ALMOST ALWAYS hedge away the foreign exchange position when they issue non-AUD denominated debt. They don’t run the fx position, they hedge it back to an AUD-exposure through the cross-currency swap market.

    What happens is that effectively the banks take the USD proceeds of the bond sale and put them on deposit in the USD money market. Then the borrow the AUD funds they require in the AUD money market. Hence they are left with no fx exposure.

    I saw this claim (that the banks are profiting from the depreciation of their USD-denominated debt) made in the SMH article of the other day, and it looks like you’ve just taken it on face value, and repeated it here without really giving any justification.

    I’ll post some further comments later.

    Cheers.

  3. Oh good grief, here we go again with the usual communist clap-trap about the banks.
    Do they rip off customers…yes (as do all tradespeople, accountants, lawyers and builders)
    Did they benefit from the 2 guarantee schemes…yes
    Are they out of order in jacking up rates in excess of the RBA to ‘recoup margins’…yes

    However just for a moment picture in your mind the social anarchy if majors went under. There would be looting, public shootings and a total breakdown in society.

    How have the Australian banks caused socialisation of losses? They were charged a scale of fees for the wholesale guarantee and the citizens of Australia have done very nicely thanks very much.
    The deposit guarantee has afforded all of us the security to go out and invest, hire, consume and pay off our mortgages without worrying that our life savings are going down the toilet.

    Don’t confuse what has happened o/s with Australia. Yes indeed the banks are very greedy yet it is in the Govt’s power to put them back in their box yet they fail to do so. Don’t go talking hairbrained nationalisation schemes when you should be giving the political parties a pasting.
    if you believe that nationalisation is the key then do what NZ did and form a people’s bank to compete with them. Australian banking is one of the industries most open to competition thanks to Paul Keating.

    “Third, what the Treasury officials didn’t tell the hearing was that the big four are reaping in the profits at the moment as a result of the appreciating Australian dollar. Around one-third of their funding comes from medium-term foreign sources (three and five-year notes) and given the AUD has moved from the mid US60c to nearly parity in the last few years then it doesn’t take much to work out that this will work in the bank’s favour.”

    Typical economists who don’t know what they are talking about but want to bank bash. All Yankee and 144a issues from the banks are fully currency hedged…they have extremely little exposure to currency movement when borrowing offshore.
    I have plenty of issues with the industry and the push for margin-related hiking is one of them but you really should research your arguments first.
    Respect lost.

  4. Although I try not to drag none MMT issues into Bills blog, in response to Rays waffle I feel the need to point out a few things.

    >How have the Australian banks caused socialisation of losses? They were charged a scale of fees for the wholesale guarantee and the citizens of Australia have done very nicely thanks very much.

    Well the lucky generation that got in early might have done ok at the top of the Ponzi pyramid, but the younger generation is wearing the debt. The banks in Australia are a government supported moral hazard. They have now leveraged the entire economy into a ridiculous ponzi system that requires ever increasing leverage on housing and external funding to keep the circus going. Many of these debt backed markets are now collapsing .. http://delusionaleconomics.blogspot.com/2010/10/its-called-systemic-risk.html and although you call what bill suggest communism, it is what is going to happen anyway. Is the US communist ?? No ?? Well then please explain freddy mac !!

    > Third, what the Treasury officials didn’t tell the hearing was that the big four are reaping in the profits at the moment as a result of the appreciating Australian dollar. Around one-third of their funding comes from medium-term foreign sources (three and five-year notes) and given the AUD has moved from the mid US60c to nearly parity in the last few years then it doesn’t take much to work out that this will work in the bank’s favour.

    As Gamma says , all non-AUD funding is converted into currency swap derivatives, so there is no upside or downside risk on currency.

    I don’t want to bank bash either, but the systemic risk created by the government and the banks is mind numbing stupidity.

  5. A 1km high plastic pig with a slot in the top is all we need. Banks are so yesterday.

  6. I’m not so sure about nationalising the banks as such, but I can certainly see that they should pay dearly for the ability to operate fractional reserve.

    As others have noted in the 100% debate, it is perfectly possible to have a bank without a state guarantee. You require matched funding and you bar direct personal investment in that bank. In other words an investment bank. Capital absorbs bad loans first and if that isn’t enough then it goes into adminstration and the creditors take a haircut.

    However that is inefficient. The alternative would be that banks take a state guarantee. This allows them to operate deposit accounts directly for the public, and lend on those deposits, but should come with strings attached – an overarching regulator that controls what they have to invest and what their ‘turn’ can be. We have a similar arrangement for the other privatised utilities in the UK.

    Then capital can take its choice between investment banks and retail banks.

  7. Ray: However just for a moment picture in your mind the social anarchy if majors went under. There would be looting, public shootings and a total breakdown in society.

    That’s the point. These organisations have become so big their demise would cripple an economy. They now hold the economic gun to nations head. If BHP went under, Rio would pick up. Bad yes, but not insurmountable. If Westpac crashed, hell, look out. Not in a month of Sundays would the Australian government and/or other banks be able assume the liabilities and stabilise the banking sector from a total rout.

    Rather than nationalise the baking sector, I’d like to see the Big 4 broken up into smaller entities. Should one of them go under, the cost would be borne by the bond and shareholders not the Australian taxpayer.

  8. Bill, I think the nationalized banks would have a confused remit. Would they just be following public purpose or would they be trying to be commercial? If they were trying to be commercial then would any of your six regulations stop banks from making daily loans to leveraged day traders? If they were trying to discern and execute public purpose rising above using money as there guide, then you might as well just have direct government funding of everything. My reservations about having direct government funding come from the tendency for governments to be elitist. In the UK the Concord supersonic airliner was a product of such a system. The Apollo moon mission and the soviet empire (best olympic team, best submarines etc etc but crappy everyday provisions) are other examples. Having giro banks to store deposits and loan companies (that sold bonds to fund loans and had no state back up) to provide credit seems to me a better way to cater for the mundane everyday business that governments tend to not do well.

  9. If the big banks when under, then stability would depend upon the system of bank administration and liquidation. Given that the state would have to bail out the depositors and then be the biggest creditor by some considerable margin I would suggest that the only form of bank administration that would work would be full nationalisation.

    So if a bank collapsed it would be nationalised and the shareholders would get nothing – much as happened to Northern Rock in the UK. If everybody knew that a bank that called upon the state guarantee would be immediately nationalised and the shareholders left without a bean then that would provide the stability required.

  10. Gamma and Ray, sorry guys, I like your reference to derivatives and no-risk claims but it is irrelevant. There are two points involved and none of them has anything to do with swaps or any other stuff.

    First, more expensive AUD allows banks to refund foreign currency balance sheet at much more favourable rate but in AUD. So the same fixed amount of AUD allows banks to “purchase” more fx-assets that they already have on balance sheet and which they issued when AUD was cheaper. So that is the gain they can realize. On the other hand fx-assets now bring NII (net interest income) which is lower in AUD and this has effect on AUD profits. Net result? Not obviously clear.

    Secondly, assume AUD depreciates. Now NII in AUD of fx-assets is higher which is a clear gain. However, loss provisions are higher as well because cheaper AUD puts more stress on borrowers to perform their fx-obligations. Net result? Not obviously clear.

    So the bottom line is it is all about sensitivities of net interest income, loss provisions, and refunding gains with respect to fx-movements. So make your guess for Australia. I have no clue but you are plain wrong talking about anything derivative here. Bank is not just a treasury. Unless we are talking Goldman Sachs here.

  11. ” Having giro banks to store deposits and loan companies (that sold bonds to fund loans and had no state back up) to provide credit seems to me a better way to cater for the mundane everyday business that governments tend to not do well.”

    That’s simply an inefficient use of money to fulfil an ideology. It will do nothing other than put the cost of banking up and the price of money.

    The state has infinite financial capacity and a guarantee lowers risk, cost and requires less money. But it should extract a price for that guarantee – that if it is called upon the bank loses its independence. Depositors are then protected, but shareholders and investors are at risk, all without vast quantities of currency in storage simply costing money to store.

  12. Sergei,
    not sure what you’re talking about brother but my comment relates to the following claim by Bill and I explain it below.

    “Third, what the Treasury officials didn’t tell the hearing was that the big four are reaping in the profits at the moment as a result of the appreciating Australian dollar. Around one-third of their funding comes from medium-term foreign sources (three and five-year notes) and given the AUD has moved from the mid US60c to nearly parity in the last few years then it doesn’t take much to work out that this will work in the bank’s favour.”

    Australian Bank A does a Yankee issue and raises usd500mm in the US market for 5yrs at US Swap rate + 200bps.
    USD is no good to Bank A so it enters into a currency swap with say GS and exchanges initial principal for AUD at the current exchange rate.
    In 5yrs it re-exchanges the same principal back to repay the bond holders. The US bond holders along the way have been paid their USD coupons (effectively by GS) by way of the interest rate swap component of the currency swap.

    Net effect is that Bank A has raised AUD in the US market by way of a bond issue + derivative transaction at Aussie swap rate + 200bps (plus fees). There is a small basis swap adjustment + fees which determine the final spread.
    I don’t really understand the other stuff you are talking about but suffice to say that anyone who says the Aussie banks make money by a rallying AUD against their USD MTN programs is wrong. They are fully currency hedged.
    The whole idea of raising money in foreign markets is to tap a deeper source of funds. Don’t you think it would be a little silly to roll the dice and take fx exposure on this exchange?

  13. I have to agree with Ray on the analysis about offshore borrowing. In my experience, banks routinely put on cross-currency swaps to immunize the currency risk. You only have to look at the volatility of the A$ (down in the past as well as up more recently) to realise that leaving this exposure unhedged would result in massive profit/loss swings for the banks, not a risk their shareholders would tolerate.

    I also saw the Verrender article and came very close to writing a post of my own saying what nonsense it was! It may well be the case that banks are implicitly colluding on their rate setting and it may also be the case that their fees are excessive, but criticisms of their profit-making are undermined when these issues are mixed with flawed arguments such as the one Verrender opens his article with.

    Offshore borrowing aside, from an MMT perspective, the question of “socialising losses” when banks get into trouble is an interesting one. If the government does bail out failing bank (as the UK government did, for example), since it’s not revenue constrained and does not have to raise taxes to finance itself, have there really been any losses socialised? Furthermore, when a government steps in to rescue a failed bank, it saves the depositors not the shareholders. Shareholders lose the lot. Of course, there are various ways that governments can come to the aid of banks. In the US it was done it a way that ended up lining the pockets of many senior bankers, but that doesn’t have to be the case. Here in Australia, the government actually ended up making money out of the guarantees (although, again, this is not really relevant for a government that is not revenue constrained). If government support of banks is clearly targeted only at depositors, then I don’t think that losses are really being socialised. It may be that management takes silly risks for short-term gain, but that remains the risk of shareholders and can be just as much of a problem for other types of business.

  14. Bill: just re-read the post you refer to above which attacks 100% reserve. I agree that a lot of Austrian pro-100% reserve stuff is cranky. As regards the point that fractional reserve leads to instability, you say better regulation can fix this. You are right in theory. But I suggest commercial banks would just love more complex bank regulation (though they won’t say so). These banks know perfectly well they can bribe and generally run rings round regulators. As Congressman Durbin said in relation to banks and Capitol Hill: “they own the place”.

    I suggest full reserve is a nice simple rule, which is simple to enforce. It means less economic activity is bank financed rather than equity financed, but who cares?

  15. Neil Wilson: “The state has infinite financial capacity and a guarantee lowers risk, cost and requires less money. But it should extract a price for that guarantee – that if it is called upon the bank loses its independence. Depositors are then protected, but shareholders and investors are at risk, all without vast quantities of currency in storage simply costing money to store.”-
    You are basically advocating a continuation of the system that created the 2008 crisis. Bank employees took their bonuses and got new jobs when it all went belly up. The only investment banker I personally know used to work for a bank that went bust in 2008 and then got another job with a different bank. Many of the movers and shakers amongst the share holders also did very nicely out of the crisis- selling at the peak and then buying up the surviving banks in spring 2009.
    I thought that the whole thrust of MMT was that money as such cost nothing more than a mouse click. The only issue at stake is whether the current system is wasteful of real resources such as highly educated employees. It seems to me to be spectacularly wasteful in that regard. The “ideology” of mine that you seem to take issue with is simply that those who require credit should pay for it based on the risk they pose in fair competition with those (such as venture capitalist) who require direct investment.

  16. Bill –

    The costs of nationalizing the banks would greatly outweigh the benefits. It would be a terrible waste of money, and it would prevent that money from being put to better use.

    Nationalizing banks would provoke overwhelming opposition from South Australia and Victoria, where the state governments had to bail out banks in the early ’90s. We know it’s something we should avoid having to do again. There’s no obligation for governments to bail out privately owned banks, and the decisions to do so in America and Europe were a panicked response, not a sensible one.

    Banks should NOT occupy a special protected place. They should be allowed to fail. But there should be a procedure to limit the damage if and when they do. Deposits should be protected, and they should pay for that privilege (as they do in Australia, as Ray pointed out).

    The days of banks being there to serve the public are long gone. Now they’re there to make money. Redefining their purpose after nationalization would cost a lot more money.

    It’s much better for the government just to accept banks are commercial businesses, then sit back and collect the tax revenue. Not that this would leave them with no say at all – the Reserve Bank can impose conditions when it lends them money. But these should be commercial creditworthy considerations like don’t believe the ratings agencies, the inclusion of CDSs doesn’t make these products low risk!

    If the banks have all set their rates too high, that suggests it’s due to insufficient competition. Under these circumstances it would be sensible for the government to set up a bank. Likewise if a bank does fail, the government should set up a new one to take over its function – but in either case they should plan to privatize it a few years down the track. They can always set up another one later if necessary, but in normal circumstances there’s no advantage for governments to own banks.

    There is the possible exception of policy driven special purpose institutions such as rural development banks. There’s actually quite a strong case for setting these up, but it’s quite separate to the issue of whether the government should be in the general banking business at all, let alone whether they should monopolize it.

  17. Bill

    This is off-topic, but I have just been back to your blog of Fri 22 Oct [Back to basics – aggregate demand drives output] as there was a bit I wanted to re-read.

    In looking at the comments, I saw some from a person calling himself Richard, just as I have done until now. So there are at least two of us using the same name.

    I found the tone and content of some of those comments really rather unacceptable. They were not written by me. I don’t write very often, maybe 10 times in total over the last 5 months. As you can see our email addresses, I am sure that you are able to tell who is posting what comments. However, the readers cannot. I am changing the way I sign in to RichardW1 in the hope that this is unique. I do not wish any future contributions of mine to be confused with such comments as those that appeared on Friday.

    Thanks for all you are writing, please keep up the good work.

  18. stone –

    I thought that the whole thrust of MMT was that money as such cost nothing more than a mouse click.
    Then you’re wrong. Creating money can be as easy as a mouse click, but the cost is a separate issue. MMT doesn’t prevent more money from reducing the value of the currency, though Bill correctly makes the point that this can be counteracted by increasing productive activity in the real economy.

  19. economicdelusion –

    Well the lucky generation that got in early might have done ok at the top of the Ponzi pyramid, but the younger generation is wearing the debt. The banks in Australia are a government supported moral hazard. They have now leveraged the entire economy into a ridiculous ponzi system that requires ever increasing leverage on housing and external funding to keep the circus going.
    That’s rubbish – the entire economy isn’t based on housing. And though businesses are leveraged, they borrow in order to increase their future profitability.

    Many of these debt backed markets are now collapsing .. http://delusionaleconomics.blogspot.com/2010/10/its-called-systemic-risk.html
    …doesn’t invalidate the long term upward trend for house prices as the population increases.
    and although you call what bill suggest communism, it is what is going to happen anyway. Is the US communist ?? No ?? Well then please explain freddy mac !!
    Firstly, Bill was advocating nationalizing all the banks. Excluding private enterprise. IMHO that’s communist.

    Secondly, Freddy Mac was an example of a public sector banking institution trying to occupy a special place in society rather than just making money. That alone seems to me to be pretty strong evidence that forcing all banks to do that is a bad idea.

  20. “You are basically advocating a continuation of the system that created the 2008 crisis.”

    Which part of ‘nationalise a bank if it fails’ happened with Halifax, Lloyds and RBS then. I must have missed that, because as far as I’m aware the original shareholders still have a stake. They should have been wiped out completely.

    It should be crystal clear that if a fraction reserve bank has to call on the state guarantee, the cost of that is full administration and nationalisation.

    As for bank employees, they will always get another job with another bank. That’s because they are workers, not owners. That bonuses, etc. are accumulating to them is nothing more than an ‘agency problem’.

    The job of the government should be to ignore that and just increase competition in the banking arena by removing barriers to entry.

    The failure of the banks was entirely down to a failure of regulation. As I’ve said before blaming bankers for being greedy is like blaming Cheetahs for liking the taste of Gazelle meat. Instead the reserve manager needs to restrict access to the Gazelles or cull the Cheetahs.

  21. It is clear that private banks’ balance sheets account for (S-I) and (X-M) but the glaring omission is any recognition of cumulative deficit spending (G-T) as a liability.

    To me that makes any notion of banks as a valid private concern ridiculous. It is clear that the main supply of the profit available for bonuses and dividends comes from Govt spending and therefore this ‘profit’ belongs to the people.

    So yes, nationalise the lot

  22. Neil Wilson “Which part of ‘nationalise a bank if it fails’ happened with Halifax, Lloyds and RBS then. I must have missed that, because as far as I’m aware the original shareholders still have a stake. They should have been wiped out completely.”-
    I take your point, it was only Northern Rock that was entirely nationalised. The RBS shareholders still have 10% of it or something I guess. I’m not sure though that a 100% loss is all that different from a 90% loss in the grand scheme of things or sufficient a potential threat to cause the banks to behave differently. My point about the employees was that it is what they do on the ground that decides whether the bank fails. They don’t suffer any loss upon collapse but they do get bonuses if there is a surge in profits irrespective of whether that is due to lemming like risks.

    “The failure of the banks was entirely down to a failure of regulation.”-
    I agree and the regulation I think is needed is to have separate giro banks and loan companies. Essentially to not have banks as we know them.

  23. Sergie,

    “Gamma and Ray, sorry guys, I like your reference to derivatives and no-risk claims but it is irrelevant. There are two points involved and none of them has anything to do with swaps or any other stuff.”

    Well as myself, and quite a few other poster have pointed out, the banks are not “reaping in the profits at the moment as a result of the appreciating Australian dollar” on their existing debt issuance as Bill and the Sydney Morning Herald tried to claim.

    A comment like this simply reveals that the author does not have much experience or understanding of how Australian bank funding arrangements actually work. They have put 2 and 2 together….and come up with 5. Not a very good look for MMT which claims to have some kind of superior insight and understanding into the functioning of the monetary system.

    You might make the point that an appreciation in the AUD might make future borrowing easier or cheaper, but I am not convinced, and you yourself have concluded that the net result is unclear, so it is really just speculation.

  24. Did anyone hear CBA’s Ralph Norris this week rabbitting on about how their margins were constantly being eroded because old pre-GPC foreign MTN deals were rolling off and they had to replace these at wider spreads?

    This is absolute, f’ing garbage and a real last resort effort from a bloke who is not fit to run a bank. All of a bank’s funding trades are marked-to-market and reflected at each reporting date so if re-issue spreads have widened then it will already be reflected.
    Each time a bank reports their results pay particular attention to their Net Interest Margin (NIM). Indeed on Bloomberg you can even plot a history of the thing (Bill might be interested for his blog). And they ain’t looking bad at all.

  25. It’s far less than a third (foreign borrowing) isn’t it? I thought it was 55-60% (of total funding) deposits, with the remainder spit between AUD s/t anf l/t funding, and non-AUD long term funding. The following link certainly bears this out (pgs 12-15 are the best) – http://www.commbank.com.au/about-us/group-funding/articles/Debtroadshow_presentationv1.pdf – though it’s only 1 of the majors.
    58% deposits
    18% s/t wholesale (Bank Bills, essentially)
    5% wholesale maturing 1y)
    plus summary RMBS etc….
    So while the foreign sourced funding makes up a hefty portion of ‘wholesale long term’ funding’, is is a small proportion of total funding. And as Ray says, it is hedged into AUD at issue……most of the time (sometimes they like to hedge initially in fx forwards if they deem the x-ccy swap to be too expensive)
    Anyway, re the post…..I’m also not a fan of nationalisation of the existing banks despite their free eiding), but also believe the government needs to put up or shut up. If they are so concerned about (the inevitable and unjustifiable) gouging, then re-enter the market. Whether it’s via Aussie Post or another bank (Billy Bank?) offering a broader array of banking services. It’s not like they haven’t been there before. I’ll bet my bottom dollar (ccy hedged!) that bank gouging will miraculously become more scarce.
    The funding argument is an interesting one, and context/base is the real key as to whether they are normal or not. Presumably the banks see the June 2007 wholesale funding levels as ‘normal’ – ie. 3yr major senior bank bonds trading BBSW +7bps…..5yr subordinated major bank bonds hitting a low point of BBSW +22bps (CDS spreads on this traded a low of about 6bps if I recall)….Let me tell you, that was far from normal, and reached only by virtue of the very products and institutions and business practices that ultimately brought the system undone – CDOs and SIVs. So to say funding costs have increased, you need to ask from where?
    Re private banks running monetary policy, I think what the RBA is is most interested in is the short term borrowing rate – I like to think of BBSW as ‘the economy’s funding rate’. With 95% of mortgages floating rate, as well as most corporate borrowing, you can see my point. The fact is, the transmission from cash to variable rate mortgage (based off BBSW) used to be so stable that the RBA really didn’t have to worry about it. Now they do.

  26. Dear Bill,

    I totally agree about nationalization of financial services industry and see only one potential weakness of public banking -corruption. How the managers will perform their duties without trying to run the bank putting their private interests first. How this will be controlled?

  27. Dear Gamma (at 2010/10/26 at 15:17), Ray (at 2010/10/26 at 16:42) and Sean (at 2010/10/26 at 22:41) – especially Ray who seems to have had a fit of apoplexy and lost all his respect!

    Clearly banks hedge their foreign exchange exposure. I didn’t deny that or hint otherwise. The question is how much? The Reserve Bank tells us that the hedging on the liabilities side (their borrowing) is incomplete for the sector as a whole and there are small open positions (around 5 per cent). The evidence (Gamma) was provided in the December 2009 RBA Bulletin which is compiled from the latest available data from the Australian Bureau of Statistics (which is March 2009). The RBA provides some more recent evidence on the assets and liabilities exposure but not the proportions that are hedged. I could also cite previous references that have studied this issue if you like.

    The tricky part is that on the assets side they have much larger open positions (so debt positions and other equity investments). The RBA in March 2009 say that:

    The survey shows that Australian banks hedge 95 per cent of their foreign currency liabilities … so that their unhedged foreign currency liabilities are relatively small at $36 billion (around 1½ per cent of banks’ total balance sheet liabilities). These unhedged liabilities are potentially fully hedged naturally as they are more than offset by the banks’ unhedged foreign currency debt assets and foreign equity investments. After hedging, banks actually hold a small net foreign currency asset position. Foreign currency debt assets, including domestic banks’ participation in international syndicated loans, have grown particularly rapidly since the previous survey to be around 10 per cent of all bank assets. On average, banks hedge around 50 per cent of these debt assets, while their foreign equity assets (primarily direct investments in foreign subsidiaries) are hedged at less than 20 per cent.

    The latest detailed data on the hedging exposure is March 2009 as stated above. You can get more recent data on the aggregates (without knowing the proportions that are hedged).

    In October 2008, the RBA statistics show that the proportion of total Bank assets which are denominated in foreign currency amount to 9 per cent of total bank assets. This ratio dropped to 5.8 per cent in August 2010.

    Further the levels and composition of international assets of the Australian-located operations of banks and RFCs have changed since the ABS published their last release. The latest statistics (see RBA) show considerable reductions in the USD-held assets to June 2010 – $462.7 billion ($216.5 in USD or 46.8 per cent of the total) in March 2009 to $348.8 billion ($141.3 in USD or 40.5 per cent) in June 2010.

    Now I don’t work in a bank and if your specific banks are fully hedged then fine the point does not apply to them. But it is reasonable to conclude that the banks have been reducing their unhedged exposure on the assets side while there is no evidence to show that the outstanding exposure on the liabilities side has been eliminated.

    Thanks Ray for considering me one of those “Typical economists who don’t know what they are talking about but want to bank bash.”

    Yes, I was bashing the banks but no I never make an empirical statement unless I have seen credible evidence.

    best wishes
    bill

  28. Why do Australian banks borrow fundings from abroad in order to make mortgage loans to credit worthy Australian customers if MMT tells us they do not need to because they can just create deposits out of thin air?

  29. Because they can’t print money. Banks are private businesses, not a sovereign government. I think you may be getting confused with creating credit (which they have to fund….via deposits, wholesale funding….) vs creating money (the preorogative of the government).

  30. Bill @ Wednesday, October 27, 2010 at 7:51

    To me what you have presented is a far cry from any evidence of “reaping in the profits”.

    From the RBA 2009 bulletin:
    unhedged liabilities were -36bn
    unhedged assets were +129bn
    derivative position -54bn
    Total +39bn

    So perhaps if the banks have reduced their unhedged foreign asset position by significantly more than 39bn they might have made money on the fx movements. The reduction in the USD assets which you pointed out does not tell us because there is no mention of changes in the hedges.

    So we don’t know. They may have made money, they may have lost money. But either way, what does this prove? Nothing much. The banks may be long or short the AUD overall if they want to take that position, but it is not intrinsically linked in any way to the fact that they source some funds offshore, which is what I (and a few others) thought you are suggesting when you say:

    “Around one-third of their funding comes from medium-term foreign sources (three and five-year notes) and given the AUD has moved from the mid US60c to nearly parity in the last few years then it doesn’t take much to work out that this will work in the bank’s favour.”

    On a slightly different point, have you been watching the sort of deposit rates available in the market at the moment (and for most of this year)?

    Despite the cash rate target being 4.50%, it is easy to get term deposits (6m, 12m) well above 6%. There are even some savings accounts (funds available at a few days notice) paying up to 6.50%. Also, these rates are for banks, not credit unions. These levels are amazing and the difference between the cash rate and market rates is the widest it’s been for a long time.

    Given that there are many home loan rates at under 7% being advertised, is there really a whole lot of gouging going on here? Even comparing to the standard variable rates of around 7.40%, it doesn’t look too bad. Of course tighter margins are always better for us borrowers and savers, but realistically there has to be some return to the equity holder and to cover bad debts and so on. What sort of margins can we reasonably expect?

  31. I don’t have a problem with 100% reserve banking, as long as the cost of reserves is reasonable. It’s kind of irrelevant if banks need to keep loans on their own books and conduct risk analysis based on good old income-stream forecasting anyway.

  32. Mammoth (Wed 10:08)

    You’re correct that banks don’t need to raise money overseas to match the volume of their assets – the liabilities were created when they created the assets (mortgages). Banks raise money overseas because it is the cheapest way of matching the duration of their assets and liabilities. In aggregate the liabilities matching the assets are in the system, but they’re at call rather than having a longer duration. Banks could raise the money on-shore but would have to offer higher rates at longer maturities; by borrowing overseas they can get the lengthening of the liabilities at a lower cost.

  33. Bill,

    I agree with you there is some kind of “public good” in having a stable financial system, but on the other hand much of the output of the banking system actually more accurately described as private goods – in the form of individual loans and deposits. So I don’t agree that the banking system needs to be or should be nationalised in order to provide the essential and public good of having a stable financial system. The government can provide this in other ways.

    One idea that I agree with is for the government to provide truly risk-free transaction and savings accounts for any Australian who wanted one. This could be done through the RBA or Australia Post or a new govt owned institution. This new bank would only hold risk-free assets (govt bonds or RBA account balances) against it’s deposit accounts, it would not make commercial loans.

    I would like to see this institution offer 2 types of accounts:

    1) A transaction account which could be used to with withdraw cash from ATMs and make EFTPOS transactions. This account would probably pay little or no interest as income from the assets held would go towards funding the required infrastructure (ATM network, use of payments system, cash holdings etc).

    2) A savings account which could offer term or at-call deposits (but no transaction facilities). These accounts would pay interest – the income from the assets held against them would be passed through to deposit holders.

    Realistically the full nationalisation of the Australian banking system is unlikely to happen anytime soon. But something like this suggestion could happen. It would go some way to decreasing the commercial banks’ privileged position and eliminating their status as TBTF.

  34. I believe “Too big to fail” is somewhat of a misnomer.
    AIG was feared to have brought down not only the global insurance market but also a large part of the financial system yet it was not a deposit-taking institution. This is not in the same category as Australia’s Big 4.

    Realistically they are “too important to fail”. Some have said that the banks should be split into smaller units yet even a relatively tiny bank with $100mm of depositor’s money it too important to fail and would cause massive hardship to those depositors struck.
    I really don’t see how any retail bank can operate post-GFC without an implicit government guarantee on depositor’s funds.
    The way the Fed dealt with the commercial bank Washington Mutual is perhaps a workable solution to the TBTF situation. Guarantee deposits and allow others in the banking system to acquire the rest of the business. In effect, equity holders are wiped out yet all depositors and most bondholders are preserved.

    I find discussion of this issue difficult because the answer is not straightforward and the arguments aren’t watertight.

  35. Dear Gamma (at 2010/10/27 at 16:02)

    I agree that as a practical matter – we are not going to nationalise our commercial banks. The nationalisation that has occurred in recent years abroad has been due to failure and our big banks are not likely to fail for all the reasons that I am sure we agree on including sounder regulation and better management. So my advocacy of that was to put the issue in a finer point.

    But I agree totally that using Australian Post as a countervailing competitive force would be a very effective policy option especially given that it is losing its core business anyway through attrition. Clearly E-bay growth cannot offset the growth in E-mail/SMS etc.

    In terms of your earlier comment (at 2010/10/27 at 13:46) I agree that the facts of whether the banks are net long or short in foreign exposure is uncertain but given the trends in the foreign-currency denominated assets and liabilities in recent years it is likely that they have benefitted from the appreciation. How much? Conjecture! The point was a small one in my overall post though. The reality is that the attacks on me “that banks are hedged” didn’t capture the point that they are not fully hedged on the liabilities and it is only the natural hedge on the assets side which may save the argument. Small issue though to me and didn’t warrant the OTT reaction (although I exclude your reaction from that category).

    On the closeness of margins and whether we would call that gouging – I agree. But the main gouging arguments normally relate to the other charges and costs that the banks are fond of levying and there is no evidence that they are narrowing.

    Thanks, as always for your discerning scrutiny of the arguments.

    best wishes
    bill

  36. These unhedged liabilities are potentially fully hedged naturally as they are more than offset by the banks’ unhedged foreign currency debt assets and foreign equity investments.

    In my experience, a certain (small) proportion of the foreign debt of Australian banks is raised to match-fund their (relatively small) foreign currency balance sheets (i.e. loans to customers in Singapore, etc). They would not hedge these because, as it indicated in the quote, the debt is “naturally hedged” by the asset. Even more interesting is what comes next:

    After hedging, banks actually hold a small net foreign currency asset position.

    This means that the banks have actually been losing money as the Australian dollar has appreciated!

  37. Ray, AIG could have happily failed had it not eagerly dived into the derivative markets and subsequently require a US tax payer bailout to payoff their counter parties. AIG wasn’t ‘Too important to Fail’, their counter parties were too important not to be paid out. I said the same as you in an earlier post; nationalisation of the banking sector is not the answer, breaking up the big banks into smaller banking units that can be allowed to fail is. Unfortunately, we’ve gone from ‘Too Big / Important To Fail’ to ‘To Big To Control’.

  38. Dear Sean (at 2010/10/27 at 20:20)

    You noted (after quoting part of my reply earlier) that:

    This means that the banks have actually been losing money as the Australian dollar has appreciated!

    That statement that I provided which led to your conclusion was made by the RBA last year based on data up to March 2009 as I noted. Since then (as I also noted) the banks have considerably divested themselves of foreign-currency denominated assets in general (or have been subject to valuation changes – but same outcome regardless) and USD-denominated assets specifically. I didn’t give all the detail but it is clear that the reduction in foreign-currency assets has been more concentrated in currencies against which the AUD has appreciated the most.

    So the March 2009 data may still apply but I strongly doubt it. If you think for a moment – all the reasonable expectations for the currency pointed to a strong appreciation given the commodity price trends. So it is highly likely that the banks would steer their open foreign currency positions away from a loss and, instead, ensure they gained from the expected move in the AUD. All the evidence suggests that that is the case.

    So really your comment just notes the obvious – they lose when they have more open foreign-currency assets than liabilities – which I had already noted. It is what has happened since that date which is interested and led to my speculation and upon which you are silent. I would be interested in your speculation on those trends based on your experience.

    We will be able to clear this issue up in a few years when the ABS release the updated foreign exposure data. Unfortunately, it only seems to come out every 4 years.

    best wishes
    bill

  39. Bill,

    I have less confidence than you in the ability of Australian bank treasuries to correctly predict future A$ moves and position themselves accordingly! In any event, any profits/loss arising from slight under or over-hedging of offshore assets would be very small and certainly nothing on the scale of the profits Verrernder was suggesting that banks were making from interest-rate differentials (or appreciating A$) if all of their offshore borrowing was unhedged.

  40. “I really don’t see how any retail bank can operate post-GFC without an implicit government guarantee on depositor’s funds.”

    No bank can operate a fractional reserve system without an implicit state guarantee of depositor’s funds. That’s why they’re depositors and not investors. Bond owners should take a haircut though in line with other creditors.

    I fail to see why we need to be so cloak and dagger about it. If you say that the state guarantees depositors in a bank and the price of that guarantee is automatic administration and nationalisation of the institution then everybody knows where they are.

  41. In the post you say: “So this blog is about banking. Not a complete story (given I am short of time today) but an account of what I think should happen to banks and banking. Note that this account is interpretative rather than a statement of MMT principles. It reflects my preferences based on my understanding of those principles. But equally, someone with a similar understanding might choose a different policy path.

    At the outset let’s cut to the chase – I would nationalise all private banks.”

    While I realize you make it clear that this is your own personal opinion and in no relation to MMT, others “connect the dots” differently. And instead of asking the source for confirmation, the following conclusions have been drawn. And repeated ad-nauseum:

    1. Bill Mitchell supports bank nationalization;
    2. Therefore, some MMTers support bank nationalization;
    3. Therefore, most MMTers propose bank nationalization.
    4. The above is done implicitly through MMT’s understanding of the state theory of money.
    5. In conclusion: MMT’s base case is the nationalization of banking system, in which everything else derives, including the MMT JG. It can be no other way.

    So, in the interest of fairness, I thought I’d give you a chance to provide a response from an MMT perspective (as opposed to your own personal views). Also, feel free to shoot the messenger here. But just remember, at some point someone at American Airlines was bold enough to propose a solution for a bag of peanuts: Open package, eat contents.

    Consider me that person. Or Captain Troubleshooter, if you will.

    Again, sorry to interrupt, and I appreciate any insight you may have.

    (Summary: Sweet Mother of Jesus! Have mercy on us and put this issue to rest, one way or the other.)

  42. Dear Trixie (at 2012/06/08 at 6:53)

    I think the position is clear in the post and from the section you quote (which I truncate even further):

    So this blog … an account of what I think should happen to banks and banking. Note that this account is interpretative rather than a statement of MMT principles. It reflects my preferences based on my understanding of those principles. But equally, someone with a similar understanding might choose a different policy path.

    I cannot help it if people (ad nauseum) cannot differentiate opinion from principle. The same people are probably those who claim the Job Guarantee is a socialist program aimed at employing all Americans. The fact that these opinions fail to even understand what socialism is is telling.

    The jump in your logical train from Point 2 to Point 3 is irrational and unfounded and it is impossible to deal logically with that degree of ignorance. I realise you are just laying out what seems to be from your perception to be a train of thought held my “others … [who] … connect the dots differently”.

    So I support bank nationalisation to resolve the tension within what is already a public-private partnership and to ensure that if the public is to socialise the losses then it should equally socialise the benefits.

    That “opinion” is consistent with but does not define Modern Monetary Theory – as a set of logical principles.

    best wishes
    bill

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