Critics of the Governor

There have been a couple of media stories this week that were less than flattering about the Governor of the Reserve Bank, Adrian Orr.  I was going to say “new Governor”, but checking the calendar I see that in another month or so he will be a quarter of the way through his first term.

The first story was by Stuff’s Hamish Rutherford, and centred on the Governor’s plan to require banks to greatly increase the share of their assets funded by equity rather than debt.   In the on-line version of the story, Orr is labelled “Mr Congeniality”.  The story begins this way

Since Adrian Orr became Governor of the Reserve Bank of New Zealand he has built a reputation of being someone who likes to be liked.

Charming and jocular, but possibly sensitive to criticism.

But Orr is now in a battle with the bulk of New Zealand’s banking sector in a way which could see him demonised, probably with the focus on lending to farmers.

He knows it. Recent days have seen Orr on a campaign to explain itself.

I’m not sure he seems any different as Governor than he ever was before –  his well-known strengths and weaknesses have continued to be on display.

I’ve written quite a lot here about the substance and process around the Bank’s capital proposals – starting with the apparent lack of consultation and coordination with APRA, through to the weaknesses of many of the arguments the Bank advances, the lack of apparent understanding of how financial crises come to occur, the grudging and gradual release of further supporting material, and (presumably partly as a result) two extensions to the deadline for submissions.

In the article Orr is quoted thus, in perhaps the understatement of the week

The consultation process, in Orr’s words “could have been tidier”.

Done properly there would have been extensive workshopping of the technical material over months before the Governor ever put his name to a specific proposal.   As it is, we have a half-baked proposals, not benefiting from any prior scrutiny, and yet the same Governor who put the proposal forward is now judge and jury in his own case, with no effective rights of appeal for anyone.    And there is big money involved –  not just the additional capital that might need to be raised, but probable losses in economic output that will affect us all to a greater or lesser extent.

Presumably no one in the industry would go on record for Rutherford’s article.  Not upsetting prickly Governors is an art the banks have sought to master (even when it involved pandering to an earlier Governor who wanted a senior bank economist censored), although presumably the banks’ submissions will be fairly forthright.  (But will the public ever see those submissions?)

But some of the tone of the off-the-record concern is there in the article

Sources across several of the major banks are warning that if the bank pushes ahead with its plan it could act as a significant constraint on lending to farmers and small businesses,  sectors which are as economically important as they are politically sensitive

Both sectors are considered risky and when capital requirements go up the impact will be magnified.

Why those sectors?  Well, the “big end of town” (Fonterra, Air New Zealand or whoever) will have no difficulty raising debt either directly (bond market) or from banks that aren’t subject to the Reserve Bank’s capital requirements (which means every other bank in the world not operating here, as well as the parents of the locally-incorporated banks operating here).  And the residential mortgage market is both pretty competitive (including from some local institutional players that are less badly hit by the Governor’s proposals than the big banks), and more open to the possibilities of securitisation (which would then avoid the capital requirements too).   Idiosyncratic small and medium loans (including farm loans) aren’t, and farm loans in particular require a level of industry knowledge that newcomers won’t acquire easily (and offshore parents often won’t have).

Perhaps these effects will be large, perhaps they will be quite moderate in the end. But the point Rutherford didn’t make, but could have, is that none of this was analysed in the Bank’s consultative document.   When a really major change is proposed we should surely expect a serious analysis of transitional paths (not just for the banks, but for customers and the economy) as well as the long run.  But there was almost nothing, and nothing in any more depth has emerged in subsequent material that has seeped out.

It simply isn’t a good policy process, and that should concern both the Minister of Finance (and his advisers at The Treasury) and the Bank’s board.   The Governor simply isn’t doing a good job on this front.  If there is a compelling case for what he proposes, he hasn’t made it.  And that is almost as bad –  in a serious independent regulator –  as not having a good case in the first place.

The second article was by the news agency Reuters.   The focus in that article is Orr’s conduct of monetary policy, and particular his policy communications (which many had expected to be one of his strengths).

There are at least two strands to the article.  There are criticisms of Orr for not yet having given a single substantive on-the-record speech on either of his main areas of policy responsibility (monetary policy and financial regulation).  I’m among those quoted

Michael Reddell, an ex-RBNZ official who served with Orr on its monetary policy committee in the 1990s and 2000s, is critical of Orr for not giving a “substantive” speech on monetary policy in the past year.

“It would be unthinkable in Australia or the United States or even under previous governors here.”

I’ve been more and more surprised at the omission as time went on.  And in respect of monetary policy it is not as if there has been much from his offsiders either.  Sure, we get the rather formulaic paint-by-numbers Monetary Policy Statement every few months, but it simply isn’t the same as a thoughtful carefully-developed speech –  which shows more of how the individual/institution is thinking, and the omission has been particularly significant given that we had a new Governor and a refined mandate.

Orr’s response to this criticism is reportedly that it is “thin”.   Whatever that means, the fact remains that in other countries top central bankers talk, quite frequently, about their thinking in on-the-record speeches.  I’ve suggested, speculatively, that perhaps he doesn’t do serious speeches on core areas of responsibility because he just isn’t that interested (saving his passion for infrastructure, climate change, diversity, and all manner of other stuff he has little or no responsibility for).  I’d  like to be wrong on that, but nothing in this article provides any countervailing evidence.

But the bigger criticism in the Reuters article appears to come from financial market participants, concerned that they aren’t able to read the Governor’s policy intentions well.

Many traders who spoke to Reuters in the past two weeks blame Orr for confusing the message, and some have even been critical of frequent references to legends of the indigenous Maori people in his speeches, saying they served little purpose for financial markets eager for more policy clues.
“I am extremely frustrated at the lack of communications for global market participants,” said Annette Beacher, Singapore-based macro-strategist for TD Securities.
“Since Adrian Orr has assumed the role, he’s managed to surprise the market every six weeks. We don’t hear anything from him in between policy decisions,” Beacher said, echoing similar complaints from others.
“So what do I recommend to my trading desk? I’m saying trade the data but we’re not quite sure what is going to happen at the next meeting. It’s not meant to be this way.”

Here, to be honest, I’m not sure quite what to make of the criticism (I mostly don’t hang out with international markets people).   I’m sure there is a great deal of eye-rolling at the tree god nonsense that Orr continues to champion, but perhaps here the longstanding central banker in me comes out and I wonder if the offshore market people aren’t being a little precious.    Markets should not need their hands held to anything like the extent some of the comments in the article suggest, and if there is a little noise in market prices as a result that isn’t necessarily a bad thing.

It seems that quite a few people the journalists talked to were grumpy about the move to an explicit easing bias at the last OCR review, I couldn’t help wondering how much of that was a disagreement with the Governor’s stance (market economists on average have been more hawkish than the Bank for years, and have been more wrong) and how much a sense that a forthcoming change hadn’t been signalled.  I was bit (pleasantly) surprised myself by the move to an easing bias, but mostly because I thought the Governor wouldn’t want to launch a change of direction days before the new MPC took over.  Perhaps that is one of the circumstances in which advance signalling  might have been appropriate?    And perhaps the two strands of concern come together here: we shouldn’t have the Governor or senior staff giving private previews to select contacts about their evolving thinking.  So it has to be serious interviews or serious speeches –  and, as Annette Beacher notes, we haven’t really had either.

The Bank has probably also suffered somewhat from being in transition. At the start of last year, they lost the ultimate safe pair of hands, longserving Deputy Governor Grant Spencer.  A new top-team took over, and within a few months Orr was restructuring, which included demoting longserving chief economist John McDermott.  He lingered for a few months before leaving entirely, but can’t have been entirely engaged.  The head of financial markets was also ousted, and it was only in late March that the new recruits started to take office.  As I’ve noted previously, on the monetary policy side of the Bank it is very much a case now of a Second XI at play (internals and externals) and there is now quite a challenge in getting communications onto a steady, sustainable, and functional path.   The goal shouldn’t be keeping overseas economists happy, but it is perhaps telling that Reuters couldn’t find a domestic one willing to go on the record defending the Orr approach.

What of the Governor’s response to all this?  I’ve already recorded his response to the concern about speeches.  Here is some of the rest of what he told Reuters

In an interview with Reuters earlier on Tuesday, Orr said he wants to reach out to a wider audience than just currency traders, analysts and bloggers.

“The broad audience for this bank is the public of New Zealand. We are seen as a trusted institution but they don’t know what we do. So that is my communication challenge,” he said.

Orr also defended the Maori references in his speeches as part of the bank’s efforts to reach out to wider groups.

“Metaphors have their limits and metaphors can be over used. I get all that, but metaphors need to be introduced and created sometimes.”

I quite get that he wants to communicate to people beyond just the likes of Annette Beacher or me.    But it is not much short of populism to pretend that the audience of people who do pay close attention to the Bank, and know something about it and other central banks (and can even think through the aptness or otherwise of his metaphors), don’t matter.  He can try to appeal over the head of the relatively knowledgable all he likes, but I suspect he won’t find many listening.  Most people have better –  more interesting and important to them –  things to do with their lives.  As it happens, the Governor released a while ago a record of which audiences he delivered speeches to last year, and despite all the rhetoric –  tree god and all –   I was a bit surprised by how relatively few and conventional the audiences were.  The only novelty seemed to be a lot of mention of the tree god – cue to eyes rolling from many of the audiences no doubt.   How many more readers, I wonder, have the cartoon versions of the MPS and FSRs won?  How many have tried twice?

There is a “retail communication” dimension to the Reserve Bank’s role –  when you are driving interest rate up (or down) and affecting people’s employment prospects, business profitability etc, you have to explain yourself.  Over 30 years of an independent Reserve Bank, successive Governors have done a great deal of it –  Don Brash almost to the point of exhaustion, in his nationwide roadshows.  But the core of the job is actually rather more “wholesale” in nature.  And the Governor doesn’t seem to have been getting that right –  at all re bank capital, and in some dimensions re monetary policy (I’m probably closer to his bottom line on the OCR than many other commentators).  All this should be a concern for the Minister of Finance, and for the Bank’s Board.

There is still time for the Governor to right the ship –  and perhaps the new MPC will end up helping –  but the signs aren’t good. Only this morning, a press release emerged from the Bank championing the cause of climate change.  Action may well be really important, but it just isn’t the core business –  or really any business at all in a New Zealand context, with the sort of loan book New Zealand banks have –  of the Reserve Bank.  It is what we have an elected government for.

Sadly, we can expect to hear more from the Governor on climate change and his tree god (flawed) metaphor, and there is no sign of any contrition around the lack of serious communication from him on monetary policy or (where he is still sole decisionmaker) financial sector regulation.

 

The Governor’s talk

It was pleasant to walk along Wellington’s waterfront this morning to hear the Governor of the Reserve Bank speaking at a local function centre.  Given the numbers who turned up –  many of them Bank staff –  they could probably have saved a few dollars by holding the event on their own premises, but, I guess, it is other people’s money.

As the Governor explicitly noted that he would “look forward to the blogs”, I should probably do my bit.

A week ago when this event was announced, I devoted a whole (short) post to the announcement of the event, including the indication that they would be filming the speech and making that footage available on the web.   Doing so is a genuine step forward and I hope it becomes standard practice.

In that earlier post I noted

I have been critical of the Reserve Bank Governor for not yet having given an on-the-record speech about either of his main functions, monetary policy or financial regulation/supervision.  Next week marks a year since he took up the job

Unfortunately a year has now passed and we still haven’t had a substantive on-the-record speech about either of his main functions –  the sort of speech that would be standard, and quite expected, under any other Governor and in any other country.

Today’s speech was billed this way

Reserve Bank Governor Adrian Orr will talk about the future of New Zealand’s monetary policy framework  …..The revised monetary policy framework comes into effect on 1 April 2019. It is an outcome of the recent Phase 1 review of the Reserve Bank Act.    Adrian Orr will talk about changes to how monetary policy decisions are made in New Zealand, including greater transparency and accountability.

But there wasn’t very much about the new monetary policy framework (any aspect of it) at all.  You can read the text for yourself (and on this occasion the speech delivered was recognisably similar to the published text, which is not always the case I gather).

The whole event started rather oddly, with a fairly lengthy greeting in Maori from someone whose name I didn’t catch but who had no apparent connection to the Reserve Bank.  Only a small portion of whatever he said was translated, so I suspect very few attendees had any idea what he’d been saying.  He did, however, take the opportunity to make a few digs in English about the Foreshore and Seabed Act – of infamous memory – including at a former Labour MP from that era who was apparently in the room.  That seemed rather inappropriate in a Reserve Bank function.  Not even the Governor has yet claimed Reserve Bank responsibility for the foreshore and seabed.

The Governor did, however, tell us that someone else in the room had just agreed to be a “kaumatua” to the Reserve Bank – a title apparently quite in vogue in trendy government agencies, but not having an obvious place in way Parliament set up the governance of the Reserve Bank.  Isn’t all that stuff –  leadership, nurturing talent, resolving disputes –  among the functions of those tedious prosaic statutory roles such as Governor, Deputy Governor, and Board members?  But there is, we are told, a forthcoming Bulletin article, “RBNZ’s Strategic Approach to Te Ao Maori”.  That will be something to look forward to, no doubt involving more expensive and tortured efforts to explain why a macro-focused government agency, which deals with general public hardly at all, needs such a strategy and not (say) a Catholic one, a secular humanist one, a Pacific one, or an NZRFU one?   For an organisation that claims to be underfunded, they certainly seem to take every opportunity to spend resources on stuff other than their core business.

The Governor keeps on doubling down with his tree god nonsense, urging us to think of the Bank as akin to Tane Mahuta, the mythological forest god.   He delivered his speech flanked by two screens of this cartoonish graphic.

rbnz-tane-mahuta.png

He claimed this myth –  which has precisely nothing to do with central banking – “is” (not “was”) “central to the Maori belief system”.    Those who bothered by such things might suggest it was “cultural appropriation” –  although, ever deferential, he did stress that he asked permission to use the myth – but as I’ve noted in an earlier post

Pre-evangelisation, Maori had their own tree god, Tane Mahuta.    As far as I can tell, not many believe any longer in this local tree god: when I looked up the 2013 Census data, there were lots of Maori recording no religion, and there were plenty of Catholics and Anglicans.  But there wasn’t a category shown for tree gods, or any of the other deities (Wikipedia has a list of at least 35 of them).

As a recent commenter on another post noted

Imagine the reaction if the Bundesbank president started discussing policy in terms of Odin and Thor…. he’d get locked up…

And in addition to those references, we got the same warmed-over inaccurate nonsense the Governor has  run repeatedly about the creation of the Reserve Bank ‘letting the sunshine in” on the New Zealand economy and financial system.  I happen to agree that the creation of the Reserve Bank was, on balance, a good thing, but you’d not know from listening to the Governor that we’d had a stable financial system and a highly prosperous and productive economy without one.

What the speech really tended to show was a Governor with not much interest in the core business of the Bank (price stability, financial regulation, notes and coins, and a few ancillary bits and pieces).    Each of those functions matter.  It is important they are done well.  When they are done well, most people should have little interest in the Reserve Bank.

But, so he told us, the Governor is bothered that when they went out to “the community” (no polling results or the like, but I’ll take his word for it), people said they had significant trust in the Bank, but didn’t really know what it did.   But then they don’t really need to, any more than (say) I need know anything much about many of the dozens of government organisations you can find listed here (and I’m a geeky policy person, and still have no idea what, say, the Accreditation Council does).  How much does the person in the street know about, say, the organisation of our judiciary, or the distinction between the New Zealand Defence Force and the Ministry of Defence.  I’d struggle to even tell you what the Ministry of Housing and Urban Development does.

But it isn’t good enough for the Governor. So, on the one hand, we get cartoon versions of Monetary Policy Statements and Financial Stability Reports.  And on the other, considerably more worryingly, we get attempts by an overtly left-wing Governor to tie himself and the institution he leads to a whole series of trendy left-wing causes.  I’m sure he is not directly partisanly political, but his colours are firmly staked to an ideological mast, in ways that are potentially quite damaging.  After all, if he wants citizens to have confidence in his organisation around its core functions, those who aren’t sympathetic to his overt left-wing agenda will be less inclined to trust him even on the core issues he has responsibility for.  A new centre-right government at some point (ok, just kidding, but at least a new National one) might also be less inclined to trust him.   And, in championing these causes, he creates unrealistic expectations about what central banks can actually do, and opens the Bank up to pressure in future to join in promoting some other government’s set of ideological causes.

As an example of what I mean, here is an extract from the speech.

In the world today, the dynamics of global and national economies are interacting to a greater extent and, at times, working at cross-purposes. Underlying these interactions are social and political movements driven by a desire for greater well-being, both for current and future generations.

More recently we have been confronted with the issue of climate change, and its complex and powerful economic and financial impact.

We have barely scratched the surface in understanding the intergenerational impacts of these developments.

This desire for well-being is regularly reflected in discontent along the lines of economic, gender, racial, and intergenerational inequities – to name just a few. Therefore, ensuring social inclusion as a way forward in capitalist societies is necessary.

The first of those paragraphs barely even makes sense.  The rest do, but none of it has anything to do with central banks doing their jobs.    If this text appeared in a speech from Grant Robertson or James Shaw it might be quite unexceptionable –  it is the sort of stuff left-wing politicians say –  but what is a (supposedly neutral non-partisan) Governor doing spouting off about his views as to how “capitalist societies” should move forward.  Since it is what he is paid for, I’d rather hear him on the New Zealand cyclical economic situation, financial stability risks, positioning monetary policy for the next serious downturn or whatever.  Intrinsically less interesting perhaps, but that is the job he and his institution are paid to do.

The Governor –  particularly in his oral delivery –  was claiming a much wider mandate for himself from the newly amended Reserve Bank Act.  He is wrong to do so.

Even the badly-worded new Remit (replacement for the Policy Targets Agreement) makes that clear

remit

Whatever good monetary policy does –  and it is only the monetary policy bits of the Act that are changed –  it is “by” doing the same old stuff: leaning against cyclical fluctuations and maintaining medium-term price stability.

Here is the purpose statement from the amended Act

purpose RB

Yes, the current government’s waffly rhetoric about “wellbeing: and a “sustainable and productive economy” is enacted, but even this legislation is clear that –  whatever else the rest of government does (or doesn’t) do, the Reserve Bank makes its contribution by doing (well) the same old basics: monetary policy, a focus on a sound and efficient financial system, and notes and coins.

Inclusion –  gender, racial, religious, ideological, socioeconomic or whatever –  just isn’t the Reserve Bank’s territory.  Neither is climate change or other “social or political movements”.  Some of those issues may be quite important. Most are very interesting.  But if the Governor wants to pursue them perhaps he could create a blog in spare time (I wouldn’t recommend it), stand for Parliament, or put in a belated application to be the new Secretary to the Treasury.  All that other stuff will either distract the Reserve Bank’s attention (and perhaps suggest it already has too many resources), and/or skew support for the Reserve Bank along ideological lines in ways that are quite unhelpful in the longer-term (the Governor talked often of “legitimacy” and that dubious left-wing concept “social licence”).  The Governor talked of “our need to be a good global citizen”, but actually the New Zealand Parliament set up the Bank, and resourced it, to be a quite limited New Zealand government agency.

I could go on, but will bring this towards an end.   Three final points:

The Governor did mention briefly his proposals to substantially increase bank capital requirements. Nothing much of the substance, but he claimed that the Bank is open-minded and urged people to get their submissions in.  That is well and good, but it might be helpful to potential submitters –  including those not from the banks, who the Governor claimed to be keen to hear from – if the Bank actually released the supporting material –  for example, the Analytical Note on aspects of the economic impact that the Deputy Governor promised in his speech now more than a month ago, or the supporting information for ad hoc claims the Governor made on this issue at his MPS press conference more than six weeks ago.   It is more than three months since the proposal was released, and process is looking increasingly shoddy, as if they hope to run out the clock rather than provide substantive evidence for their proposals.   (Incidentally, in his delivered speech –  but not in the published text –  the Governor claimed that “we know” that significant bank failures cause significant damage for “all future generations”.  Perhaps that is another claim he might like to substantiate.  But it is probably just another one from off the top of his head.)

As I noted at the start, a former Labour MP was present.  That former MP was Tim Barnett who now leads what looks like a worthy organisation called FinCap which is

a new entity driven by the public good, acting in the interests of New Zealanders seeking budgeting and financial capability advice.

Sounds worthy. The Governor seemed keen on it, and said that the Reserve Bank would be endorsing this organisation in public.  Thus far, probably fine.  What was much less acceptable was to hear the Governor of the Reserve Bank say that he would be “coercing banks” to support it.  One hopes he wasn’t entirely serious, but when a regulator already wields a great deal of power on a wide range of fronts, they have to bend over backwards to avoid even suggesting any pressure (let alone ‘coercing’) on regulated entities to do things the regulator personally might like, but for which he or she has no statutory mandate.

Finally, the Governor ends the speech talking of how he and the Bank are going to “maximise their mandate”. I suspect he has in mind actually doing as much as possible to fulfil the mandate he has been given by Parliament, but it does sound awfully like a bureaucrat looking to expand –  to the maximum-  the role and scope of his bureau.  That isn’t what we need. We need a pretty boring organisation getting on and doing the (important, but quite limited) basics well.  At present, they are some very considerable margin away from the goal he articulates of being the “world’s best central bank” –  and nothing in this speech, or the others the Governor has given (and his term is now one-fifth over already) suggests they are making any progress towards it. If anything – and as evidenced in this speech – they are drifting further away.

But they turned on a good sausage roll, it was a good chance to catch up with a few people I hadn’t seen for a while…..and it really was a nice morning for a walk.

Just a shame about the central bank that was on display.

Kudos to the Governor

I have been critical of the Reserve Bank Governor for not yet having given an on-the-record speech about either of his main functions, monetary policy or financial regulation/supervision.  Next week marks a year since he took up the job, and 1 April is the day he loses exclusive control of monetary policy to the new MPC, which he will nonetheless chair (and effectively control).

But this invitation just turned up.  It seems to be an open invitation, so anyone interested should feel free to sign up.  I’ll certainly be there and will no doubt write about what he has to say.

orr speech

It is also commendable that the invitation indicates that the Bank will be releasing video of the Governor’s speech (and any Q&A?)  This is a well overdue step forward –  especially as this Governor is quite open about freely departing substantially from his written texts –  and, if adopted consistently, will bring the Bank into line with how things have long been done at the Reserve Bank of Australia.

Presumably, by next Friday the Minister of Finance will finally have announced the other members of the new Monetary Policy Committee.

The apostle of the tree god

There wasn’t going to be a post today but then someone sent me the link to a super-soft interview the Herald’s Liam Dann had done with Reserve Bank Governor Adrian Orr.   Had the Bank’s own PR consultants been scripting the interview it would scarcely have been softer (in fact, they might have advised a couple of serious questions to give the resulting interview a bit of credibility).

Orr will by next week have been in office for 11 months, wielding vast amounts of policymaking power singlehandedly, and yet we’ve still not had a single speech on either of his main areas of responsibility; monetary policy, and the regulation of much of the financial system.  But there is still time to play the tree god line (that’s the Herald headline: “Orr embraces the forest god”).

I’ve written about this silliness before.  Extracts

The latest example was the release on Monday of a rather curious 36 page document called The Journey of Te Putea Matua: our Tane Mahuta.   Te Putea Matua is the Maori name the Reserve Bank of New Zealand has taken upon itself (such being the way these days with public sector agencies).  It isn’t clear who “our” is in this context, although it seems the Governor  – himself with no apparent Maori ancestry – wants us New Zealanders to identify with some Maori tree god that –  data suggest –  no one believes in, and to think of the Reserve Bank as akin to a localised tree god.  Frankly, it seems weird.  These days, most New Zealanders don’t claim allegiance to any deity, but of those of us who do most –  Christian, Muslim, or Jewish, of European, Maori or any other ancestry – choose to worship a God with rather more all-encompassing claims.

But the Governor seems dead keen on championing Maori belief systems from centuries past.    In an official document of our central bank we read

A core pillar of the evolving Māori belief system is a tale of the earth mother (Papatūānuku) and the sky father (Ranginui) who needed separating to allow the
sun to shine in. Tāne Mahuta – the god of the forest and birds – managed this task after some false starts and help from his family. The sunlight allowed life to flourish in Tāne Mahuta’s garden.

This quote appears twice in the document.

All very interesting perhaps in some cultural studies course, but what does it have to do with macroeconomic management or financial stability?  Well, according to the Governor (in a radio interview on this yesterday) before there was a Reserve Bank “darkness was on our economy”.  The Reserve Bank was the god of the forest, and let the sun shine in.  Perhaps it is just my own culture, but the imagery that sprang to mind was that of people who walked in darkness having seen a great light.   But imagine the uproar if a Governor had been using Judeo-Christian imagery in an official publication.

On the same page we read

Many of these birds feature on the NZ dollar money including the kereru, kaka, and kiwi – core to our belief system and survival.

I’m a bit lost again as to who “our” is here.  I’m pretty sure I’m like most New Zealanders; I never saw a bird as “core” to my “belief system”.  Perhaps the Governor does, although if so we might worry about the quality of his judgements in other areas.

As I say, it is an odd document.  There are pages and pages that have nothing whatever to do with monetary policy or the financial system.  Some of it is even quite interesting, but why are we spending scarce taxpayers’ money recounting stories of New Zealand general history?  …. There is questionable history,….highly questionable and tendentious economic history, and overall a tone (perhaps comforting to today’s liberal political elite) that seems embarrassed by the European settlement of New Zealand.     There is lots on the difficulties and injustices that some Maori faced, and little or nothing on the advantages that western institutions and society brought.  Reasonable people might debate that balance, but it isn’t clear what the central bank –  paid to do monetary policy and financial stability –  is doing weighing in on the matter.

As I noted earlier, in a radio interview yesterday the Governor claimed that prior to the creation of the Reserve Bank ‘darkness was on our economy’, that the Reserve Bank had let the sunshine in, and that Australia and the UK had somehow turned their backs on us at the point the Bank was created.   In fact, here it is – Reserve Bank as tree god –  in the document itself.

The Reserve Bank became the Tāne Mahuta of New Zealand’s financial system, allowing the sun to shine in on the economy.

I think there was a plausible case for the creation of a central bank here, but to listen to or read the Governor you’d have no idea that New Zealand without a Reserve Bank had been among the handful of most prosperous countries in the world.  Here from the publication, writing about the period before the Reserve Bank was created

The infrastructure funding was further hindered by the banks being foreign-owned (British and Australian) and issuing private currency. Credit growth in New Zealand was driven by the economic performance of these foreign economies, unrelated
to the demands of New Zealand. Subsequent recessions in Britain and Australia slowed lending in New Zealand when it was most needed.

Very little of this stands much scrutiny.  You’d have no idea from reading that material that the New Zealand government had made heavy and persistent use of international capital markets, such that by 1929 it –  like its Australian peers –  had among the very highest public debt to GDP ratios (and NIIP ratios) ever recorded in an advanced country.  You’d have no idea that New Zealand was among the most prosperous countries around (like Australia and the United States, neither of which had had central banks in the decades prior to World War One).   You’d have no idea that the economic fortunes of New Zealand, trading heavily with the UK, might reasonably be expected to be affected by the economic fortunes of the UK –  terms of trade and all that.   Or that economic cycles in New Zealand and Australia were naturally quite highly correlated (common shocks and all that).  And of course –  with all the Governor’s talk about how we could “print our own money” – within five years of the creation of the Reserve Bank, itself after recovery from the Great Depression was well underway, that we’d not unrelatedly run into a foreign exchange crisis that led to the imposition of highly inefficient controls that plagued us (administered by the evil twin of the tree god?) for decades.  Or even that persistent inflation dates from the creation of the Reserve Bank

One can’t cover everything in a glossy pamphlet, even one that seems to purport to be aimed at adults (including Reserve Bank staff according to the Governor), but there isn’t much excuse for this sort of misleading and one-dimensional argumentation, aka propaganda.

The propaganda face of the document becomes clearer in the second half.   Among the issues the government’s review of the Reserve Bank Act is looking at is whether the prudential and regulatory functions of the Bank should be split out into a new standalone agency, a New Zealand Prudential Regulatory Authority.  …. There are arguments to be made on both sides of the issue, but you wouldn’t know it from reading about the Governor’s vision of the Bank as a Maori tree god, where one and indivisible seems to be the watchword.      Everything is about “synergies”, and nothing about weaknesses or risks, nothing about how other countries do things, nothing about the full range of criteria one might want to consider in devising, and holding to account,  regulatory institutions for New Zealand.

I don’t have any problem with officials, including from affected agencies, offering careful balanced and rigorous advice on the pros and cons of structural separation. But that is a choice ultimately for ministers and for Parliament.  And among the relevant considerations are issues of accountability and governance.  Neither word appears in Governor’s propaganda piece.   But then tree gods probably aren’t known for accountability.  New Zealand government regulatory institutions should be.   If ministers and Parliament decide to opt for structural separation, I wonder how the Governor will revise his document –  his tree god having been split in two.

Among the tree god’s claims about financial regulation and what the Bank brings to bear was this breathtaking assertion, prominently displayed at the head of a page (p27).

The Reserve Bank is highly incentivised to ‘get it right’ when it comes to prudential regulation. We have a lot at risk

It is an extraordinary claim, that could be made only be someone wilfully blind –  or choosing to ignore –  decades of serious analysis of government failure, and the institutional incentives that face regulators, regulatory agencies, and their masters.

There is nothing on the rest of that page to back the tree god’s claim.   On any reasonable and hardheaded analysis, the Reserve Bank has very weak incentives to “get it right”, or even to know –  and be able to tell us –  what “get it right” might mean.   When banks fail, neither the Reserve Bank Governor nor any of the tree god’s staff have any money at stake (at least in their professional capacity, and as I recall things, Reserve Bank staff – rightly –  aren’t allowed to own shares in banks).  It is all but impossible to get rid of a Reserve Bank Governor, and it is even harder to get rid of staff (for bad policy or bad supervision).  Most senior figures in central bank and regulatory agencies of countries that ran into financial crises 10 years ago, stayed on or in time moved on to comfortable, honoured (a peerage in Mervyn King’s case) retirements, or better-remunerated positions in the private sector.

And when the Reserve Bank uses its powers in ways that reduce the efficiency of the financial system, or stopping willing borrowers and willing lenders writing mortgage contracts, where are incentives on the Reserve Bank to “get things right”.  There are no personal consequences –  the Governor and his senior staff either won’t have, or would have no problem getting, mortgages.  The previous Governor got to exercise the bee in his bonnet about housing crises, and to play politics, with no supporting analysis and no effective accountability.    The current head of the tree god opines that lenders and borrowers can’t be trusted –  but tree gods apparently can –  but when challenged produced no analysis to support his claim.  That sort of system creates incentives for sure, but they aren’t to “get it right”.

End of extracts.  2019 here again.

The Governor was at it again in the interview, including running his bizarre version of economic history in which “sunshine” was let in upon the New Zealand economy in 1934  (there was also the surprising claim that the banks had chosen to graft themselves into the Reserve Bank, apparently oblivious to the fact that the main banks have been around New Zealand a lot longer than the Reserve Bank).

The Governor claims his metaphor is wildly popular –  except among “two bloggers” apparently (although I could give him a rather longer list of sceptics) –  and I’m sure it is in some quarters. It probably sounds cool, accessible, relevant and so on. But metaphors can be used for good and for ill, and the Governor attempting to have us all think of the Bank as akin to a tree god doesn’t serve the public interest well at all, even if it happens to suit his personal campaigns.

There were plenty more questionable claims made by the Governor is the course of the interview.  Some of them literally invite questions –  they might be true, or they might not, we just don’t know.  For example, the Governor claims that his proposed new capital requirements will be “in the pack” by international standards, but they’ve not yet shown any evidence to support this claim (especially once one takes account of their irrational distaste for cheaper Tier 2 capital, and for the high minimum overall risk weights they are planning to impose).  It should be a simple matter to put the evidence and analysis out there for scrutiny, but instead apparently we are simply supposed to trust this apostle of the tree god.

Then there was the claim –  made in the consulative document but not supported with one shred of serious analysis or evidence –  that the Bank’s proposed capital requirements will make the economy not only safer but also more efficient.  I’ve shown this chart previously

something for all

In today’s interview he explicitly asserted that New Zealand –  and all other advanced economies –  are to the “south-west” of that green dot.     Perhaps he’s right, but you’d think there would be some support offered for these “free lunch” claims.  It isn’t in the consultative document, it wasn’t in the Governor’s interview.  Perhaps  (at last) it will be in the Deputy Governor’s speech next week?

The interview ended with a super-soft invitation to the Governor to campaign for more taxpayer’s money, more staff, and more financial resources.   Perhaps there is a case for more  (actually I suspect there is).   But the idea that we should put more of our scarce money in his hands isn’t as persuasive as it should be when we get repeated doses of this tree god silliness, attempts at playing politics, repeated bold claims that just aren’t supported (complete with assertions that people who disagree him haven’t read his documents –  the problem is, they have), diversions onto all manner of things that just aren’t his responsibility, and a lack of serious –  as opposed to superficial –  transparency and accountability.

UPDATE: The interview and accompanying article might have been incredibly soft, but in many respects the sub-editors of the hard-copy Herald say it all with their headline on the front page of Saturday’s business section: “How Maori myth is guiding the Reserve Bank”.    Were it so –  and even I don’t think it really is –  it would explain a lot about the policy and comms mis-steps……

And as a commenter overnight observed

It shows how bad things have gotten in New Zealand – not so much that he makes these examples but because no one else even thinks to challenge it. Imagine the reaction if the Bundesbank president started discussing policy in terms of Odin and Thor…. he’d get locked up…

 

The tree god again

Some months ago the Governor of the Reserve Bank inaugurated his audacious bid to have his institution –  seen by most as a official agency created by, and accountable to, Parliament –  seen as some sort of local pagan tree god, with him (I assume) as the high priest in the cult of Tane Mahuta.  We’ve been told, by the Governor, that a people –  New Zealanders –  walked in economic darkness until finally the light dawned with the creation of the Reserve Bank.  It is pretty absurd stuff, not even backed by decent history or analysis, and one might be inclined just to ignore it, but the Governor seems serious.  In particular, he keeps returning to his claim. In fact, he was at it again –  claiming the mantle of Tane Mahuta –  yesterday with another little release that poses more questions than it offers answers (and which presumably means we’ll end the year still with no substantive speech from the Governor on anything he actually has statutory responsibility for).

Readers might recall that there was a damning report on the Reserve Bank as financial regulator, drawing on survey results of regulated institutions, released in April by the New Zealand Initiative.    This chart summed it up quite well

partridge 1

It has, presumably, been a priority for the Governor to improve the situation.   After all, even the Bank’s Board –  always reluctant to ever suggest any weaknesses at the Bank, even though their sole role is monitoring and accountability –  was moved to comment on this report, and the issues it raises, in their Annual Report this year.

And thus the Governor begins

In a step toward achieving the best “regulator-regulated” relationships possible, the Reserve Bank (Te Pūtea Matua) has established a Relationship Charter for working effectively with banks. The Charter will also be discussed with insurers and non-bank deposit takers in the near future.

One might question just how “best” is to be defined here –  after all, the public interest is not the same as that of either the Reserve Bank or of the banks, and there have been many examples globally of all too-comfortable relationships between regulators and the regulated.

But it was the next paragraph that started to get interesting.

Reserve Bank Governor Adrian Orr said the Relationship Charter commits the Bank and the financial sector to a mutual understanding of appropriate conduct and culture. “This is underpinned by the principle ‘te hunga tiaki’, the combined stewardship of an efficient system for the benefit of all,” Mr Orr said.

I’m not sure that understanding is necesssarily advanced when an institution operating in English introduces little-known phrases from another language to their press releases.  Here is how Te Ara explains “te hunga tiaki”

Te hunga tiaki

The Te Arawa tribes use the term ‘te hunga tiaki’ instead of kaitiaki, explains Huhana Mihinui.

The prefix ‘hunga’ is more common than ‘kai’ amongst Te Arawa, hence te hunga tiaki rather than kaitiaki. The essence of hunga is a group with common purpose. Hunga may also link with the sense of communal responsibilities. The same meaning is not conveyed with ‘kai’ … te hunga tiaki likewise invokes ideas of obligations to offer hospitality, but also to manage and protect, with the implicit recognition of the group’s mana whenua [customary authority over a traditional territory] role in this respect. 1

Which sounds pretty problematic frankly.  Banks and the Reserve Bank do not have a common purpose or a common set of responsibilities.  The Reserve Bank has legal responsibilities to the people of New Zealand, and the banks have legal responsibilities to their shareholders.  The two won’t always be inconsistent, but at times they will and there is little gained (and some things risked) from trying to pretend otherwise.  In both cases –  but particularly in that of the Reserve Bank –  there are limits on the ability of the principals (citizens and shareholders) to ensure that the boards and/or managers are actually operating according to those responsibilities.   Shareholders can sell.  Citizens are stuck with the Governor.

The statement goes on

“Writing it was the easy part. Operating consistently with the conduct principles is the challenge. We will regularly mutually review behaviours with the industry. Appropriate conduct is critical to the trust and wellbeing of New Zealand’s financial system, and the Reserve Bank – the ‘Tane Mahuta’ of the financial garden,” Mr Orr said. 

It is the tree god again –  a tree god that has some considerable way to go in improving its own conduct, be it around attempting to silence critics or whatever.

But this is also where I started to get puzzled.   In both those last two paragraphs from the statement, there is a suggestion that this document is some sort of agreed position between the banks and the Reserve Bank.   It is there in the charter document itself –  a one pager, complete with cartoonish tree god characters.

RBNZ-Relationships-Charter

(What I didn’t see was, for example, “we will avoid abusing our office and putting pressure on regulated bank CEOs to silence their economists when those economists write things we don’t like”.)

The word “mutual” is there twice, clearly suggesting that the banks have signed on to this.

But, if so, isn’t it a little strange that there are no quotes from any bankers, or the Bankers’ Association, in the press release, just the Governor’s own spin?   And when I checked the Bankers’ Association website, there was no statement from them. In fact, I checked the websites of all the big four banks and there was not a comment or statement from any of them.   Frankly, it doesn’t seem very “mutual”.   It looks a lot like gubernatorial spin.

And, to be frank, I don’t really see any good reason why there should be such mutual commitments.   Regulated entities don’t owe anything to the regulators.  They may often be intimidated by them, (privately) derisive of them, or even respect them.  But the regulated entities are just private bodies trying to go about their business in a competitive market.  By contrast, the Reserve Bank  –  the Governor personally –  carries a great deal of power over those entities, and they have few formal remedies against the abuse of that power.   What might reasonably be expected is unilateral commitments by the Governor as to how his organisations will operate in its dealings with regulated entities, standards (ideally measurable ones) that they and we can use to hold the regulator to account.      But that is different from what purports to be on offer in yesterday’s statement.

Of the brief specifics in the list of commitments, I don’t have too much to say.  There is a big element of “motherhood and apple pie” to them, and a few notable elements missing.  There is nothing about analytical rigour, nothing about transparency, nothing about remembering that the Bank’s responsibility is primarily to the New Zealand public, nothing about maintaining appropriate distance between the regulator and the regulated.  But I guess those would have been inconsistent with the fallacious claims about all being in it together and working for common goals.

It is at about this point that the Bank’s press release changes tone quite noticeably (not quite sure what happened to “one organisation, one message, one tone”).   Deputy Governor Geoff Bascand takes over and claims

Deputy Governor Geoff Bascand said the Reserve Bank’s recent announcement of a consultation with banks about the appropriate level of bank capital highlights the usefulness of the Relationship Charter.

And even in that one sentence he captures some of the mindset risks.  As I read the announcement the other day, it was a public consultation about the appropriate level of bank capital, and yet the Deputy Governor presents it as a “consultation with banks”.  If the Bank is going to run with this “Relationship Charter” notion, perhaps they could consider one for their relationship with the only people who give them legitimacy, Parliament and the public (having said that, perhaps I should be careful what I wish for).

And then weirdly –  in a press release supposed to highlight a new era of comity, open-mindedness etc –  the Deputy Governor launches into an argumentative spiel about the proposed new capital requirements.

“There is a natural conflict of interest. Banks will want to hold lower levels of capital to maximise returns for their shareholders. However, customers and society wear the full economic and social cost of a bank failure. We represent society’s interests and will naturally insist on higher capital holdings than any one individual shareholder,” Mr Bascand said.

Strange use of the phrase “conflict of interest”, which usually relates to a person or an organisation having two competing loyalties (perhaps personal and institutional), but even if one sets that point to one side for now, the rest is all rather one-dimensional and not terribly compelling.  He seems unaware, for example, that banks often hold capital well above regulatory minima –  creditors and rating agencies have perspectives too –  or that in most industries firms happily determine their own levels of capital, and somehow society manages (and prospers).  And, of course, there is not an iota of recognition of the way in which bureaucrats all too often serve bureaucratic interests (rather than societal ones), of the distinction between loan losses and bank failures, or of how the interventions of official and ministers often create the problems in the first place.

And then there is the final paragraph

“Following our Relationship Charter, we long signalled the purpose of our work and shared our analysis and consultation timetable. We have also committed significant time to engage with banks and provide a sensible transition period to make any changes we decide on. The Charter means what we are looking to achieve can be discussed professionally, while we continue to build appropriate working relationships. Outcomes will be superior and better understood and owned by society,” Mr Bascand said.

Of course, for example, whether the proposed transition period is “sensible” is itself a matter for consultation (one would hope –  and not just with banks).  Given the high probability of a recession in the next five years –  and the limited firepower here and abroad to deal with a severe recession –  some might reasonably wonder at just how wise it would be to compel big increases in capital ratios over that five year period, at a time when the Bank’s own analysis repeatedly suggests the banks are sound with current capital levels.   Credit availability might well be more than usually constrained.

One might go on to note that the level of disclosure in the consultative document is seriously inadequate for such a substantial intervention –  one that would take New Zealand further away from the international mainstream not closer to it.   As I noted in a post a few days ago, back in 2012 the Bank published a fuller cost-benefit analysis of the sorts of capital requirements that were then in place.  There is nothing similar in the consultative document issued last week, not even (I gather) any engagement with the previous cost-benefit analysis.  Given the amounts of money involved, that is simply unacceptable.  I’ve lodged an Official Information Act request for the (any) modelling and analysis they’ve done, but I (and others) shouldn’t have needed to; it should have been released as a matter of course.  In fact, even better they should have published a series of technical background papers over the year, held discussions with a range of interested parties (not just banks) before coming to the decisions they chose to formally consult on.      That is what good regulatory process might have looked like.

And then there is that bold final claim

Outcomes will be superior and better understood and owned by society

I’m all for effective and professional relationships between the Reserve Bank and the banks it regulates.  Perhaps that may even lead to better policy outcomes, but there is no guaranteee of that (after all, at the end of it all the law allows the Governor to make policy pretty much on a personal whim –  which is a lot like what the proposed higher capital ratios feel like).  But quite how a better relationship between the Reserve Bank and the banks will make outcomes “better understood and owned by society” is a complete mystery to me.   There are plenty of examples of regulators and the regulated ganging up against the public interest, and others of the regulators ramming through changes that might –  or might not –  be in society’s interest.  There is simply no easy mapping from a better relationship between the Bank and the banks, and good outcomes for society, let alone ones that –  whatever it means –  are “owned by society”.   Good outcomes rely heavily on very good and searching analysis.  And nothing in the Charter commits the Bank to that.

When one reads the argumentative second half of the press release it is little wonder the banks themselves wanted nothing to do with the statement.   I guess there isn’t much chance of the banks and the Reserve Bank getting too close to each other in the coming months as they (and the bank parents and APRA no doubt too) fight over the billions of additional capital Adrian Orr thinks they should have.

Meanwhile, the Governor can play at tree gods.  But it would be much better for everyone, including most notably citizens, if he were to engage openly and (in particular) more substantively on the issues he has legal responsibility for.   Cartoons and glib statements don’t build confidence where it counts.

 

 

 

Funding the Reserve Bank: focus on your statutory mandate

The Reserve Bank has been joining the ranks of the public sector agencies bidding for more money –  not just doing so in the conventional manner, behind closed doors in private discussions with relevant ministers, but in public.

There were some initial comments a few weeks ago, which I didn’t notice at the time, using this totally spurious argument

we are a net contributor to Crown revenue rather than a cost, and we’ve asked if we can hang on to a little more of what we make in order to fund extra work,” the Reserve Bank spokesman said.

The Reserve Bank generates a lot of money (mainly) by issuing zero interest bank notes (a statutory monopoly) and investing the proceeds in interest-bearing assets.  It takes little skill to collect this (what is in effect a) tax.     That income should have no bearing, formal or rhetorical, on how much of our resources the Reserve Bank is permitted to spend on other stuff –  mostly more bureaucrats to do regulation, analysis, and (see below) political positioning, of the sort many other cash-constrained bureaucracies in Wellington do.   Those activities do not generate even an iota of revenue for the Crown.

They were back with the begging bowl this week at the annual financial review undertaken by Parliament’s Finance and Expenditure Committee.  I saw two accounts –  one from Newsroom, and one from interest.co.nz.      There were a couple of strange claims, including the Governor appearing to suggest that the CBL failure might have occurred because the Reserve Bank didn’t have enough staff.  I don’t regard that as a totally implausible story  –  then again, the system is not supposed to prevent all failures, and at least some concerns relate to what the Bank did do (suppression orders) rather than what it didn’t do.  But if staffing was a concern, and the Bank thought it didn’t have the resources to do the job Parliament had given it, surely the previous year’s Annual Reports would have said so.  And I’m pretty sure they didn’t.

Orr is also reported as claiming that

….now was the time to resource-up and ready the bank for a crisis.

“The time when under-resourcing most shows up is generally during a time of crisis and we aren’t in one of those times,” Orr said.

I doubt that is so. In a crisis it is all hands to the pump, and institutions pull through.  If there is under-resourcing (and that is an open question) it is more likely to affect progressing work programmes in more-normal times.

Perhaps it is why, 8.5 months into his governorship, we still haven’t had a substantive speech from the Governor on either monetary policy or financial stability/regulation?  But that can’t really be the explanation either –  after all, we’ve always only had one Governor, and his predecessors somehow managed.

The Reserve Bank’s finances are not very tightly managed (externally, by the minister or Parliament).  Under the current Act there is provision for (but not a necessity for) a five-yearly funding agreement, outlining how much the Bank can spend.   It isn’t a great model, for various reasons, even if it was a step forward on the total lack of formal controls that existed prior to the 1989 Act.

But my experience was that almost every year, the Reserve Bank’s actual spending undershot what was provided for in the Funding Agreement.  I knew they had had the odd tighter year this decade, but other than that it isn’t something I follow closely.  But here is interest.co.nz’s account of what the Bank said in its latest Annual Report released in October.

The Reserve Bank’s annual report, issued last month, showed it had undershot spending allowed through its funding agreement by $26.7 million over three years and paid a $430 million annual dividend. By June 30 the Reserve Bank had spent $173.1 million of a possible $199.8 million allowed by its 2015-2020 Funding Agreement, signed with the previous National-led government. Net operating expenses in the June 2018 year were $4.1 million below the funding agreement, despite rising $8 million year-on-year to $76 million.

“The $26.7 million cumulative underspending is expected to partially reverse in the last two years of the funding agreement, as capitalised expenditure on systems improvements is amortised to operating expenses, and the issuance of new banknotes continues. The Bank expects to be within the five-year aggregate expenditure provided for in the funding agreement,” the annual report said.

Bottom line?  They’ve been underspending again, and even though that is “expected to partially reverse” over the next two years, the forecast reversal is only partial and, once again, they expect to underspending the Funding Agreement allowance.  And, under the current statutory model there are no adverse consequences for the Bank if it were to have spent a little more than the Funding Agreement number anyway.  But the issue is moot –  they seem to have managed in a way that will actually underspend (again).

Which leaves another of Orr’s comments ringing a bit hollow

Orr in the select committee again pointed out the limitations of the five-yearly model, saying a “phenomenal” number of “unanticipated” events had happened in the last five years, and the same would be the case in the next five years.

And probably every five years since 1990, and yet the Bank still almost always underspends.

Having said that, this may be one of the areas in which there is some convergence of views between me and the Governor.  The five-year funding agreement model is crazy and should be scrapped.   No corporate – no government agency for that matter –  sets operating expenditure budgets five years in advance, and it is simply silly to expect to do so for the Reserve Bank.  It is fine to do rough medium-term plans to help ensure that foreseeable expenditure pressures are identified well in advance, but that is different from a binding five-year budget.

Where we may well diverge again is that I think the Reserve Bank’s policy, regulatory and related activities should be funded –  as most government agencies are – by means of detailed annual appropriations by Parliament (and will be forthrightly making that case when the current review of the Reserve Bank Act gets round to looking at funding issues).  I wrote about the issue in a post earlier in the year.   Here were some of my points:

A common argument –  at least among central bankers –  is that somehow central banks are different.  There is only one important respect in which they are: they earn far more than they spend.  But even that isn’t very important here.  Central banks make money largely through the statutory monopoly on currency issue, which is just (in effect) another form of taxation.  And spending and revenue are two quite different bits of government finance: IRD might collect lots of money, but it can only spend what Parliament appropriates.

And what of those arguments about avoiding back-door pressure?  Even they don’t mark out central banks.  After all, we don’t want ministers interfering in Police decisions either (a rather more important issue than a central bank), but Police are funded by parliamentary appropriation.  So is the Independent Police Complaints Authority.   There are plenty of regulatory agencies where policy might be set by politicians, but the implementation of that policy is set by an independent Board, and where backdoor pressure could –  in principle be applied.  Other bodies publish awkward reports that make life difficult for politicians.  But those bodies too are typically funded each year by parliamentary appropriation.  It is just how our system of government works.

When I wrote about this issue in 2015 (having only recently emerged from the Bank), I was hesitant about calling for radical change.   The funding agreement system itself could be tightened up in various ways, which might represent an improvement on what we have now.   But there isn’t any very obvious reason not to start with a clean sheet of paper, and build a new system –  aligned with how we manage public spending in the rest of government –  starting from the principle of annual appropriations, with a clear delineation by functions (monetary policy, financial system regulation, physical currency etc), and standard restrictions on the ability of ministers to reallocate funds across votes).

I’m not aware of any country that funds it central bank by annual appropriation.  But historically, central bank spending all round the world was subject to weak parliamentary control.  This is one of those areas where the international models aren’t attractive, and the standard should instead be the way in which we authorise spending across the rest of government.   This is a policy and regulatory agency ….  and should be funded, and held to account, accordingly.

But if the Governor really thinks he doesn’t have enough resources to do aspects of the job Parliament has given, perhaps he could look rather hard at how he prioritises.  In his FEC appearance the other day, he claimed to have been doing so, but in my observation his sense of priorities appears personal, idiosyncratic and even political, not at all well-aligned with the Bank’s statutory mandate.

Recall that the Governor has only been in office for just over eight months, but already we’ve had things like:

  • speeches on climate change, helping out his buddies in the government and in the liberal wing of the business community,
  • the “Reserve Bank as tree god” exercise, which surely didn’t just flow off the end of the Governor’s pen in an idle hour one Saturday afternoon. It will have consumed real resources, at an opportunity cost,
  • cartoon versions of the Monetary Policy Statements and Financial Stability Reviews,  and
  • swamping those individually modest items by several orders of magnitude there was the conduct inquiry of which I noted upon its release

Despite highlighting several times in the report that this was really none of their business (of course they phrased it more bureaucratically: “neither regulator has a direct legislative mandate for regulating the conduct of providers of core banking services”), they’d spent an estimated $2 million of public money to mount their bully pulpit, lecture the banks, lobby for more powers for themselves.  

It simply wasn’t their job, but it suited the Governor’s ambitions to sweep in and spend large amounts of public money –  for modest-sized agencies –  on a personal campaign, to discover what?

The waste goes on.  There is an advert out at the moment for a Manager, Performance and Corporate Relations.  There appears to be some real work associated with the role (some of the bureaucratic hoop-jumping all government agencies have to do) but part of the role is this

Leading a mid-sized team of specialists, the person appointed will provide leadership to organisation-wide initiatives such as the Bank’s Climate Change Strategy and Te Ao Maori framework.

There can be no possible need for whatever a “Te Ao Maori framework” actually turns out to be.   The Reserve Bank isn’t some social agency dealing with troubled individual families, where quite possibly individual cultural backgrounds matter.  It doesn’t really deal with ordinary people much at all –  that is not a criticism, it doesn’t need to.    It runs monetary policy –  which affects and benefits people quite regardless of ethnicity-  and it regulates banks (and other financial institutions) again –  one would hope –  regardless of the ethnicity of individual managers or shareholders.  Fortunately, the “principles of the Treaty of Waitangi” are not part of the Reserve Bank Act.     I don’t suppose the Bank will be spending a vast amount of money in this area, but every little bit reallocated to financial regulation would surely help, at least if you believe the Governor and his Deputy.  It has the feel of the Governor pursuing another personal political agenda at the expense of the taxpayer.

And then there is “the Bank’s Climate Change Strategy”.    I’ve touched on this before, but as a reminder the Reserve Bank is an office-bound organisation, with precisely two offices (main one and a small one –  probably unnecessary –  in Auckland).  For practical reasons (to do with specialist vaults) the Bank –  unlike most central government agencies –  owns a building in central Wellington, and if they own any vehicles at all it might be just one car.  They are a wholesaler of one physical product –  bank notes –  but they import that product from overseas producers, for whom the Reserve Bank is no more than a modest-sized customer (thus with little market power).  But they do, I suppose, travel to lots of overseas meetings (but last I looked, international air travel still isn’t captured in the agreed international carbon reporting framework or our own current government’s incipient net-zero goal).

There is just no obvious reason –  at least not one that isn’t ultra vires –  for the Reserve Bank to be spending public money on a “climate change strategy” at all.  It is a feel-good piece of political positioning, perhaps helping the Governor is his turf fights around the Reserve Bank Act, and assisting him in a cause that he clearly feels strongly about personally –  even if there is little sign of him thinking about it deeply.

I’ve written prevously about the sheer vacuity of much of this, especially in the New Zealand context –  our banking system hardly being heavily exposed to, say, oil producers.  There was a vapid box in the FSR a few weeks ago, and as I noted of it

The text burbles on about possible risks, but it all adds up to very little.     There are numerous risks banks and borrowers face every decade, every century.  Relative prices change, trade protection changes, external markets change, exchange rates change, technology changes, economies cycle, land use law changes.  Oh, and the climate changes.

If one looks at the structure of New Zealand bank (or insurer balance sheets) it just isn’t credible that climate change poses a significant risk to the soundness of the New Zealand financial system (that pesky law again).   Some individuals are likely to face losses from actual and prospective sea-level rises, but banks (and insurers) typically have diversified national portfolios.   People can’t have mortgage debt without insurance, and so the insurers are likely to be constraining people first.   Much the same surely goes for the rural sector?   Sure, adding agriculture into the ETS at the sort of carbon price some zealots have called for would be pretty detrimental to the economics of a dairy debt portfolio, but then freeing up the urban land market probably wouldn’t be great for residential mortgage portfolios, and we don’t see double-page spreads from the Reserve Bank on that issue, or the Governor trying to play himself into some more central role in that area.     It smacks of politics –  signalling the Governor’s green credentials –  more than anything legitimately tied to financial system soundness.

As it happens, the Bank yesterday released its “Climate Change Strategy“, a 10 point statement which seems almost equally devoid of content relevant to the statutory responsibilities of the Bank.  Instead, the Governor is offering political support to the government (that is the gist of the first paragraph) and bidding to be a player.  Here are two of their 10 points.

8.No single institution working alone can achieve meaningful progress on a global challenge such as climate change. Furthermore, it is not for financial policymakers to drive the transition to a low-carbon economy, nor is it the role of the Bank to advocate one policy response over another. That is the role of government.

9. However, appropriate action on a national or global level can only be achieved if individuals and entities are able to take action on a micro level. For this to occur, two conditions need to be met. First, there has to be proactive and effective leadership to drive our collective understanding of climate risks and to establish robust strategies to respond to those risks. Second, there has to be effective and timely dissemination of those assessments and strategies. Appropriate information will be vital in enabling entities and individuals to price and manage risks, facilitating the transition to a low-carbon economy, and ultimately contributing to both the soundness and efficiency of the financial system.

You might agree, disagree, or simply yawn, but when did this become an issue for a central bank, with important, powerful, but quite limited, statutory responsibilities?  And a central bank crying poor, claiming it doesn’t have enough money for its day jobs.   It is more like a creed than something one might reasonably expect from a central bank.

As part of the Bank’s statement we learn that

The Bank has also been welcomed as member of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The Network was set up in December 2017 at the Paris ‘One Planet Summit’ to strengthen the global response required to meet the goals of the Paris agreement.

Head of Department Financial System Policy and Analysis Toby Fiennes says the Reserve Bank is very proud to have been accepted as a member of the NGFS.

“Playing our part globally, and as a leader in the Pacific region, is important both in terms of reinforcing New Zealand’s reputation as a ‘good global citizen’, and in providing us access to the latest thinking around the globe,” Mr Fiennes says.

(Among this small group of (excessively funded?) central banks and regulators is the central banking arm of the Chinese Communist Party. )

I guess it is the sort of feel-good, but empty, rhetoric one now expects from public servants.  And I guess when you see yourself as a tree god, the fit with an organisation devoted to “greening the financial system” must be almost complete?   But it is all empty.  “Playing our part globally” seems likely to involve little more than another round of international meetings to attend –  all those extra emissions – at the taxpayers’ expense, to advance Orr’s personal agenda at a time when he suggests the institution has insufficient money to do the job the taxpayer instructed them to do.  On an issue where there are no material financial system implications at all.

I’m open to the idea that the Bank might in fact need more financial resources, given the various jobs that (wisely or not) Parliament has instructed them to do.   There are other agencies and causes that might have a stronger case  and (on the other hand) some that should simply be wound up altogether.  But the Bank’s case would be that much more compelling if there weren’t repeated signs that the Governor was using the institution and public resources to advance personal, often quite political, agendas that reach beyond his statutory responsibilities.  He should be ensuring –  and the Board insisting –  that resources are rigorously prioritised to focus on the statutory mandate.

What?

In the press release for last week’s Reserve Bank Financial Stability Report, the Governor commented that

Our preliminary view is that higher capital requirements are necessary, so that the banking system can be sufficiently resilient whilst remaining efficient. We will release a final consultation paper on bank capital requirements in December.

In commenting briefly on that, I observed

Time will tell how persuasive their case is, but given the robustness of the banking system in the face of previous demanding stress tests, the marginal benefits (in terms of crisis probability reduction) for an additional dollar of required capital must now be pretty small.

There wasn’t much more in the body of the document (and, as I gather it, there wasn’t anything much at the FEC hearing later in the day), so I was happy to wait and see the consultative document.

But the Governor apparently wasn’t.  At 12.25pm on Friday a “speech advisory” turned up telling

The Reserve Bank will release an excerpt from an address by Governor Adrian Orr on the importance of bank capital for New Zealand society.

It was to be released at 2 pm.   The decision to release this material must have been a rushed and last minute one –  not only was the formal advisory last minute, but there had been no suggestion of such a speech when the FSR was released a couple of days previously.

And, perhaps most importantly, what they did release was a pretty shoddy effort.    We still haven’t had a proper speech text from the Governor on either of his main areas of responsibility (monetary policy or financial regulation/supervision) but we do now have 700 words of unsubstantiated (without analysis or evidence) jottings on a very important forthcoming policy issue. which could have really big financial implications for some of the largest businesses in New Zealand and possibly for the economy as a whole.

The broad framework probably isn’t too objectionable.  All else equal, higher capital requirements on banks will reduce the probability of bank failures, and so it probably makes sense to think about the appropriate capital requirements relative to some norm about how (in)frequently one might be willing to see the banking system run into problems in which creditors (as distinct from shareholders) lose money.  At the extreme, require banks to lend only from equity and no deposit or bondholder will ever lose money (there won’t be any).

But what is also relevant is the tendency of politicians to bail out banks.  Not only does the possibility of them doing so create incentives for bank shareholders to run more risks than otherwise (since creditors won’t penalise higher risk to the same extent as otherwise), but there is a potential for –  at times quite large –  fiscal transfers when the failures happen.  Politicians have more of an incentive to impose high capital requirements on banks when they acknowledge their own tendencies to bail out those banks.  If, by contrast, they could resist those temptations –  or even manage them, in say a model with retail deposit insurance, but wholesale creditors left to their own devices –  it would also be more realistic to leave the question of capital structure to the market –  in just the same way that the capital structure of most other types of companies is a mattter for the market (shareholders interacting with lenders, customers, ratings agencies and so on).

But nothing like this appears in the Governor’s jottings.  Instead, we have the evil banks, the put-upon public and the courageous Reserve Bank fighting our corner.   I’d like to think the Governor’s analysis is more sophisticated than that, and one can’t say everything in 700 words, but…..it was his choice, entirely his, to give us 700 words of jottings and no supporting analysis, no testing and challenging of his assumptions etc.

There are all manner of weak claims.  For example

We know one thing for sure, the public’s risk tolerance will be less than bank owners’ risk tolerance. 

I think the point he is trying to make is about systemic banking crises –  when large chunks of the entire banking system run into trouble.  There is an arguable case –  but only arguable –  for his claim in that situation, but (a) it isn’t the case he makes, and (b) I really hope that (say) the shareholders of TSB or Heartland Bank have a lower risk tolerance around their business than I do, because I just don’t care much at all if they fail (or succeed).  Their failures  –  should such events occur –  should be, almost entirely, a matter for their shareholders and their creditors, with little or no wider public perspective.

There are other odd arguments

Banks also hold more capital than their regulatory minimums, to achieve a credit rating to do business. The ratings agencies are fallible however, given they operate with as much ‘art’ as ‘science’.

Bank failures also happen more often and can be more devastating than bank owners – and credit ratings agencies – tend to remember.

And central banks and regulators don’t operate “with as much ‘art’ as ‘science'”?   Yeah right.   And the second argument conflates too quite separate points.  Some bank failures may be “devastating” –  although not all by any means (remember Barings) –  but the impact of a bank failure isn’t an issue for ratings agencies, the probability of failure is.   And I do hope that when he gets beyond jottings the Governor will address the experience of countries like New Zealand, Australia, and Canada where –  over more than a century –  the experience of (major) bank failure is almost non-existent.

The Governor tries to explain why public and private interests can diverge (emphasis added)

First, there is cost associated with holding capital, being what the capital could earn if it was invested elsewhere. Second, bank owners can earn a greater return on their investment by using less of their own money and borrowing more – leverage. And, the most a bank owner can lose is their capital. The wider public loses a lot more (see Figure 2).

But what is Figure 2?

figure 2

Which probably looks –  as it is intended to –  a little scary, but actually (a) I was impressed by how small many of these numbers are (bearing in mind that financial crises don’t come round every year), and (b) more importantly, as the Governor surely knows, fiscal costs are not social costs.  Fiscal costs are just transfers –  mostly from one lots of citizens (public as a whole) to others.  I’m not defending bank bailouts, but they don’t make a country poorer, all they do is have the losses (which have arisen anyway) redistributed around the citizenry.  If the Governor is going to make a serious case, he needs to tackle –  seriously and analytically –  the alleged social costs of bank failures and systemic financial crises.  So far there is no sign he has done so.  But we await the consultative document.

There is a suggestion something more substantive is coming

We have been reassessing the capital level in the banking sector that minimises the cost to society of a bank failure, while ensuring the banking system remains profitable.

The stylised diagram in Figure 3 highlights where we have got to. Our assessment is that we can improve the soundness of the New Zealand banking system with additional capital with no trade-off to efficiency.

and this is Figure 3

capital chart

It is a stylised chart to be sure, but people choose their stylisation to make their rhetorical point, and in this one the Governor is trying to suggest that we can be big gains (much greater financial stability, and higher levels (discounted present values presumably) of output) by increasing capital requirements on banks.

I don’t doubt that the Bank can construct and calibrate a model that produces such results.  One can construct and calibrate models to produce almost any result the commissioning official wants.  The test will be one of how robust and plausible the particular specifications are.  We don’t know, because the Governor is sounding off but not (yet) showing us the analysis.  Frankly, I find the implied claim quite implausible.   Probably higher capital requirements could reduce the incidence of financial crises.  But the frequency of such events is already extremely low in well-governed countries where the state minimises its interventions in the financial system, so I don’t see the gains on that front as likely to be large.    And, as I’ve outlined here in various previous posts I don’t think that the evidence is that persuasive that financial crises themselves are as costly as the regulators (champing at the bit for more power) claim.  And many of the costs there are, arise from bad borrowing and lending, misallocation of investment resources, which are likely to happen from time to time no matter how well-capitalised the banks are.

There are nuanced arguments here, about which reasonable people can disagree. But not in the Governor’s world apparently.

He comes to his concluding paragraph, the first half of which is this

A word of caution. Output or GDP are glib proxies for economic wellbeing – the end goal of our economic policy purpose. When confronted with widespread unemployment, falling wages, collapsing house prices, and many other manifestations of a banking crisis, wellbeing is threatened. Much recent literature suggests a loss of confidence is one cause of societal ills such as poor mental and physical health, and a loss of social cohesion.

Oh, come on.  “Glib proxies”……..    No one has ever claimed that GDP is the be-all and end-all of everything, but it is a serious effort at measurement, which enables comparisons across time and across countries.  Which is in stark contrast to the unmeasureable, unmanageable, will-o-wisp that the Governor (and Treasury and the Minister of Finance) are so keen on today.

As for the rest, sometimes financial stresses can exacerbate unemployment and the like,  but the financial crises typically arise and deepen in the context of common events or shocks that lead to both: people default on their residential mortgages when they’ve lost their jobs and house prices have fallen, but those events don’t occur in a vacuum.  And anyone (and Governor) who wants to suggest that mental health crises and a decline in social cohesion can be substantially prevented by higher levels of bank capital is either dreaming, or just making up stuff that sounds good on a first lay read.

The Governor ends with this sentence

If we believe we can tolerate bank system failures more frequently than once-every-200 years, then this must be an explicit decision made with full understanding of the consequences.

As if his, finger in the dark, once-every-200 years is now the benchmark, and if not adopted we face serious consequences.   Let’s see the evidence and analysis first.  Including recognition that systemic banking crises don’t just happen because of larger than usual random shocks –  the isimplest scenario in which higher capital requirements “work” –  but mostly from quite rare and infrequent bursts of craziness, not caused by banks in isolation, but by some combination of banks and (widely spread) borrowers, often precipitated by some ill-judged or ill-managed policy intervention chosen by a government.   Higher capital ratios just aren’t much protection against the gross misallocations that arise in the process –  in which much of any waste/loss is already in train (masked by the boom times) before any financial institution runs into trouble (the current Chinese situation is yet another example).

Perhaps as importantly, under the current (deeply flawed) Reserve Bank Act the choice about capital is one the Governor is empowered to make.  But his deputy, responsible for financial stability functions, had some comments to make on this point in a recent speech (emphasis added)

And Phase 2 of the Government’s review is an opportunity for all New Zealanders to consider the Reserve Bank’s mandate, its powers, governance and independence. The capital review gives us all an opportunity to think again about our risk tolerance – how safe we want our banking system to be; how we balance soundness and efficiency; what gains we can make, both in terms of financial stability and output; and how we allocate private and social costs.

It may be that the legislation underpinning our mandate can be enhanced, for example, by formal guidance from government or another governance body, on the level of risk of a financial crisis that society is willing to tolerate.

These are choices that should be made by politicians, who are accountable to us, not by a single unelected and largely unaccountable (certainly to citizenry) official.  We need officials and experts to offer analysis and advice, not to be able to impose their personal ideological perspectives or pet peeves on the entire economy and society.

We must hope that the forthcoming consultative document is a serious well-considered and well-documented piece of analysis, and that having issued it the Governor will be open to serious consideration of alternative perspectives.  But what was released last Friday –  700 words of unsupported jottings –  wasn’t promising.

(I should add that I have shifted my view on bank capital somewhat over the years, partly I suspect as a result of no longer being inside the Bank. It is somewhat surprising how –  for all one knows it in theory –  things look different depending on where one happens to be sitting.  But my big concern at present is not that it would necessarily wrong to raise required bank capital, but that the standard of argumentation from a immensely powerful public official seems –  for now – so threadbare.)