Portrait of a strongman

It didn’t seem like the best weekend for Reserve Bank Governor Adrian Orr.

First, there was Radio New Zealand’s Insight documentary on the Governor’s bank capital plans, and other possible new regulatory burdens.  I was impressed with the huge amount of time and energy that was put into the programme, although inevitably there are limitations in what a programme designed for a mainstream Sunday morning audience can deal with.     In some ways, the best public service now would be if Radio New Zealand and/or the Reserve Bank agreed to release the full interview Guyon Espiner did with the Governor –  we were told it was an hour long, but no more than five minutes would have been used in the programme (I presume this was par for the course on Espiner’s background work, as I did an interview with him that went for perhaps 40+ minutes).

In commenting on the substance of the programme one then has to be a bit careful.  The selection of quotes and the framing is Espiner’s (and I did notice a couple of small errors) and although he is a responsible senior journalist, the way he presented material isn’t necessarily the way the Governor himself might have chosen to.  Then again, the Governor has plenty of communications media open to him and after 18 months in the job still hasn’t given a speech about financial regulation topics, for which he personally has huge personal policy freedom.

But as RNZ presented the Governor’s arguments, they were less than impressive.  They seemed to be playing distraction more than engaging with what should be the core issues.  Not once, at least according to my notes, did he engage on the possible costs and distortions his proposals would introduce (whatever the possible benefits). Not once, for example, did he engage with how comparable his proposals are to the regime that will apply in Australia to the respective banking groups (hint, Orr’s are much more onerous).

Instead, we got irrelevancies.  The Governor decreed that banks were earning too much money in New Zealand.  Not only that, in his tree god and garden imagery, the (Australian) banks were “darkening the garden”, such that the market was not as competitive as it should be.  Perhaps there is something to those arguments, but they are simply not the Governor’s job and should be irrelevant considerations in proposing to exercise regulatory powers under the Reserve Bank Act (directed to promoting the soundness and efficiency of the financial system).  We have a Commerce Act, there are powers now for the Minister of Commerce or the Commerce Commission to initiate a market study.  But that has nothing at all to do with the Reserve Bank, the prudential regulator, not the competition authority.

Orr came a little closer to his own ground, and to respectable arguments, when he suggested that existing capital (and leverage) ratios were just too low, and thus that banks were “too risky”.  That might have been a touch more persuasive if, for example, he’d engaged with the standalone credit ratings of the banks operating here, or talked about the differences between a strongly-diversified big bank and an individual borrower (instead he tried to imply that the risks, and hence appropriate capital, were much the same).  There was the rather weak claim that “at times” housing crises have led to banking crises, but no attempt to unpack that claim, or to engage with the repeated stress tests his own institutions has done this decade.  Let alone, to consider the experiences of banking system like our own (or Australia’s or Canada’s or Norway’s) that with floating exchange rates and governments out of the housing finance market have proved resilient over many decades.

Instead we got another attempt at distraction, suggesting that the New Zealand experience in 2008/09 was really rather a close-run thing.  He knows it wasn’t so. He knows that the issues the New Zealand banks (and their parents) faced in 2008/09 were about liquidity, not about credit quality or loan losses.  There had been a degree of complacency among the banks about liquidity in the 00s –  I recall one discussion with the head of risk at a major bank in about 2006 who simply could not conceive of a world in which funding liquidity markets would dry up almost completely.   But liquidity is a different issue than loan losses –  which were modest in a fairly deep recession after a period of very rapid credit growth – and even the liquidity/funding issues New Zealand banks faced never threatened to bring any of them down.  And the Bank addressed the funding/liquidity issues almost a decade ago, with much more stringent policy requirements.    And risk-weighted capital ratios are already higher than they were going into the last recession  –  partly under regulatory pressure, partly market pressure  –  a recession when (to repeat) the loan losses were pretty modest and not at all threatening.

Then we had more rhetoric about how the Bank was not going to “keep falsely subsidising bank businesses”, although the nature of any such “subsidy” was never clear given (a) the resilience of banks to the Reserve Bank’s own stress tests, and (b) the central place the Bank has long argued OBR should have in handling any bank failures in New Zealand.   But it probably sounded good.  And then he fell back on attempts to exaggerate the costs of financial crises, with talk of “generations of lost employment opportunities”, mental health failures, and vague allusions to various “challenges” of the world right now –  the Brexit, Trump duo again I suppose – being down to insufficient bank capital.    Evidence and sustained argumentation would help –  if not on a short radio programme then, for example, in speeches and robust consultative documents and –  perish the thought –  upfront cost/benefit analyses (as distinct from the ex post one they might eventually show us).

There was some discussion of dairy lending.  As the Governor fairly noted there had been some fairly aggressive and unwise lending to that sector over the last 15 years (in the early part of that period the impression was that the offshore parents had little real idea of what the subsidiaries were doing in that sector).  Dairy farm economics doesn’t look as it once did, for various market and (actual/proposed) regulatory reasons, so no doubt there isn’t the same bank risk appetite there once was.  But it is quite unconvincing for the Governor to try to pretend his capital proposals won’t exacerbate pressures in that sector, or in other sectors where specific hard-to-extract and manage  knowledge/experience is key to good lending.  Big corporates, for example, who can simply turn to banks not affected by the Governor’s proposal (overseas-based banks, and even the parents of the NZ locally-incorporated banks).  I doubt credit supply will be too adversely affected for residential mortgage finance either.  But for other sectors, including dairy, who does the Governor expect to step into the gap?  Wasn’t he talking (see above) about insufficient competition?  Won’t these proposals weaken that competition, especially as all the locally-owned banks are themselves capital constrained?

The Governor also tried to claim that the Bank’s existing capital rules had somehow “caused” the banks to run into problems on dairy lending, citing differences in risk weights used by various banks for apparently similar lending.   Even to the extent there is an issue there, it is worth remembering that (a) by far the biggest increases in dairy lending occurred (last decade) before the advanced models approach came into effect, and (b) good banks get things wrong from time to time, and none of the actual or stress-tested dairy losses pose any threat to systemic stability.  The Governor’s numbers tell him so.   We want banks to lose money from time to time –  were they not doing so the Governor (on another day, another trope) would probably be complaining about them taking insufficient risk, holding back opportunities etc.

And then, of course, there was the cavalier line I wrote about on Friday: the Governor in essence telling the banks that if they don’t like his rules (and him as prosecutor, judge and jury in his own case) they can just take their money and go.  I wrote about this  irresponsible line on Friday.

Perhaps we should see his talk –  all it appears to be at present – about banning people from serving on both the boards of parent and New Zealand subsidiary at the same time, as all part of that same mentality of suspicion of Australian banks.  The Governor shows little or no sign of appreciating the value New Zealand, and New Zealanders, get from having banks that are part of much larger banking groups, from a country with a track record of a stable and well-managed banking system.  He talks a lot about the standalone capacity of New Zealand subsidiaries in a crisis, but very little about the benefits of integrated banking operations in more normal circumstances (ie at least 99 per cent of the time).  He seems to be hankering for the Australian banks to sell down their shareholding in the New Zealand subsidiaries –  acting as, in effect, an agent for NZX and the New Zealand funds management industry – while showing no sign of recognising that a more arms-length New Zealand operation might also be one less well-placed to receive parental support if something ever does go wrong.

All in all, I just wasn’t persuaded that Orr was even trying to make a serious sustained analytical case for the specific policy he is pursuing.  Playing distraction seemed to be more the style.  (Perhaps I’m wrong and the tape of the full interview would no doubt tell us more.)  That, after all, is the problem with the regime: at least formally, under the law, having dreamed up this proposal all by himself, the only person he actually has to convince of its merits is….himself (final decisionmaker).

Oh, and I almost forgot to mention Auckland University economics professor Robert MacCulloch’s comments.  He highlighted the “sheer lack of raw intellectual firepower” at the Bank, and claimed that neither the Board nor the senior management were really up to the job.  I probably wouldn’t have put it quite that strongly –  there are still able people but in the Board’s case they seem to have no interest in doing anything other than covering for the Governor, and in the staff’s case, personal self-protection –  with a Governor who does not welcome challenge –  is a deterrent to people speaking up even if they have (a) stayed on, and (b) disagreed.      The Bank has lost a lot of good people this year, for various reasons, but few would have had much involvement in the bank capital issues.  MacCulloch’s other comments resonated more strongly with me: there is no history of extreme fragility in the New Zealand banking system (“rather the opposite in 2008”) and that the Governor’s style is undermining confidende in the Reserve Bank, at home and abroad.

Of course, only a few geeks would try to unpick the Insight programme.

But the Sunday Star Times did us a public service with a big double-page article on the Governor that was distinctly less than flattering.  The online version ran under the title “Portrait of the Governor as a strongman”.  I’d encourage you to read the article. Several critics were actually willing to go on the record –  not, of course, ones from among the banks (the “strongman” has a lot of power over them).

Here is an extract, starting with reference to the heavyhanded stance Orr took with veteran and highly capable journalist Jenny Ruth at a recent press conference

The video of the conference remains on the Reserve Bank’s website. Some reporters said they were stunned Orr would air his anger so publicly and called it bullying.

But other observers were not surprised. Details of Lubberink’s experience were already circulating in Wellington and industry sources say they match a pattern of hectoring by Orr of those who question the Reserve Bank’s plan.

“There is a pattern of [Orr] publicly belittling and berating people who disagree with him, at conferences, on the sidelines of financial industry events,” said one source who’s been involved in making submissions to the Reserve Bank on the capital proposal.

There have also been angry weekend phone calls made by Orr to submitters he doesn’t agree with.

“I’m worried about what he’s doing.”

The source said some companies have “withheld submissions,” for fear of being targeted by Orr.

“They’re absolutely scared of repercussions. It’s genuinely disturbing,” he said.

(Orr told someone recently he didn’t read what I write –  his perfect liberty of course –  so I guess I’m safe from the “angry weekend phone calls”.)

Sadly, one can’t really say it is shocking.  It is, more or less, what one might have come to expect.  But it is appalling, and a far cry from the sort of standard the public has a right to expect from such a powerful public servant.  Wielding so much power singlehandedly, with few checks and balances, we need someone with a judicious and calm temperament, happy to engage openly and non-defensively, and so on. Instead we have Adrian Orr.

The article reports that Orr refused to be interviewed.  But perhaps the bigger question is why the journalist responsible –  for a very useful and courageous article –  showed no sign of having sought comment from Neil Quigley, the chair of the Bank’s Board who is paid to hold the Governor to account.  And there was no sign either of having sought comment from Grant Robertson, the person who actually has the power to dismiss the Governor and whom –  as voters –  we might expect to be visible when concerns like these are raised.  (And if the Minister of Finance isn’t visible, why isn’t the Prime Minister insisting that her Minister do his job?)  The behaviour as reported should be unacceptable in a democratic society governed by the rule of law and conventions of acceptable conduct.

Another quote from the article

In the cut and thrust of the debate, Orr’s jokey style and everyman charisma fell away. In recent months he’s dogmatically insisted the cost of his plan would be minimal and has picked personally at critics in the media, academia, and the financial services industry.

He’s been variously described as defensive, bullying, and perilously close to abusing his power.

“He’s in danger of bringing scorn on his office,” said long-time industry watcher David Tripe, professor of banking at Massey University. “I used to know him well. I no longer feel so confident.”

I was exchanging notes last week with someone about comparisons between Graeme Wheeler and Adrian Orr.   The SST article reports insiders claiming that Wheeler had not been keen on the idea of big increases in capital requirements for locally-incorporated banks.  If so, that is to his credit.

Not much else was. I’m not going to repeat his failings, but recall just how unpopular he had become with key stakeholders by late in his term (the survey the New Zealand Initiative undertook). By the end, his departure was almost universally welcomed, and must almost have been a relief to him too, as someone never at all comfortable in the public spotlight.

Orr is more a polarising figure, in that he does still have some supporters, but they must be getting quite uncomfortable with his style, even if they are sympathetic on substance.  But a rerun of that NZI survey would be unlikely to show up the Bank in a good light.  The more time goes on the more unsuited Orr appears to be for the office to which the Bank’s Board and the Minister of Finance appointed him.     He degrades the standing of the Bank here and abroad, as well as eroding its internal analytical capability and whatever spirit of robust internal debate was left after Wheeler, and undermines confidence in the institution’s ability to manage real threats.  It is rather sad to watch, but perhaps only a slightly more extreme example of the sustained degradation of policy capability and leadership in New Zealand public life and public sector this century.

 I hear on RNZ this morning the Governor was quoted as pushing back – I think mainly against MacCulloch – suggesting that criticisms were “narrow nitpicking”.  But there is a long list of sceptics, and of reasoned critical submissions on what is proposing, and how he is doing it. For anyone interested, here was my formal submission