Committing pointless economic suicide?

There has been some silly nonsense published in various overseas publications about the change of government – all that on top of things like the Wall St Journal‘s weird pre-election suggestion that Jacinda Ardern was some sort of Trump-like figure.

I’ve written about some egregious examples of ill-informed commentary here.  There was, for example, Nick Cater’s piece in The Australian praising the reformist nature of the previous government, the outperformance of the New Zealand economy, and specifically John Key and Bill English who “stand as inspiration to the rest of the developed world in these anxious and volatile time”.  And then, more recently, there was the Washington Post column by an Auckland-based American lifestyle journalist who sought to convince his readers that the new government was controlled by the far-right.   It was a case, we were told, of “Ardern may be the public face, it’s the far right pulling the strings and continuing to hold the nation hostage”.

Sure we are small and remote and not of that much objective significance to the rest of the world.  But the scope for really badly-informed commentary is still a bit of a surprise: in both cases, it seemed,  involving the authors projecting onto New Zealand what they wanted to see, and causes they themselves wanted to champion (in Cater’s case, genuine reform from the centre-right government in Australia, and in Ben Mack’s case probably a desire for something well to the radical-left of what any party in Parliament stands for).

Another example of detached-from-reality commentary turned up yesterday on Forbes magazine’s website, by an American investment adviser/commentator named Jared Dillian.  I’d never heard of him before, but apparently he has a following in some circles, and is clearly willing to speak his mind.  By the look of his new article on New Zealand, doing a little basic research first might help though.

His article has a moderate enough headline, New Zealand, An Economic Success Story, Loses its Way.    In fact as a headline in 1960 it would have been spot-on.   Without the constraints of magazine editors, his message was then amped-up when he tweeted out the link to the article, under the heading “New Zealand commits pointless economic suicide”.

I probably wouldn’t have bothered writing about it, but TVNZ asked me to go on this morning and comment on it, and preparing for that involved reflecting a bit more (than the piece really deserved) on where he was wrong and why.

I suspect the author must have been raised on some mythology about the 1980s reforms, which (rightly) got a fair amount of attention internationally then and for a decade or more afterwards.

There is the gross caricature of the pre-1980s New Zealand economy for a start (“most of industry was nationalized”, “extraordinary levels of government debt” [well, not much more than half –  as a share of GDP –  current debt levels in the US]).   And then the claims about the subsequent period that are utterly detached from any sort of data: “New Zealand is a supply-side economic miracle”, “New Zealand enjoyed unprecedented economic growth”, “it became one of the richest countries in the world”.

All this in a country which over the last 30 years has had one of the lowest rates of productivity growth of any advanced country –  none at all in the last five years –  and which looks set to be overtaken by Turkey and such former communist states as the Czech Republic, Slovakia and Slovenia.   We’ve just drifted slowly further behind most of the rest of the advanced world.  Numbers of those leaving fluctuate cyclically, but over the post-reform decades we’ve had one of the largest cumulative outflows of our own people of any advanced country in modern times.

But what of the suicide note that Dillian appears to believe the new government’s policy agenda represents?

Top of his list is any changes to the Reserve Bank Act.  He is, clearly, a big fan of the Reserve Bank and of New Zealand’s lead role in introducing inflation targeting.  That’s fine, and reasonable people can differ on whether there is a strong case for change, and the extent to which possible changes (details yet unseen) might change substance (as distinct from appearance/style).   But Dillian apparently knows already.

At 4.6%, unemployment is already low, but she wants to take it well below four percent, for starters. She would rather that the central bank tolerate higher levels of inflation in order to get unemployment lower, risking all that the RBNZ has achieved over the years.

A bit of basic research would have told him that the government has repeatedly indicated that they will not be seeking to give the Reserve Bank a numerical unemployment target, and that they recognise that other structural measures are needed if unemployment is going to be sustainably lowered very much further.  And in his press conference a couple of weeks ago. Grant Spencer “acting Governor” of the Reserve Bank didn’t exactly seem to think the baby was about to get thrown out with the bathwater.  If he did think so he could easily have said; after all he is retiring in four months’ time.  And the Bank had one of their friendly foreign academics, on a retainer from the Bank, out making pretty reassuring noises the other day too.  As he points out, the rhetoric from the government talks of modelling the Reserve Bank’s goals on those used in Australia and the United States –  central banks which, mostly, behave much the same way our Reserve Bank does when it is following its current mandate.

It isn’t just goal changes that worry Mr Dillian.

She also wants to include an external committee in the RBNZ’s monetary policy decisions, which will certainly give the bank a more dovish tilt.

When central banks as diverse as those of the UK, Australia, Sweden, the United States, Israel and Norway include external members on their monetary policy decisionmaking committee, it is difficult to take seriously the suggestion that moving to such a committee will “certainly” make New Zealand monetary policy more “dovish”.   What it may, perhaps, do is reduce the risk of the sort of false starts we’ve twice had to put up with from successive Governors this decade.

Then there is the forthcoming legislative ban on non-resident non-citizens buying existing residential properties.

New Zealand has, by anyone’s measure, one of the biggest housing bubbles in the world. Banning foreign ownership of property sets the country up for a possible real estate crash.

Set aside for the moment the question of whether the market is a “bubble” (I don’t think so, on any reasonable measure) but somehow adopting the same policy as Australia has had for years is suddenly going to fix our housing market problems.  If only.

What of immigration?

Ardern also opposes high levels of immigration, along with her coalition partner, Winston Peters. It is set to drop dramatically. Immigration, especially skilled immigration, has been a big contributor to economic growth over the years.

Actually, the Labour Party policy, which will be the government’s immigration policy, does not change the number of non-citizens annually given the right to live here permanently by even one person: the target remains at 45000 per annum (or around thre times per capita the rate in the United States).  Official policy supports continued high rates of immigration.  On immigration, Winston Peters won nothing beyond the rather limited, one-off, changes that Labour has proposed.

But, yes, really rapid increases in the population, driven by net immigration numbers, have greatly boosted headline GDP over the last few years.  Meanwhile, per capita real GDP growth –  surely the metric that matters rather more –  has been pretty anaemic at best.  And –  have I mentioned it before? –  there has been no productivity growth at all in the last five years.

Dillian ends with two final predictions.   Having heralded our high rankings on some of the economic freedom indices, he now asserts that “New Zealand will probably lose its status as one of the most open, free economies in the world”.    Frankly, that seems pretty unlikely.  As I’ve shown previously, on the measure he appears to cite our score has been pretty flat for 20 years now, through the ebbs and flows of the policy changes put in place by both National-led and Labour-led centrist governments.

econ freedom

Perhaps this government will prove different, but on the evidence to date – the published policy programmes – there isn’t much sign of it.

And what of Dillian’s final prediction?

It seems likely that New Zealand will experience a recession during Ardern’s term.

As it is now seven years (or eight, depending on how you count these things) since the end of the last recession, any detached observer would have to think there is a non-trivial chance of a recession in the next three years.  Periods of expansion don’t typically die of exhaustion, but New Zealand has never gone 10 years without a recession of some sort or other (and although some Australians like to boast of their 25 year run, in fact even they have had an income recession in that time –  a sharp correction in the terms of trade in 2008 for example).   Our modern history is a small sample of events, but it wouldn’t be too surprising if something went wrong in the next few years.

Of course, most –  but not all –  of our recessions have had a significant international dimension to them.   And that is still probably our greatest area of vulnerability in the next few years –  some shock, or series of shocks, arising out of insufficiently-weighted (or priced) areas of vulnerability, accentuated by the fact that most other countries now have little room to use fiscal policy for counter-cyclical purposes and almost none to use monetary policy (most policy rates being very close to, or below, zero). When the next foreign recession hits it is going to be difficult for other countries’ authorities to respond effectively.

Could we mess things up ourselves?  It is always possible –  and monetary policy mistakes are among the possibilities –  but even if you think the new government’s policy platform will reduce potential growth (or potential productivity growth) and even if there is some sort of “winter of discontent” fall in confidence next year, it is difficult to see what in the current mix of proposed domestic policies would tip New Zealand into recession.   Lower headline GDP growth seems quite possible, but was also likely if the previous government had returned to office.

Dillian’s story seems to rest on the forthcoming “housing crash” and cuts to immigration.  But if net migration is a lot lower in the next few years than it has been in the last few that is most likely to be because the Australian economy –  our largest trading partner – is doing better.    Policy itself is designed to maintain a high average net inflow of non-citizen migrants (and is the poorer for that).  As for housing, unless/until land use laws are substantially liberalised, the idea of a crash in house prices is just a scary fairy tale –  and were land use laws to be substantially liberalised, it would be more likely to be a force for good –  including allowing some productivity gains – than one that would drag the economy down (tough as some of the redistributive consequences might be for some people).    Among our good fortunes is that if demand does look like weakening materially, the Reserve Bank still has a fair amount of room to cut interest rates –  not enough probably, but more than almost all other advanced countries.

All of which Mr Dillian could have found out with the slightest amount of digging.  If there is a “suicide” dimension to economic policy in New Zealand, it is the wilful blindness of successive governments led by both main parties, who keep on doing much the same stuff, and either believe they’ll get a different and better (productivity) result, or who just don’t care much anymore.

What does The Treasury want to know? Not about productivity apparently

Last week I joined 80 or 90 other economists and people from related disciplines, drawn from the public sector, universities, consultancies, and think tanks, together with a few commentators, at an event organised by The Treasury.  It was billed as “Wealth and wellbeing: High quality economics in the twenty-first century”.  They were looking for input.

The symposium began with a presentation by The Treasury’s chief economist, Tim Ng, based around a paper he and a couple of colleagues had written, “Improving economic policy advice”.  That paper, in turn, built on the Living Standards Framework that Treasury has devoted a lot of effort to building and promoting over the last half dozen years or so (and which you can read all about here).

The Living Standards Framework has troubled me from the first, and despite the numerous refinements, and attempts to articulate how it is used, and how government policymaking benefits, I remain sceptical.   I’m not the only one: the New Zealand Initiative’s Bryce Wilkinson published a critique last year (pages 7 and 8).  Bryce made a number of good points, including the merits of a traditional cost-benefit analysis approach, and the tendency of the Living Standards Framework to assume the benevolence (and knowledge) of officials and politicians, in a way that simply ignores much of the economic literature around incentives, information, and the possibilities of the sort of government failure we see all the time.

The Treasury has for some years now proclaimed a vision for itself

Driving what we do is our vision to be a world-class Treasury working toward higher living standards for New Zealanders.

Like Bryce, I’m also uneasy about that

Personally, I am not a fan of vision statements for government agencies. Public servants are paid to serve their elected ministers in the wider public interest and perform their delegated authorities impartially.

Either Treasury’s vision has content –  in which case it has no more legitimacy than the personal preferences of a group of senior officials –  or it is little more than vacuous waffle (“we want to do well”).

There is much the same lack of clarity around the Living Standards Framework, the  centrepiece of which now appears to be this smart new picture.

Higher Living Standards - The Four Capitals - Natural, social, human and financial/physical

Good things flow from these “four capitals”.

There is an accessible, relatively recent, guide to using the Living Standards Framework(LSF).  But it is still not clear whether there is very much substance to it at all, or whether it ever means anything more than “when you do policy advice, there are lots of dimensions it can be important to think about”.  As if anyone ever doubted it.    Treasury talk about a list of six ways they have used the framework.  The first was for brainstorming, but then surely the whole point of brainstorming is not to be tied into an artificial organising framework?   They also show an example of analysing defence policy using the LSF, but (despite the pretty picture, page 10) it is not clear at all how analysing defence policy as a contribution to “social cohesion: abroad” is particularly helpful to anyone.   And their final use is “to measure progress”, featuring a heroic attempt to illustrate change across each of the dimensions since 1870.  An exercise of that sort might be useful for economic and social historians –  with all the inevitable caveats –  but it isn’t clear how it helps today’s ministers.  In fact, it would still be interesting to know whether any major decisions during the term of the previous goverment were made differently because of the advent of the LSF.

Perhaps it will be different under the new government? My observation at the time Treasury first came up with the LSF was that they seemed to be preparing for a Labour/Greens government.

There is also still the tone of a “grab bag” of the latest trendy ideas to it.   This line appeared in the paper presented to the Symposium

To be relevant, wellbeing measurement and cost-benefit analysis need to be sensitive to changing technological, ecological and social trends, such as digitalisation, globalisation, the rise of China, environmental limits, and an increasing policy focus on inequality.

And anything else ministers, citizens, or bureaucrats happen to find “relevant” at the time?  It doesn’t sound like much of a basis for rigorous, detached, free and frank advice.

One of the many problems is that there is little robust basis for aggregating all these issues, concerns and indicators.   But that doesn’t stop The Treasury, who have apparently decided to use the OECD’s Better Life Index, another theory-free ad hoc summary measure (on which New Zealand happens to score well).

Conveniently perhaps, the OECD index doesn’t even include either GDP per capita or related productivity measures (although there are some other income measures).   For some of the variables, it isn’t even clear whether, or why, something counts as good or bad.  The employment rate is in the index, but employment is mostly an input (inputs are costly), not an output –  and yet I presume the OECD counts a high employment rate as “a good thing”.   New Zealand score on ‘years of education’ will presumably lift now that we are going to have free tertiary education, but there is no assurance that the policy will lift average national wellbeing (as distinct from transfering it from one group to another).   Labour market insecurity appears in the index, in a measure in which a country is penalised for having low unemployment benefits relative to market wages –  but what basis is there for the OECD’s implicit judgement that one system is better than the other in the longer-term?  The share of expenditure devoted to housing also appears in the index: it will tend to be higher in a country with larger houses, but what basis is there for any sort of welfare interpretation of the numbers.   (And, on the other hand, the share of the native-born population living abroad –  a reasonable relative-welfare indicator, taken from revealed preferences – doesn’t appear in the index at all.)

These indices, and the Treasury’s Living Standards Framework, often seem to be developed in reaction to some sort of caricatured view that GDP (even per capita GDP) is everything.   But the problem with the caricature is that it is view that no one has ever held.  Every economic policy adviser recognises (for example) that GDP includes the spending/activity to replace depreciated physical capital.  A measure of net domestic product is a little more useful for welfare purposes, and a measure of net national income (distinguishing the income generated that accrues to residents) better still.   Measures of consumption per capita might be better again, if the purpose of economic activity is conceived as supporting consumption over time.   And it is not as if the concepts of externalities, or the depletion or degradation of natural resources, are exactly new phenomena.   And if some government were crazy enough (and powerful enough) to simply set out to maximise GDP per capita, they’d conscript us all, prohibiting retirement, individualised childcare, or even any leisure beyond what the maintenance of productive capacity might require.   It doesn’t happen in free societies (although it came close in wartime).   It is a straw man.  (As incidentally would a similar articulation about GDP per hour worked: if a government were crazy enough to seek to unconditionally maximise that variable they would simply ban all but the most productive people from working at all.)

So the issue about productivity, or GDP per capita, isn’t that the goal of policy has ever been to maximise either.  After almost 70 years of underperformance (productivity growth less than in other countries), one doesn’t have to get into debates about “maximising productivity” to want Treasury to be able to offer good answers about why we are in this situation, and how we might out of it.   Officials and advisers might concentrate on identifying roadblocks –  government policies that impede firms and households making choices they would otherwise take –  the removal of which might result in GDP/productivity outcomes more in line with those in other, apparently more successful, countries.  Of course, each of those interventions needs to be evaluated on its own merits.    There are good reasons to make schooling compulsory, or not have lump sum taxes or whatever, but many regulatory interventions won’t pass any sort of decent test (as, in its day, rules that led to the assembly of TVs didn’t).  I’d argue that our immigration policy doesn’t.

And if I can’t fully put my finger on what I don’t like about the “four capitals approach” it is a sense –  not stated, perhaps not even believed, but implicit nonetheless –  that these are resources of the government, to be marshalled and managed by governments in what they judge to be some sort of “national interest”.   And all too little of a sense that governments more often corrode these so-called capitals than foster them.

And in the New Zealand specific context, a focus on the Living Standards Framework can come to provide cover for the failure to grapple with New Zealand’s long-term economic underperformance and (in this specific context) the failure of The Treasury –  the government’s principal economic advisers –  to be able to offer compelling advice, built on compelling analysis and narrative, for what has gone wrong, and what might be done to fix it.   Perhaps we’ll see some startling new insight on that problem when the Treasury’s Briefing for the Incoming Minister is finally released, but I’m not expecting it – there have been no new ideas tested in working papers or speeches or anything of the sort.  In the paper presented at last week’s Symposium there was more on macroeconomic stabilisation issues (which New Zealand does relatively well) than on productivity, and no obvious policy ideas (on productivity) beyond changing the tax treatment of housing and land use laws (there might be elements of use in that, but no one seriously believes those changes alone would close the 60 per cent gap between, say, productivity levels in New Zealand and those in places like France, Germany, the Netherlands or the United States).

Much of the focus on the Symposium seemed to be on building links between Treasury and the academics.  I’m not sure they got far on the day, although the forum did provide a good opportunity for the academics to remind Treasury that (a) research costs money, (b) research takes time, and (c) the PBRF university ranking and funding scheme strongly discourages academics from doing any research, however well-remunerated, that doesn’t lead to publication to international journals or books published by university presses.

Treasury also used the occasion to launch something called the Community for Policy Research as part of strengthening relationships with researchers working on New Zealand issues.    As part of that, they have released a Research Interests document, a list of research interests which is

“our assessment of where additional research with a New Zealand focus could be useful.  It reflects a number of judgements, including our sense of gaps in the evidence base, where we believe polciy development is being hampered by lack of evidence and emerging medium to long term issues. Often we are looking for research that will help us make a step change, where wider debate will be necessary over the medium to long term”.

Which sounds fine, until one actually turns to the list.

On fiscal policy, for example, there is an item

“Should New Zealand have an Independent Fiscal Council?”

Perhaps it should, perhaps it shouldn’t, but it is explicit Labour and Greens policy that we should.   Presumably the outstanding issues are around the form, and responsibilities, that Council should take?

There are 13 macroeconomic topics –  many of them rather technical (output gap estimation, time-varying NAIRU estimation –  and not a single one of those topics relates to any sort of timeframe beyond the cyclical.    Thus, they are interested in “different approaches to population/immigration projections (eg Bayesian)” but apparently there are no outstanding issues around the longer-term term impact of immigration policy (whether on productivity, or those social and environmental capitals).

In fact, the word “productivity” doesn’t appear at all (or any cognates).  Does Treasury have all the answers already, or have they more or less given up?    The productivity issues seem like classic New Zealand-specific longer-term issues that The Treasury –  principal economic advisers to the government –  really should be looking for answers to, and associated research on.  But, apparently, topics like “What is the relationship between volunteer work, social and human capital?” count as more pressing.

Several people at the symposium took the opportunity to push back in reaction to Treasury’s recent boast that this year it had hired no one with just a straight economics degree.   As one public servant put it, they wouldn’t want to go to a mechanic for brain surgery, and as another former public servant noted, Treasury needs to be really excellent in its economic advice –  and tacking a few short day-release economics courses on to a degree in a quite different subject isn’t really likely to be enough.  One might be less bothered if there was a sense that Treasury’s analysis and advice was consistently excellent, and the only obstacle to first-rate policy was the politicians (of whatever stripe).  That just isn’t so these days.

Finally, it was interesting to observe the numbers of Treasury speakers and of panellists attempting to use Maori phrases, or introductions, or talking about the need to incorporate Maori perspectives into thinking about wellbeing.  As it went on, I started looking round the room trying to spot anyone who might themselves be Maori (noting that there were at least four adult migrants at my table –  of 10  –  alone).  Finally, my curiosity was satisfied when one of the panellists, clearly with the same sort of reaction, asked for a show of hands.  In a room of at least 80 people,  two responded that they identified as Maori. I hope it left the organisers just a little uncomfortable.

I’ve been reasonably critical of Treasury’s work in this (excessively long) post.  But I would commend them on the aspiration behind the occasion, and on going to the effort of openly engaging with a wider group of policy and research people, openly articulating issues they are interested in seeing research on.  There is a place for confidential policy advice and for the free and frank exchange of views between ministers and officials, but our understanding of the issues is only likely to be advanced by open, two way, dialogue and debate at earlier stages of the process.  Some of the challenges New Zealand faces are substantial, and the pool of able, interested and available people isn’t large, or necessarily restricted only to the public service.




Speaking out or selling out?

There was a disquieting, if perhaps not unduly surprising, article in the Financial Times the other day.   New restrictions imposed by the Xi Jinping-led Chinese Communist Party regime, new measures to assert the dominance of the party (ideology, personality or whatever), just continue the pattern of the last few years.  Just recently, villagers in one province were being told to remove pictures of Jesus and replace them with pictures of Xi Jinping.   Leading academic publishers have been put under pressure –  some have given in to it – to remove access in China to all sorts of journal articles.  There was the requirement to establish Communist Party cells even in private businesses, whether foreign or domestic-owned.  There is chilling forthcoming “social credit scoring” regime to monitor and control hehaviour.

The latest article was about the new rules for foreign joint venture universities in China –  of which there are now, reportedly, some 2000.  Such joint ventures will, it is reported, be required to establish a Communist Party cell and –  more concerningly –  the party secretary in each ventures “will be given vice-chancellor status and a seat of the board of trustees”.   Many of these trustee boards require unanimous votes for major decisions, including senior appointments.   So much for the prospects of any sort of sustained academic freedom, and as the FT article notes even where there is explicit provision for academic freedom in joint venture agreements there is real doubt about whether those provisions will be honoured, or be effective (control the budgets, control the people, and there is a lot of incentive to just go along).

I haven’t seen the story reported in New Zealand yet, which is a little surprising given the close ties New Zealand tertiary institutions seem to have with China.  I’m not sure how many others have formal joint venture arrangements, but I recalled reading quite recently about how Waikato University is now offering degrees to Chinese students without them ever leaving China and so I looked up what was going on there.  Just this year, they launched a joint venture in China with Zhejiang University City College.  According to the deputy vice-chancellor

it was generally difficult to get permission to run these types of programmes in China, but the university’s 15-year relationship with ZUCC paved the way.

It would be interesting (but predictable enough really) to know how Waikato University is responding to the latest Chinese government control initiative.  How, for example, will they protect the academic integrity of the programmes they are running in China –  when the Party gets to veto all major decisions?  Perhaps the subjects that will be taught (Finance, Computer Graphic Design and Design Media) aren’t likely to be particularly politically sensitive, but the point of principle remains.   And with this sort of direct Party control over a significant Waikato subsidiary, one can only assume it is even less likely than ever that the hierarchy will be comfortable if any of their staff here are speaking openly in ways that upset Beijing.

But I don’t suppose we will be hearing any concerns voiced by the Chancellor (former Prime Minister Jim Bolger) or Vice-Chancellor of Waikato, or by Universites New Zealand.

There was an interesting commentary on this specific issue on an Australian “public policy and business innovation website”.    Australia’s leading universities –  generally much higher ranked than New Zealand universities –  appear to be much more engaged in this joint venture business than those here.

Monash University, for instance, is an institution that was at the forefont of the international student surge. It has a fully-fledged joint venture university with Southeastern University, a Graduate Management Institute in Suzhou part of the populous Yangtze River delta in middle of which sits Shanghai.

Most of the Group of Eight universities has at least one joint venture research institute, although some of these are “virtual”

As the commentary notes

The strategy reflects a broader project that was initiated under Xi several years ago to tighten state’s control over China’s already state-run universities, some of which were displaying a bit too much independent thinking for the control freaks in Beijing.

Party Committees were expanded and upgraded, and all students were made to take classes in Marxist-Leninist Theory with the usual rider of the version ‘with Chinese characteristics’.

So, in fact, Australian universities are already deeply complicit in compromised academic environments in the bewildering range of partnerships with scores of Chinese universities.

The author sees the whole thing ending badly, as it has for so many other private sector investments in China

Now the CCP has stuck an entire foot in to truly test the water to see how this could be stomached. But rest assured that further steps will have already been lined up to rollout for those who champion mammon over ethics.

The final result, and this is just a hypothesis based on the Party’s track record, will be fire sale with only one bidder.

For now, Australia’s universities are staying mum. Universities Australia offered a thoughtful and erudite contribution of “no comment.”

Doubtless the Group of 8 – and all the rest as well – are busily attending to duties in private, but at some stage they will have to say something without offending the Chinese.

It’s a classic Beijing trap: Stay silent and the West condemns you, speak up and Beijing cuts off your biggest revenue stream, Chinese students.

Or, in New Zealand, perhaps no one of note condemns you, because almost the entire establishment has simply chosen to do the kowtow.  But it is a reminder that when, for examples, universities stay silent, it is about continuing to do deals with the devil –  self-interest, blind (self-chosen) to the character of the people one is dealing with.  Do otherwise-decent people really have no qualms about the sort of regime they deal with and which, by their silence and their trade, they make themselves complicit with?

In the same vein, I happened to notice a forthcoming half-day seminar at Victoria University on New Zealand’s relations with China, marking the 45th anniversary of diplomatic relations with the PRC.  It looked potentially interesting, and was free, and I wondered if I might go along.  But then I had a closer look.  Sure enough, the seminar is co-organised by the Confucius Institute at Victoria University –  recall that these Institutes (there are hundreds around the world) are funded by the Chinese government, and subject to extensive Chinese government controls.    The seminar is supported by the New Zealand China Council, New Zealand China Friendship Society and New Zealand China Trade Association,  groups from whom never a critical word (about China anyway) is heard.    You certainly won’t find Professor Anne-Marie Brady, or the sorts of concerns she has been raising, on the agenda, as one might reasonably expect in a forum organised by a body genuinely interested in open debate, critical scrutiny etc (eg an old-fashioned university).  You might agree or disagree with her on some or all issues, but the lack of open debate in such fora should be a concern.  Instead, Victoria University prostitutes itself.

Australia has its own problems in these areas, including –  as noted in the commentary above –  the desperate desire of universities for the money that comes from keeping quiet and getting on.  But I was struck over the last few days by a contrast between the New Zealand Labour Party in Parliament, and the actions of words of an Australian federal Labor MP.

When the list of select committee memberships came out the other day, Labour’s Raymond Huo was the senior government member on the Justice select committee.  This is the same Raymond Huo whose affinities with Xi Jinping Anne-Marie Brady has written up, and of whom Charles Finny –  former senior diplomat and now leading lobbyist – told us recently that he was always very careful what he said in front of Huo, knowing that he was close to the Chinese Embassy.

What is the Justice select committee responsible for?

The Committee looks at business related to constitutional and electoral matters, human rights, justice, courts, crime and criminal law, police, corrections, and Crown legal services.

Huo’s place on committee –  whether he chairs it, or an Opposition MP ends up doing so – doesn’t fill one with any confidence that the government might take seriously issues around foreign electoral donations, for example.

And, by contrast, there was a speech given the other day in Tokyo by Michael Danby, an Australian federal Labor MP (and member of the foreign affairs select committee), headed “China’s rise in hard strategic and political power”.    There is a lot of material in the speech, and when he gets to China’s political influence operations he draws at length from Anne-Marie Brady’s work.  He calls out the expansionist activities in the South China Sea –  about which barely a word is ever heard in our Parliament –  about the push to establish Chinese bases across the Indian Ocean, about repression of religion, restrictions in Xinjiang, attempts to control Chinese language media in other countries, the co-option of politicians and business people.  Even Jian Yang gets a mention.

Sadly, it is hard to imagine any of our MPs willing or able to engage at such a level, and so openly, in dealing with the issues raised by a large aggressive repressive major power.  It is true of all sides of politics, from what we observe.

Then again, Australia is the country where the Secretary of Foreign Affairs, Frances Adamson, recently gave a pretty strongly-worded speech, clearly authorised by ministers, highlighting some of the risks around Chinese interference and what it means to be a free society, one with very different values from China.  Meanwhile, her New Zealand counterpart sits of the board of the government-funded China Coucil, which pumps out innocuous pap (avocados to China anyone?), sponsors seminars that avoid anything controversial, and only reinforces the sense that New Zealand’s elites have sold themselves out so much that they are almost afraid of their own shadows, and of standing up at all for the sorts of values that New Zealanders –  and probably many Chinese –  hold, but which the Chinese government counts as anathema.





Revisiting Westpac and the Reserve Bank

Last week I wrote a post about the Reserve Bank’s announcement that it had increased Westpac New Zealand Limited’s minimum capital requirements –  by quite significant amounts – “after it failed to comply with regulatory obligations relating to its status as an internal models bank”.

Two things in particular annoyed me last week:

  • the complete lack of any serious explanation, from either the Reserve Bank or Westpac, as to what had gone on and why, how and by whom the errors were uncovered, what remedial steps had been taken (in both institutions), how we could be sure similar problems didn’t exist in other banks, and
  • the absence from both statements (Reserve Bank and Westpac) of any reference to Westpac’s directors, even though under our system of bank regulation and supervision, the directors have primary responsibility for attesting to the accuracy of disclosure statements, and face potential civil and criminal penalties for (strict liability) offences for publishing false information.

One can understand why Westpac would not want to say anything more, even if (for example) they thought the Reserve Bank had overreacted: don’t upset the regulator is one of the watchwords of the banks, because even if your concern might be justified on one point, the Reserve Bank has many other ways to get back at you on other issues (where, eg, approvals are needed) if you make life difficult.

The Reserve Bank’s stance is more disconcerting.  It is, after all, a government regulatory agency, responsible to the public for the exercise of its statutory powers, and for the management of its own operations.    And yet, as so often with monetary policy, they seem to think it is up to them to decide how much they will graciously tell us, rather than to be accountable and answer the questions that people have.  I gather they are refusing to explain themselves further at all.  If, as it says it is, the government is serious about increasing the transparency of the Reserve Bank, this is just another example of why reform –  and a new culture –  is needed.

When I wrote last week, there were several things I didn’t notice.

First, I noticed the lack of any sign of contrition in the Westpac statement, but didn’t go on to draw the obvious conclusion that lack of any sign of contrition –  even feigned for the public – might suggest that they felt they were being rather unjustly dealt with in this matter.    Had they been caught out doing seriously bad stuff, you’d have expected them to, if anything, overdo the public contrition (mea culpa, mea culpa, mea maxima culpa and all that).

Second, the Reserve Bank’s statement was clearly designed to have us believe that there had been systematic problems for nine years now, ever since Westpac was first accredited to use internal models.  Why do I say that?  This is what they said.

The report found that Westpac:

  • currently operates 17 (out of 35) unapproved capital models;
  • has used 21 (out of 32) additional unapproved capital models since it was accredited as an internal models bank in 2008;

But someone pointed out to me Westpac’s initial disclosure of the problems in its September 2016 disclosure statement.   In that statement (page 9) Westpac disclosed a couple of trivial errors dating back to 2008 (in sum, lifting risk-weighted assets by $44 million on a balance sheet of $86 billion).  And what about the model approvals errors?  Well, this is what the directors’ disclosure says:

“The Bank has identified that it has been operating versions of the following capital models without obtaining the Reserve Bank’s prior approval as required under the revised version of the Reserve Bank’s Capital Adequacy Framework (Internal Models Based Approach)(BS2B) that came into effect on 1 July 2014”

If it is correct that prior to July 2014 internal models banks did not require Reserve Bank approvals for specific models (and I have now have vague recollections of internal discussions on exactly this point in 2013/14, and an earlier version of BS2B does not have the requirement) that would put a rather different light on Westpac’s errors than was implied in the Reserve Bank statement.    Transition problems associated with a pretty new requirement look rather different than a failure that had run for nine years since the inception of the Basle II regime.

The original conception of allowing banks to use internal models to calculate risk-weighted assets (for capital adequacy purposes) had not been to have the Reserve Bank micromanaging the process, but rather reaching an overall judgement about the ability of banks to responsibly use such models, while imposing supervisory overlays where the Reserve Bank thought the models were producing insufficiently cautious results (as we did from day one in respect of housing mortgage exposures).  Over the years, the Reserve Bank grew less confident in the internal models approach, culminating (apparently) in the 2014 requirement that all models have prior Reserve Bank approval.

As the situation stands now

Registered banks may only use approved internal models for the calculation of their regulatory capital adequacy requirement. Banks must advise the Reserve Bank of all proposed changes to their estimates and models before implementing them.

There are specific requirements laid down about the information banks have to submit to the Reserve Bank when seeking such approvals. I’ve been told that the Reserve Bank can then take up to 18 months to work through the process of approving any change (there are, after all, 32 models for Westpac alone, and four internal-models banks).

The Reserve Bank also requires that

A bank that has been accredited to use the IRB approach must maintain a compendium of approved models with the Reserve Bank. This compendium has to be agreed to by the Reserve Bank and only models listed in that compendium may be used for regulatory capital purposes. The compendium is to be reviewed and relevant sections are to be updated at least once a year. The compendium must be updated as soon as practicable after a model change has been approved by the Reserve Bank. The compendium lists basic model-related information such as version number, approval date, risk drivers, key parameters, as well as information from the most recent annual validation report on RWA, EAD, validation date and model outlook, and any other model-related information required by the Reserve Bank.

All of which sounds sensible enough, but it raises some obvious questions.  If this was a new requirement in 2014 (but in fact whenever the requirement was introduced), surely the Reserve Bank would have insisted on a compendium from each bank of the models that bank was using at the time, and then would have put in place a process to (a) monitor any changes it was approving, and (b) ensure, whether by directors’ attestation or whatever, that any changes to the models banks were using actually had prior Reserve Bank approval.  But did any of this happen?

Since we don’t have anything in the way of a good explanation from either Westpac or the Reserve Bank we can only guess at what must have happened.  I’m pretty sure Westpac didn’t consciously set out to deceive the Reserve Bank –  the banks are gun-shy, terrified of breaching conditions of registration –  and the Reserve Bank’s own statement seems to accept that story.

Perhaps there is a clue in this line from the Reserve Bank statement as to what the independent investigation found.  Westpac New Zealand

failed to put in place the systems and controls an internal models bank is required to have under its conditions of registration.

Most or all of the risk modelling work is likely to have been being done in Sydney (by the parent bank) and not by Westpac New Zealand at all.   Quite possibly, people on this side of the Tasman only ever see the bottom line numbers, and pay no attention to the modelling or (small?) changes in it.    Perhaps Sydney went on refining risk models, including updating the models for changes in data composition (as the composition of individual loan portfolios changes), and just didn’t know that they were now (unlike the first few years as an IRB bank) required to notify and get Reserve Bank approval for each and every change?   If so, it is still a system failure –  and potentially of concern for the way it highlights how things could go more seriously wrong –  and shouldn’t have been allowed to happen, but it doesn’t seem like the most serious failing in the world.  Did the Reserve Bank see Westpac’s model compendium in 2015, and if so did they confirm with the Westpac risk people in Sydney (presumably who they are primarily dealing with) that the models in the compendium, and only those models, were being used?  If so, why it did it take another year to uncover the problems.  And if not, why not?

Without a proper explanation, we don’t know if this is the story.   But depositors and creditors should be owed an explanation by Westpac, and the public are owed one by our regulator, the Reserve Bank.

The third thing I didn’t pay much attention to last week was the statement that Westpac now had a total capital ratio (share of risk-weighted assets) of 16.1 per cent.  It seemed surprisingly high, but it was higher than the (temporarily increased) regulatory minima, and than the level Westpac had undertaken to maintain, so I passed over it quickly, and I shouldn’t have.

Here are Westpac New Zealand’s capital ratios (common equity tier one, and total capital) for the last couple of years.  The data are taken from disclosure statements and, for September 2017, from Westpac’s press release last week.

wpac capital ratios

I couldn’t find any reference anywhere to Westpac New Zealand Limited having issued any capital instruments on market in the September 2017 quarter.    But the Westpac New Zealand branch did issue $US1.25 billion of perpetual subordinated contingent convertible notes in September.  Those instruments would qualify as Tier One capital (though, of course, not as common equity).  Since we don’t yet have the September disclosure statement, we can’t be sure what went on, but it looks as though the proceeds of that issue might have been used to subscribe to (eg) a private placement of similar securities by Westpac New Zealand to its parent.  Whatever the story,  it seems unlikely that the sudden increase in Westpac New Zealand’s capital ratio had nothing to do with the fight they were then no doubt in with the Reserve Bank about the appropriate response to the model-approvals issue.

Again, we deserve a better explanation from the Reserve Bank (and Westpac) as to what actually went on.  For example, did the Reserve Bank insist that Westpac take on more capital, even beyond the temporarily increased regulatory minima, and then let Westpac raise the additional capital before letting the public (and depositors/creditors) in on what was going on?  Perhaps not, but the alternative –  in which Westpac New Zealand just happened to decide to raise more capital just before the regulatory sanction was announced  –  seems a bit implausible.  The news coverage would have been at least subtly different if last week’s announcement of the model approvals errors had been accompanied by the statement that Westpac New Zealand would need now to take steps to increase its level of capital (as distinct from just glossing over a fait accompli).

Which also brings us back to the unanswered questions?   We don’t know how much difference the use of unapproved models actually made to Westpac’s risk-weighted assets –  in fact, we don’t even know if the Reserve Bank knows.   And we don’t know if the Reserve Bank insisted on this new capital –  although it seems likely given that they noted that

In addition, the Reserve Bank has accepted an undertaking by Westpac to maintain its total capital ratio above 15.1 percent until all existing issues have been resolved.

when 15.1 per cent is well above even the temporarily higher regulatory minima for Westpac.

But if so, is the penalty proportionate to the offence?  It is impossible to tell, on the information the Reserve Bank has so far made available, and that isn’t a good state of affairs –  no basis for holding this (weakly-accountable) regulator to account.

And, to return to one of the questions I posed last week, why wouldn’t prosecution of the directors have been a more appropriate penalty, and one better-aligned with the design of the regulatory framework?  I’m not suggesting anyone should have gone to prison, but if what actually went on here was a governance design failure, surely it is an obvious case for trying out the penalty regime designed to ensure that directors do their job (of, among other things, ensuring that management do their job)?  A fine on each director –  for what are, after all, strict liability offences –  looks as though it could have been a more appropriate penalty.    But if such prosecutions had been contested, that might have forced the Reserve Bank to disclose more, including about their own system failures, than perhaps they would have been comfortable with?   Bureaucrats protect themselves, and their bureau.

As I said last week, I hope journalists use the opportunity of the Financial Stability Report press conference next week to pose some of these questions to the “acting Governor” and Geoff Bascand, the new Head of Financial Stability.  They can’t force the Reserve Bank to answer questions, but if the Bank continues to stonewall, in the face of repeated questions from multiple journalists, in a news conference that is live-streamed, it won’t be a good look for the Reserve Bank (or for Geoff Bascand personally, if he is still in the race to become the next Governor).



Looking for a successful outward-oriented economic strategy 

I could bore you with thoughts on (a) Supreme Court rulings on the duties of trustees to disclose material to members/beneficiaries, or (b) even more recondite rulings on severability (the conditions under which, having inserted an invalid and unenforceable provision into a deed, the discovery of that invalid provision invalidates (or not) the rest of the deed).  Doing so might help straighten out my thinking for a meeting this afternoon, but it would bore you witless.

Instead, I’ll just leave with a link to a piece I wrote that appeared on the New Zealand Centre for Political Research website over the weekend.

A month or so ago, on the day the new government was to be sworn in, I wrote a post here about the apparent tension between the government’s stated ambition to increase the outward-orientation of the New Zealand economy (including the appointment of a Minister for Export Growth) and various specific policies the new government seeemed committed to, which seemed likely to reduce exports as a share of GDP (all else equal).  In some cases, those policies represented overdue elimination of explicit or (more often) implicit subsidies.  In other cases, no doubt some sort of case could be made for each of the policies on their own merits.  Nonetheless, taken together they looked likely to continue to shrink the foreign trade share of the New Zealand economy (the actual outcome under the previous government, despite the regularly restated goal to substantially increase exports as a share of GDP.

In that earlier post, I included this chart, of exports and imports as a share of GDP, back to 1971/72.

trade shares

There are some data revisions due out later this week.  It would be very surprising if they changed the broad picture.  Foreign trade has been becoming less important as a share of New Zealand’s economy, even though every successful case of economic transformation I’m aware of has involved getting the preconditions right that result in more domestic firms successfully taking on the world market.

There are some unavoidable factors that explain a temporary diversion of resources towards the domestic economy: the repair and rebuild process after the Cantervury earthquakes being the most obvious. But the peak of that process has passed, and yet Treasury’s advice in the PREFU was that the downward trend (in exports/GDP) would continue.  The problems look structural.

A few days after that earlier post I was mildly encouraged to see references in the Speech from the Throne to the need to lift productivity in New Zealand.  Exports were highlighted in this paragraph

This means working smarter, with new technologies, reducing the export of raw commodities and adding more value in New Zealand. For example, by securing the supply for forestry processing, greater investment in fishing and aquaculture, increasing skills and training, and more research and development to add value to dairy and other products and to create new technologies.

I couldn’t track down old Speeches from the Throne, but it did strike me as the sort of stuff almost any government could have (and probably did) say for at least the last 50 years.   The previous government, for example, claimed to be keen on aquaculture, and removing regulatory roadblocks to it.  Forest processing as a big theme in the 1950s when the government led the formation of Tasman Pulp and Paper (and my old hometown of Kawerau).  And so on.

And yet, as the old line has it, if one does the same stuff over and over again, why would one expect a different result?  We’ve been drifting behind the rest of the advanced world –  and have had no productivity growth at all in the last five years –  and foreign trade as a share of GDP hasn’t been sustainably increased for 25 years now.

Muriel Newman, former ACT MP, at NZ CPR saw that earlier post and asked if I’d like to do something shorter, and a bit more policy-focused for their newsletter.    The result is here.

I noted that there are lots of things that could be dealt with to lift our economic performance

I hope that the new ministers are going to turn their minds pretty quickly to how they might achieve the sort of reorientation in the economy that their own campaign recognised is needed. Regional development funds aren’t likely to be the answer; in fact, over the last 15 years, “the regions” have generally done better than “the cities”.   Auckland has been the laggard (again in per capita terms).

There are plenty of things that could be done to lift the competitiveness of the New Zealand economy.  For example, we now have a company tax rate that is above that of the median OECD country.   Lower taxes on the returns to business investment are one of best ways of getting more such investment.   We also already have one of the highest minimum wages rate, relative to median incomes, of any OECD countries.  Reforming our land use and planning laws could markedly lower the cost of housing, and help ensure that people and businesses can locate in the best locations.

In response, Muriel Newman asked a bunch of other regulatory issues.  I noted that I agreed that there was plenty of room for improvement on many fronts

But it is worth remembering that things on the regulatory front are typically not worse here than in most other advanced countries (indeed, we often score a little better than average on summary measures).   There is a lot we could do to remove roadblocks in these areas, but if we are to understand why NZ has continued to do badly relative to other advanced countries, i think we need to focus on things that are different here than abroad.  As per the column, our company tax rate is now high, and our minimum wage is high (both relative to other OECD countries).  But we are also very remote, in an era when personal connections seem to matter more than ever, and we have an immigration policy that is very unusual by international standards.  Of other OECD countries, only Australia and Canada come close to our target inflow (and Israel will take any Jewis person who wants to come –  that is a different issue).

And to revert to the concluding paragraphs of the NZCPR article

Defenders of our very high target rate of immigration talk constantly about skill shortages.  But OECD data show that New Zealand workers are already among the most skilled around.  We don’t need more workers – skilled or otherwise.  In fact, because of how difficult it is to base internationally competitive businesses here, there is an almost irreconcilable tension between continuing to drive the population up, wanting to deal with the pressing environmental issues associated with natural resource exports, and still wanting First World living standards.  The best way to square the circle would be to cut back sharply on the target rates of non-citizen immigration.

There isn’t anything necessarily wrong, in principle, with a growing population.  But successive governments have been putting the cart before the horse – driving the population up in the idle hope that a bigger population might somehow spark higher productivity growth.  In a location that isn’t a natural home to lots of people, that was never very likely.  Instead, we need to focus instead on the able people we already have – and to heed the wisdom of the New Zealanders who’ve been leaving.   Without a change of course, we seem set to slowly drift ever further behind other advanced countries, increasingly unable to offer our people the world-leading living standards we once delivered and could, with the right policies, once again aspire to.

It is a shame that the new government shows no interest in tackling our anomalous, and deeply unfit-for–this-location, immigration policy (indeed, there are now reports they are in no hurry even to fix the manifest problems around student visas and associated work rights).  Unless they do so –  and in the process achieve a substantial sustained reduction in the real exchange rate –  it is very difficult to see a path through which the Minister for Export Growth will get to the end of his term and be able to point to a sustainable turnaround in performance, and a trajectory for exports (and imports) as a share of GDP that might offer some hope of New Zealand one day catching up with the rest of the advanced world again.

Growth in debt, but barely at all in New Zealand

I’m a bit tied up for the next couple of days, and so posting might be light and insubstantial  My share in the stewardship of a financial entity that has now operated for decades without appropriate authorisations and approvals is somewhat time-consuming (thank goodness we have a Reserve Bank to deal with cases where major commercial banks don’t follow the rules).

But for today, I’m just going to leave you with a simple chart. presumably constructed by Moody’s from BIS data, that I found in a newsletter last night.  It shows the change in the ratio of business and household debt to GDP between 2007 (just prior to the recession and financial crisis) and 2017 for 41 advanced and emerging countries.

household and corporate debt

In some quarters you hear a lot about high and rising debt in New Zealand.  I’ve pointed out previously that the “rising” bit is mostly wrong –  and that levels comparison across countries are difficult to do meaningfully, because of issues such as the tax treatment of debt.  Despite the surge in house prices in the last few years, household debt as a share of GDP isn’t much higher now than it was in 2007.

What this chart highlights is that New Zealand is towards the end of the spectrum with the least increases in private debt as a share of GDP.   Of these 41 countries, only five advanced economies and two emerging ones had less of an increase (more of a fall) than New Zealand.

And here is a slightly more detailed chart on the specific New Zealand data, showing credit for each of the three sectors the Reserve Bank reports, as a share of GDP.


In the years leading up to 2007 we did, indeed, see a big increase in private sector indebtedness (as a share of GDP), across households, farms, and non-farm business.  In the crisis-prediction literature it was a classic warning sign –  taking on lots of new loans very quickly is often associated with a serious deterioration in credit standards.    But it didn’t come to anything much, at least outside the (small) finance company sector.

Sure, we had a serious recession in 2008/09 –  as most other countries did (it was largely a global phenomenon, with roots in the US in particular) –  but our core financial sector came through the recession unscathed.  Banks weren’t perfect by any means (they are run by humans in a world of imperfect information so that is hardly surprising) and of course there was some increase in loan losses and provisions.  But nothing to threaten the soundness of any major institution or the system as a whole.

There probably are some serious questions to ask about what has gone on, and what might yet happen, in some of the countries in the chart that have had big recent increases in debt to GDP ratios –   China most notably –  but as was the case pre-2007, a big increase in debt is unlikely to be any sort of safe predictor of future financial sector problems.

And whatever the situation abroad, New Zealand at present doesn’t look like one of those places where anyone should be concerned about financial system risks.  Yes, our house prices are cruelly high, but the structural policy failings that took them there don’t show any sign of being sustainably fixed.  And there just hasn’t been much new debt taken out for other purposes.

All this is, of course, backed up by successive waves of stress tests undertaken by the Reserve Bank.   Which does leave you wondering why we now have such a regulatorily-distorted and suppressed market in housing credit.


More questions than answers

When a Reserve Bank press release turned up yesterday afternoon, announcing that the Reserve Bank had temporarily increased the minimum capital requirements for Westpac’s New Zealand subsidiary, after breaches had been discovered in Westpac’s compliance with its conditions of registration, my initial reaction was a slightly flippant one.  It must, I thought, be nice for the Reserve Bank to be able to impose penalties when banks don’t do as they should, but it is a shame that there is no effective penalty operating in reverse.   When the Reserve Bank misses its inflation target, imposes new controls with threadbare justification, flouts the principles of the Official Information Act, allows OCR decisions to leak, or attempts to silence a leading critic what happens?  Well, nothing really.

But as I reflected on the Reserve Bank’s statement and the Westpac New Zealand, both reproduced here, I became increasingly uneasy.

This is what we know from the Reserve Bank

Westpac New Zealand Limited (Westpac) has had its minimum regulatory capital requirements increased after it failed to comply with regulatory obligations relating to its status as an internal models bank.

Internal models banks are accredited by the Reserve Bank to use approved risk models to calculate how much regulatory capital they need to hold. Westpac used a number of models that had not been approved by the Reserve Bank, and materially failed to meet requirements around model governance, processes and documentation.

The Reserve Bank required Westpac to commission an independent report into its compliance with internal models regulatory requirements. The report found that Westpac:
·currently operates 17 (out of 35) unapproved capital models;
·has used 21 (out of 32) additional unapproved capital models since it was accredited as an internal models bank in 2008; and
·failed to put in place the systems and controls an internal models bank is required to have under its conditions of registration.

The Reserve Bank has decided that Westpac’s conditions of registration should be amended to increase its minimum capital levels until the shortcomings and
non-compliance identified in the independent report have been remedied.  …..

In addition, the Reserve Bank has accepted an undertaking by Westpac to maintain its total capital ratio above 15.1 percent until all existing issues have been resolved.  The Reserve Bank has given Westpac 18 months to satisfy the Reserve Bank that it has sufficiently addressed those issues or it risks losing accreditation to operate as an internal models bank.

There is nothing additional in the Westpac statement, but they don’t appear to dispute either the Reserve Bank’s findings or its response.

There are a few things to clear away.  First, the temporary increase in the minimum capital requirements for Westpac New Zealand does not constitute a financial penalty at all.    Arguably that might be true even if it increased the actual amount of capital Westpac had to hold (Modigliani-Miller and all that), but this measure does not do that.    The Reserve Bank statement tells us that as 30 September, Westpac’s total capital ratio was 16.1 per cent.

That doesn’t mean it is no penalty at all.   I’m sure there has been a great deal of very uncomfortable anguishing in recent months both among Westpac New Zealand directors and senior management, and at head office (and the main board) in Sydney.  APRA is likely to have taken a very dim view of this sort of mismanagement by an Australian bank’s subsidiary.  And, of course, a lot of scarce staff time is now going to have be devoted to sorting these issues out over the next 18 months.  That resource has an opportunity cost –  other things those people could have been used for, which might have boosted the bank’s earnings.

But what I found more striking was how little either the Reserve Bank or Westpac statements said about breaches of conditions of registration which appear to go to the heart of our system of prudential supervision.

There is, for example, nothing at all in the Westpac statement about how these errors happened (use of numerous unathorised models, dating back to 2008), and not much contrition either.  The closest they come is this

WNZL is disappointed not to have met the RBNZ’s requirements in this area.

And our system of banking supervision is supposed to, at least in principle and in law, rely very heavily on attestations from each individual director that the bank they are directors of is fully in compliance with the conditions of registration (which includes provisions around calculation of minimum capital requirements and associated models).  But there is no apology from the directors, and no sign that any director has lost his or her job.   Potential heavy civil and criminal penalties –  including potential imprisonment –  are supposed to sufficiently focus the attention of directors that depositors and other creditors can rely on the information banks publish.  Westpac’s clearly haven’t been able to rely on their disclosure statements for almost a decade.  And yet there is no specific mention of the directors in the Reserve Bank’s statement either.

There is also nothing in either statement (Reserve Bank or Westpac) about the quantitative significance of the errors.   The Reserve Bank tells us that they accept that Westpac did not deliberately set out to reduce its regulatory capital, but intent and effect are two different things.    These problems appear to have been known about for more than a year –  Westpac tells us they first reported them in their September 2016 Disclosure Statement.  But was the effect, over the years since 2008, to reduce the amount of capital Westpac had to hold relative to what it would have been if they’d been using Reserve Bank approved models?  Or does no one –  at the Reserve Bank or Westpac –  yet know?   When the issues are sorted out will Westpac New Zealand be required to restate its capital ratios for the whole period since 2008?

The Reserve Bank’s own processes also seem lax at best.    And this comes closer to home for me, since I sat for a long time on the Bank’s internal Financial System Oversight committee.  The precise mandate of that committee was never fully clear –  in a sense, it was to provide advice on whatever issues the Governor wanted advice on –  and we didn’t typically do individual bank issues at this level of detail.  But that Committee provided advice to the then Governor to go forward with Basle II and, in particular (back in 2008), to allow the big banks to use internal-models based approaches to calculating regulatory capital requirements.    I don’t recall if anyone ever asked how we –  the Reserve Bank –  could be confident, on an ongoing basis, that an internal-models bank was actually using approved models.  But had anyone done so, I’m pretty sure the answer would have been along the lines of “director attestations” and the stiff potential civil and criminal penalties directors could face for what are, after all, strict liability offences (directors don’t have to be shown to have intended to mislead –  it is enough that their statements were subsequently found to be false.)

For a long time the concern was that any questions we (the Bank) asked of bank management would weaken the incentive on directors to get things right –  they might, after all, claim they had relied on us.   But that mentality had been changing in the last decade –  eg the Reserve Bank started collecting private information that creditors don’t have access to.     But where were the questions around Westpac’s models?  After all, it wasn’t a single model where someone overloooked getting Reserve Bank sign-off, but roughly half of all the models, stretching back years.

If there is nothing in the Reserve Bank statement about steps the Bank may have taken to improve its own monitoring and recordkeeping (given that they had to grant approval, how did they not know that so many models were being used and had had no approval?), there is also nothing about any steps they may have taken to assure themselves that there are not similar problems in any of the other IRB banks.   Have they even asked the question?  Surely, one would think, but mightn’t we expect to be told?

As I noted, there was no mention of the directors in the Reserve Bank statement.  But did the Reserve Bank consider taking prosecutions against Westpac’s directors, who signed false disclosure statements over the years from 2008 to 2016?  If not, why not?  If the directors believed (as presumably they did) that the statements they were signed were correct, did they have reasonable grounds for that belief?  What procedures or inquiries had they instituted over eight years that (a) they had confidence in, and (b) still proved wrong?  The Reserve Bank insists on independent directors: those on the Westpac NZ board look quite impressive, but what were they doing all those years?

If the Reserve Bank has lost confidence in a system of rather condign punishment of directors, perhaps it should tell us so, and seek legislative changes.  But if it really still believes that director attestations have a central role in the framework, surely this is as good an episode, and time, to make an example of someone as there is ever likely to be?  After all, it was about a core aspect of the regulatory framework (capital requirements), and comes at times when there are no jitters around the health of the financial system.  If there is no penalty for directors, no doubt directors of other banks will take note.

And then there is the question of the other (apparent) breaches of the conditions of registration. I don’t make a habit of reading Disclosure Statements (and don’t bank with Westpac anyway –  although, come to think of it, the Reserve Bank Superannuation scheme, that the “acting Governor” is a trustee of, does).  But I had a quick look at the latest Westpac statement.  On page 2, there is half page of disclosures of things Westpac NZ is not compliant with.  Several appear to be dealt with by yesterday’s announcement, but another five don’t.   Perhaps they are all pretty small matters –  they look that way to this lay reader – but banks are supposed to be fully compliant.   It is the law.

From the Reserve Bank’s side, the press statement went out in the name of Deputy Governor (and new Head of Financial Stability) Geoff Bascand.  But he has been in the role for less than two months now.  By contrast, “acting Governor” Grant Spencer was head of financial stability from 2007 to 2017, spanning the entire period of the use of internal models, and one of his direct reports, the head of prudential supervision, has also been in his role that entire time.    One would hope that the Reserve Bank’s Board is now asking some pretty serious questions about just what went on, about how the Reserve Bank has handled these issues over the last decade, and about how much confidence New Zealanders can have in an avowedly hands-off system.

Most probably, the empirical significance of this protracted breach of the rules will prove to have been small.  For that small mercy, we should of course be grateful.  But it is also small comfort because the fact that such breaches could go on for so long –  and the statements aren’t even clear how they came to light – leaves one wondering about what other gaps we (or the Reserve Bank, or Westpac or other IRB banks) might not yet know about.  Often enough, such problems only come to light when it is too late.   In many other central banks and regulatory agencies, if they hear about this episiode, there will be tut-tutting along the lines of “well, that is what you get when you don’t have on-site supervision of banks”.  Personally I wouldn’t want to see New Zealand go that way, but my confidence in our approach has taken a blow in the last 24 hours.

The Reserve Bank has a review of capital requirements underway at present.  I hope final decisions are not going to be made before a new Governor is in place.   There is plenty of unease around the use of internal-models for calculating capital requirements –  especially for rather vanilla banks such as those operating here.  Personally, I’d be comfortable moving away from that system, back to a standardised model for calculating capital (which would, among other things, put Kiwibank –  somewhat put upon by the Reserve Bank – and TSB on the same footing as the large banks).  But, for now, the law is the law, and needs to be seen to be enforced.  A breach of this sort, with little serious direct penalty, risks undermining confidence in our system.

And, of course, there is the small matter of openness.  Not every aspect of the Reserve Bank’s dealing with an individual bank can be published, but there are a lot of questions –  including about the Reserve Bank itself –  to which we really should be entitled to more answers than the Bank has yet given us.

I hope some journalists are willing to pursue the matter further.  Questions could be directed to David McLean, the well-regarded Westpac NZ CEO, to the Board members past and present (especially the independents), perhaps to the parent bank in Sydney, and –  of course –  to Grant Spencer and Geoff Bascand –  if not before then at their next (financial stability) press conference, which is now only a couple of weeks away.