Off the top of the Governor’s head

From a post a couple of weeks ago, just after the release of the Reserve Bank’s Financial Stability Report.

In a similar vein, I noted a story on Newsroom this morning, reporting the Governor’s appearance at the Finance and Expenditure Committee yesterday.  He was reported thus

But he told the select committee he would much rather the Reserve Bank, as banking regulator, could trust banks and borrowers to be prudent.

“I would love to not have to be active in that space. If banks had true long-term horizons, if the consumers were fully aware and myopia didn’t exist across borrowers, all the different foibles that people have, then you wouldn’t need the regulatory imposts.”

Talk about “nanny state” –  the Governor wishes he could trust us.  I wish we could trust him and his colleagues.

But, more specifically, the Governor here asserts again that banks are too short-term in their operations, that borrowers are myopic, and we need Reserve Bank intervention (he was talking of LVR and DTI restrictions) to save us from ourselves.  Par for the course, the Governor offered no evidence for his proposition (and there was none advanced in the FSR), it just seems to be some sort of new gubernatorial whim (as Graeme Wheeler came with the scarring experience of living through the US crisis, in this case Orr comes with an NZSF perspective –  neither grounded in specific  analysis of the New Zealand banking system).  I’ve lodged an OIA request this morning for any Reserve Bank analysis in support of these propositions.

To the credit of the Reserve Bank, they seem to have started responding to OIA requests more promptly.  I got the Bank’s response this morning.  Here is what it says:

On 10 May you made an Official Information request seeking: 

copies of any research, analysis or related material generated by, or for, the Reserve Bank suggesting that New Zealand banks had inappropriately short lending horizons, and New Zealand borrowers suffered from “myopia”. 

Under the provisions of OIA section 18(e), which allows refusal of a request where the information is not held, the Reserve Bank is refusing your request.

The Governor’s view as expressed in the reported comment was formed without recourse to specific material produced by, or for, the Reserve Bank.

So there was no analysis in the FSR supporting his claim, and nothing the Bank had done –  not even apparently in the previous five years – that supported his claim about the need for Reserve Bank interventions (LVRs, DTIs etc) constraining New Zealand banks’ lending, and New Zealand households’ access to credit.

He appears to have just made it up.  It was a whim, a prejudice, a line that sounded good as he said it…….and this is the basis on which the Governor makes policy (singlehandedly) and testifies to Parliament.  In a way, it isn’t that surprising, given the criticisms people like Ian Harrison and I have levelled at the quality of the analysis used to support their actual and proposed regulatory interventions, but to hear it direct from the Bank is still pretty telling.

 

 

Please Mr Orr, could we have some better analysis

In yesterday’s post, I was a bit critical of the relatively superficial analysis in much of the Reserve Bank’s Financial Stability Report.

Here is one example

fsr chart 1

A snippet which seems to contain three problems in just a few lines.  First, the Bank runs their asset price charts from the bottom of the international financial crisis and recession in 2009.  Of course, equity prices have risen strongly since then.  Second,  all these series are shown in nominal terms: in the case of OECD house prices (red line in the second panel) there will have been hardly any increase at all in real prices over the nine years.    And thirdly, they are attempting to argue that low interest rates have been a major causal influence on debt levels and asset prices without (a) looking back at whether trends are more pronounced this decade than they were in the previous –  higher interest rate –  decade (hint: they aren’t) and (b) without giving any apparent consideration to the reasons why interest rates might have been persistently low.  For a central bank, that really is inexcusable sloppiness.

Take household debt, for example.  Here is the Reserve Bank’s chart

FSR chart 2

It is interesting to see the breakdown between households with a mortgage and the all-households number.   Perhaps even more interesting is the snippet they include in the text that “only 8 per cent of households own investment properties, but they account for 40 per cent of housing debt” (although it would be interesting, in turn, to know how that share has changed over, say, the last decade).

But what I’ve always found striking about charts like Figure 2.1 is how small the increase in household debt ratios has been over the last decade or so.   In the previous house price boom, household debt to income ratios rose much more sharply than they have in the most recent boom.  Among households with mortgages, the ratio rose by 90 percentage points of income from the cyclical low in real prices in mid 2001 to the peak, but that same ratio has risen by less since 30 percentage points from the previous peak to now.  On the more familiar metric –  total household debt to total household income –  the comparable numbers are 47 and 10 percentage points respectively.

Another way of looking at the data –  which I prefer, for various reasons including that all national income ultimately belongs to households –  is to look at the ratio of household debt to GDP.  Here is the chart of that series.

chart 3

Household debt as a share of GDP is lower now than it was a decade ago.   Even if you make allowance for the fact that the previous peak itself was during the recession (when GDP had dipped), the current ratio of household debt to GDP has barely changed since the previous peak in real house prices in mid 2007.  In many ways, this is extraordinary.

(And recall, of course, that banks’ housing loan portfolios came through the last recession –  a pretty serious recession, with a fall in nominal house prices –  unscathed.)

Here is the chart of real house prices (the QV index deflated by the CPI), expressed in log form.

chart 4

Real house prices are much higher than they were at the peak of the last cycle, and have risen by about 60 per cent from the 2011 low.

As the chart in log form illustrates, the percentage rate of increase in house prices has been less this time round than in the previous phase of the boom (2001 to 2007) when real prices rose by 87 per cent on this measure.

But that shouldn’t be any comfort.  If real house prices go from $250000 to $500000 in one period, and then from $500000 to $750000 in a subsquent period, the percentage increase is lower in the second period.  But if real incomes haven’t changed, one $250000 increase is just as burdensome as the other.

And that is pretty much what has happened with New Zealand house prices.  Relative to a base of 100 in mid-2001, real house prices increased by 84 percentage points from 2001 to mid 2007.   From mid 2011 to the present (Dec 2017 data being most recent) the increase, again relative to a base of mid-2001 prices, has been 94 percentage points.   Real incomes have increased a bit, to be sure, but actually the rate of increase (whether simple percentage increases, or relative to the 2001 base) in real GDP per capita was smaller in the more recent period.

None of that should be very surprising. In both periods we had really large, unexpected, population pressures, and in both periods we’ve had binding land use restrictions (not factors featuring in the Bank’s discussion).  Interest rates, of course, have been much lower in the second period than the first, but it doesn’t look as though one needs some exogenous interest rate story to explain another bout of house price increases of similar size to the one that happened when interest rates were a lot higher.

But it all leaves the debt to income (household income or GDP) charts a little puzzling.  As I’ve illustrated before –  and is pretty obvious with a moment’s reflection –  debt increases occur over a much longer period of time than house price increases do.  If house prices double today, the only people who will have been taking on more debt right now will have been the small minority of people transacting in houses in this particular short period. But now that house prices are higher, even if they rise no further, every new purchaser will be needing to finance the new higher prices.  Since the housing stock can take decades to turnover fully, the increase in the debt to income (or GDP) ratios can be expected to lag quite a bit behind house prices.

Here is a very simple stylised example of what I mean.  In this scenario, house prices have been unchanged for a long time, and debt stock is steady.  The aggregate debt to income ratio is about .5 (roughly what it was in New Zealand 30 years ago).  Now assume that some exogenous factor (call it “new land use regulation”) doubles house prices today.  Even if new entrants to the market borrow the same proportion of the purchase prices that their predecessors did when prices were low (on the same 25 year mortgages), it will take decades for the associated lift in the aggregate debt to income ratio to occur (35 years for even two-thirds of the adjustment to occur).

chart 5.png

And yet, in real world New Zealand, despite an equally big house price increase since 2011 as we saw from 2001 to 2007, there has been little or no increase in household debt ratios in the last decade (even though the aggregate ratios should still have been adjusting to the earlier price shock).

I’m not sure quite what the explanation is.  One explanation might be that (real) house prices have risen to such levels that a larger share of the houses are being purchased by more cashed-up buyers.  That would be consistent with the decline in the owner-occupation rate.  Perhaps regulatory financial repression is also playing a part –  successive waves of unprecedented LVR restrictions (grounded in gubernatorial whim rather than robust analysis) may have made some difference, not necessarily in a good way.   But it seems like an issue that we might have expected the Reserve Bank to explore in a document like an FSR.

Similarly, when the Reserve Bank talks up risk

The high level and concentration of household sector debt in New Zealand is the largest single vulnerability of the financial system. …..This risk has not changed materially since the last Report. Growth in household debt has slowed and house price inflation has stabilised, but significant vulnerabilities remain.

you might expect them to discuss:

  • the way rather similar levels of household debt performed in the last severe recession,
  • the Bank’s successive stress tests which suggest bank housing lending is not a systemic threat even under very severe (often unrealistically severe –  around unemployment) scenarios, and
  • their own capital requirements on banks, which are –  we are told –  calibrated to take account of the relative riskiness of different types of loans (even within an overall framework that has further increased capital requirements per unit of risk weighted assets).

But, as far as I could see, there was none of that in the document itself, and nothing of it in the Governor’s remarks at his press conference.    In the meantime, we have distortionary LVR controls kept in place –  on one man’s whim –  when, if anything, there appears to be less credit outstanding than one might reasonably have expected given the way other regulatory distortions have lifted house prices.

In a similar vein, I noted a story on Newsroom this morning, reporting the Governor’s appearance at the Finance and Expenditure Committee yesterday.  He was reported thus

But he told the select committee he would much rather the Reserve Bank, as banking regulator, could trust banks and borrowers to be prudent.

“I would love to not have to be active in that space. If banks had true long-term horizons, if the consumers were fully aware and myopia didn’t exist across borrowers, all the different foibles that people have, then you wouldn’t need the regulatory imposts.”

Talk about “nanny state” –  the Governor wishes he could trust us.  I wish we could trust him and his colleagues.

But, more specifically, the Governor here asserts again that banks are too short-term in their operations, that borrowers are myopic, and we need Reserve Bank intervention (he was talking of LVR and DTI restrictions) to save us from ourselves.  Par for the course, the Governor offered no evidence for his proposition (and there was none advanced in the FSR), it just seems to be some sort of new gubernatorial whim (as Graeme Wheeler came with the scarring experience of living through the US crisis, in this case Orr comes with an NZSF perspective –  neither grounded in specific  analysis of the New Zealand banking system).  I’ve lodged an OIA request this morning for any Reserve Bank analysis in support of these propositions.

I could have added, but overlooked doing so, a request for any evidence that – the private sector being inevitably flawed (by nature of being human) – that government regulators (also being human) can consistently improve on the outcomes of the market.  In a banking system (New Zealand, but Australia as well) where the only financial crisis in more than 100 years arose in the transition as heavy controls were being removed –  and neither the private sector nor the regulators really knew what they were doing –  you might suppose some presumption of responsibility and capability might be accorded to the private sector.  But not, it appears, by this Governor, or this Reserve Bank.  When a big ego and extensive statutory powers combine in a single person, the lack of serious supporting  analysis itself becomes a threat, including to the efficiency of the financial system.

Why not split up the Reserve Bank?

That is, deliberately, a slightly ambiguous title for the post.   I favour splitting the Reserve Bank in two, setting up a new New Zealand Prudential Regulatory Authority to pick up the regulatory and supervisory responsibilities the Bank currently has (subject to various refinement).   I’ve made the case here and here, and late last week highlighted my former colleague Geof Mortlock’s new article articulating the case for change.   We know that the Reserve Bank’s conduct of those functions isn’t highly regarded and the minutes (and OIA releases) suggest that the Reserve Bank’s Board –  paid to hold the Governor to account in the public interest –  were asleep at the wheel while this situation was developing.  All told, I reckon there is a pretty clear-cut case – in principle, and based on the actual track record – for structural reform.  Structural reform is never a panacea, but with the right will, and the political determination that things will be done better in future, it can play a part, making a demonstrable break with the past and establishing a new and better institutional culture.

But, of course, there are counter-arguments.  The Reserve Bank is likely to be making them forcefully at present.  I suspect the Governor’s populist participation in the current attack on the banks – not grounded in any of his own legislation, not related to any systemic soundness threats – may be a part of that effort, wanting to appear “useful” to the government and somehow “in touch” with some sort of “public mood”.  (If so, that in itself should be grounds enough for structural and personnel changes.)

If I were the Bank I would probably be trying to arrange a visit from (Sir) Paul Tucker, former Deputy Governor of the Bank of England, who has just published a new book Unelected Power, on the delegation of economic powers to independent agencies, with a particular focus on central banks.  Despite his background on the markets side of the Bank of England, Tucker didn’t leave officialdom to make money in the financial sector, but instead turned to academe and has produced an impressive book.  I’ve already referred to it in a couple of recent posts, and expect to do so in a few more relevant to the current efforts to overhaul the Reserve Bank Act.    As one UK commentator recently described it

….it is mainly about central banking, and on this is it authoritative. It will be an essential read for everybody involved in monetary policy, or researching it.

Not by any means will everything he writes be music to the ears of our central bankers, but Tucker’s views on the structural separation issue will be.  Perhaps that isn’t too surprising, since he was Deputy Governor at a time when the British government was bringing the financial sector supervisory and regulatory functions back inside the Bank of England (albeit with separate government-appointed decisionmaking structures for the various functions).  The Bank of England model informed Iain Rennie’s report last year, and if a decision is finally made to leave all the existing Reserve Bank functions together a structure like that of the Bank of England (but slimmed down for our circumstances) would probably be the way to go.

Tucker doesn’t argue that the regulatory and supervisory functions have to be in the same institution as monetary policy but that, subject to certain important conditions, it is better if they are.    To my mind, one of the weaknesses of his book is that it is very focused on the US and the UK (with some discussion of ECB/Europe but the issues are very different there given the idiosyncratic relationship between the ECB –  set up by international treaty and not really very accountable to anyone –  other EU institutiuons, and the national states of the EU/eurosystem).  Thus he simply doesn’t engage with the experience of the many other advanced countries – in fact, most of those outside the euro –  where the primary role in prudential regulation/supervision is undertaken by an entity other than the central bank.   This was the list of such countries I ran the other day

Canada, Australia, Norway, Sweden, Korea, Japan, Poland, Chile, Turkey, Mexico, Switzerland, and Iceland

It is a mix of large and small, of countries with very big financial systems operating internationally and countries with mostly domestic banks, of countries where the split has been longstanding (eg Canada) and countries where it has been more recent (eg Australia), and countries that ran into financial crisis in 2008/09 and countries that did not.  I’d find Tucker’s claim for the superiority of his model (essentially the UK one) more compelling if he’d addressed the experience of some of these countries.

As I read his material on this issue, it seemed to me that Tucker had two main arguments for keeping prudential supervision/regulation and monetary policy together.

The first of these is about the central bank’s lender of last resort function (for which the relevant statutory provision in our legislation needs refinement).  A central bank is the only agency with the unquestioned ability to provide immediate liquidity to an individual bank, or to the system as a whole, when severe liquidity pressures arise –  whether it is a run to physical cash, or simply a freezing up of interbank markets leaving some players unable to operate with external injections of liquidity.     Failure to respond to systemwide increases in liquidity demand will, all else equal, be likely to result in the central bank falling short of its inflation target (through the resulting financial crisis and economic shakeout).  Provision of liquidity, and a responsiveness to changes in demand, is an integral part of modern central banking (even though the stress events may not occur even as frequently as once a decade –  in the New Zealand case, Y2K and the liquidity pressures around 2008/09).

Liquidity provision usually involves either buying assets outright from a bank, or lending on the security of those assets (mainly repo agreements).  That is easy when it involves the outright purchase of a well-known widely-traded asset like a government bond.  But it gets trickier when it is a loan (in economic substance, if not legal form) and when the assets involved are pretty opaque and not generally traded at all, and when the general injunction –  enshrined in legislation in some countries –  is that central banks should only lend to solvent institutions (solvency here being a positive net assets test, not an “ability to meet payments as they fall due” test).    To caricature just slightly, Tucker argues that a PhD in macroeconomics won’t be much use in enabling a central bank to decide whether or not to provide funds to a bank that comes knocking.  You need, instead (or as well), detailed banking and credit expertise.  Specifically he notes

Even opponents of “broad central banking” generally accept that, as the lender of last resort, the central bank cannot avoid inspecting banks that want to borrow.

Going on to argue that

A central bank must be in a position to track the health of individual banks during peacetime if it is to be equipped to act as the liquidity cavalry.

I’m not persuaded, for a number of reasons.  First, of course, we don’t “inspect” banks in New Zealand at all (but that is trivial point).   Second, clearly many countries operate with exactly the sort of model Tucker deems impossible or inadmissible (presumably by relying on some peacetime exchange of information, and wartime written recommendations or assurances from the prudential regulatory agency).   Third, the central bank making the decision to lend is not the only option: it would be possible to envisage a model in which the central bank was simply the operational agent, but the credit risk from any crisis support to an individual institution was taken directly by the government, on the advice (and analysis) of the prudential regulatory agency.   And, finally, LLR powers aren’t the only relevant ones.  In the 2008/09 crisis, perhaps the most important single regulatory response in New Zealand was the deployment of the Minister of Finances’s extensive guarantee powers (under the Public Finance Act).    The Minister of Finance doesn’t do prudential supervision, and to the extent he needed comfort that any institutions guaranteed were likely to be solvent, he had to rely on advice from officials.  In this case, it was primarily the Reserve Bank, but it could as easily have been advice from a Prudential Regulatory Authority.   The same goes for choices (regrettable as they may be) to bail out individual institutions.

My claim isn’t that there can never be any advantages in having prudential supervision and central bank liquidity operations in the same entity, just that the case for them to be so isn’t generally compelling once set against the other arguments for structural separation.  In a crisis, it is typically all hands to the deck (including, for example, the Treasury and the Reserve Bank working together, even though they are separate institutions) and. more generally, there are numerous examples of interagency arrangements for information sharing.   It is undoubtedly important for all relevant agencies to coordinate closely, and have in place appropriate protocols and be prepared to run exercises to war-game the handling of crises.  But the functions don’t all need to be in the same agency, and there are likely to be costs in normal times to having them all together.

One point Tucker touches on elsewhere, but not here, is the importance of having people running functions believing in them.  It is, for example, dangerous to have financial supervision (or AML) in an institution where the chief executive doesn’t really believe in the importance or value of the function.  Reasonable people could argue that that –  rather than separation –  was part of the UK’s problem in 2007: the then Governor, Mervyn King, seemed quite averse to lender of last resort responsibilities, even though they were still an intrinsic part of the powers assigned to the Bank of England.

Tucker’s other main argument for keeping prudential and monetary policy functions together is one he lists under a heading “Harnessing the authority of the central bank”. noting that

If an economy’s central bank is already endowed with both authority and legitimacy, giving it responsibility for stability might be preferable to the uncertainties of starting afresh. In particular, the risks of industry capture might be reduced, as monetary policy makers’ standing in the community does not depend on bankers.

I’m not even persuaded by that final sentence – too many central bank policymakers have seen their post-central bank opportunities being among the bankers (just among Governors, Glenn Stevens, Ian Macfarlane, Ben Bernanke).     Tucker’s argument appears to be made in the UK context, where the prudential functions were split out of the Bank of England after 1997, into a new standalone prudential agency.  Perhaps the FSA never had the prestige of the Bank of England but it isn’t obvious that the problems the UK ran into were a reflection of lack of prestige or legacy legitimacy.  Political emphasis on promoting the financial sector was a significant part of the story.  And the Bank of England’s own analysis of the emerging macro risks didn’t exactly cover the institution in glory.

But, perhaps more importantly, there are other case studies.  The Reserve Bank of Australia had been around for decades when APRA was split out of it. It looks to have been a pretty successful split, and it isn’t at all obvious now that the RBA enjoys any greater authority or respect in its areas of responsibility than APRA does in its.   And, given the feedback on the Reserve Bank of New Zealand’s regulatory stewardship, I don’t suppose anyone would want to mount a serious argument here to leave the functions together because the Reserve Bank’s reputation and authority stands so high.

As it happens, Tucker isn’t too keen on New Zealand’s contribution to public sector management, including the notion (from the New Public Management literature of the 1980s) that one function per agency helps to enhance accountability.

In the UK, I suspect that NPM was a subtle (and baleful) influence on the 1997 decision to transfer prudential supervision away from the Bank of England.  That mattered beyond Britain’s shores. Given London’s position as a global financial centre and given that various other countries, including China and Korea, followed the UK, at least in some cases probably encouraged by the IMF, the UK contrived to put the world onto a false, even delusional, path,  Administrative fashions come unstuck eventually, and this one did spectacularly.

Methinks he doth protest too much  (even as he goes on to note that there are hazards in having the functions together).

He highlights one issue which I hadn’t given much thought to, arguing that if the central bank is to be responsible for both monetary policy and prudential supervision it needs to have the same degree of autonomy in each function.  He argues that if the central bank has less authority in supervisory areas than in monetary policy, it could provide a wedge through which politicians could exert pressure on the Bank over monetary policy.  I’m not so sure that is right or that, realistically, it is that important an issue especially if (as he insists) each function has its own statutory committee, and its own direct accountability.

But if there is something in what Tucker says, it would reinforce my doubts about keeping the functions together.  At present, in the New Zealand system the PTA is set every five years (and central bank budgets too), and beyond that there is no routine ministerial involvement in monetary policy.  On the regulatory side, plenty of powers are reserved to ministers (eg around failure management, AML, the rules of non-bank deposit takers, disclosure rules for banks) and as I’ve argued here before the Reserve Bank still has too much discretionary policymaking power over banks (LVR limits, with significant distributional consequences are a good example –  and one Tucker seems to have quite a lot of reservations about).  As I read him, he would favour delegating more policy power to the central bank in the supervisory/regulatory area.  Personally, I think there is a good case for giving the regulator less power, and for a clearer delineation between setting the rules of the game (politicians) and implementing them (independent agency).  And keeping the functions in separate institutions will make for stronger effective accountability –  a key theme of Tucker’s –  than two or three committees with the Governor and his Deputy sitting on all of them.  You can only fire – or not reappoint –  a Governor once.

One of reasons Tucker worries about differing degrees of independence is that it would not ‘be conducive to successful institution-building’, citing the way in which the Greenspn Fed looked down on supervisors as a “lower form of life”.   Again, I’m not sure I fully buy the argument –  it is more about the priorities and beliefs of the people at the top than about formal statutory remits –  but as both Geof Mortlock and I have argued in the New Zealand context, standalone agencies helps enable the creation of cultures of excellence in both institutions.   And even Tucker recognises that culture is one of the challenges to a multi-function central bank, even if both functions have equal statutory importance.

In many cases, these aren’t open and shut issues.  There are different models around the world, although on my reading in most advanced countries –  and especially most small ones –  structural separation is the route chosen.  It is far from obvious that the new British model is better than the old (only the next crisis is likely to test that), even if appropriately some issues have been clarified and powers refined out of the 2008/09 experience.  But in the New Zealand context, most of the arguments now line up pretty clearly in favour of structural separation, and the creation of a new standalone prudential regulatory agency, with powers, personnel, and governance/accountability structures specifically fit for purposes, rather than shoehorned into an institution designed primarily for a monetary policy role.

 

The Governor on banking and deposit insurance

There was another interview the other day with new Reserve Bank Governor Adrian Orr.  This one, on interest.co.nz, focused on issues somewhat connected to the Reserve Bank’s responsibility for financial sector prudential regulation/supervision, and associated failure management responsibilities.

In the interview Orr touched again on an idea he has already alluded to in one of his interviews: the idea of getting a clearer, more quantified, sense from Parliament as to what it is looking for from the Reserve Bank in its conduct of regulatory policy.

It is an appealing idea in principle.  For monetary policy, Parliament has specified a goal of price stability, and in the Policy Targets Agreement the (elected) Minister of Finance gives that operational form (a focus on 2 per cent annual inflation, within a range of 1 to 3 per cent).   There is nothing similar for the extensive regulatory powers the Bank has.

In respect of banks, section 68 of the Act sets out the goals

68 Exercise of powers under this Part

The powers conferred on the Governor-General, the Minister, and the Bank by this Part shall be exercised for the purposes of—

(a)  promoting the maintenance of a sound and efficient financial system; or

(b)  avoiding significant damage to the financial system that could result from the failure of a registered bank.

Which is fine as far as it goes –  and what isn’t there (eg a depositor protection mandate) is often as important as what is.   But it isn’t very specific, and provides no guidance as to how to interpret the idea of an “efficient” financial system (as a result, it has been debated internally for decades), no sense of how sound the system should be (or even what a “sound system”, as distinct from sound institutions, might be.   And the same overarching provision (sec 68) has seen the Reserve Bank’s approach to bank regulation and supervision change very substantially over the years, with little or no involvement from Parliament.

There is a reasonable argument –  made quite forcefully in former Bank of England Deputy Governor Paul Tucker’s new book on such matters – that if in a particular aspect society’s preferences aren’t reasonably stable, and able to be written down reasonably well, then policymaking powers in that area should not be delegated to an independent agency (let alone what is formally a one-man agency).  With the second stage of the review of the Reserve Bank Act underway, Orr can obviously see a threat to the Bank’s powers, and thus he suggests an attempt be made to have Parliament articulate its preferences, and views on possible trade-offs, more directly.  If they could do so, having unelected decisionmakers then working to deliver on that mandate might be less democratically objectionable, and the Reserve Bank might have a greater degree of legitimacy in these areas than it does now.

And so the Governor told his interviewer

“For inflation targeting we’ve got a clear target [being] 1% to 3% on average. For the prudential regulation, – how do we articulate that target? In other words what is the risk appetite of the people of New Zealand as represented by Members of Parliament for banking regulation? Do you screw it down to one corner where nothing can happen – it’s very sounds but totally inefficient, or do you have trade-offs allowing firms to come and go and consumers to be aware etc? So that is going to be a really good, useful articulation that will come out of that,” says Orr.

At first blush it sounds promising, and I’m certainly not going to discourage an effort to try to uncover such an articulation of preferences.  But I am a little sceptical that anything very stable or useful will emerge from the process.  I’d prefer that all rule-making powers were removed back to the Minister of Finance (or indeed Parliament), leaving the role of the Reserve Bank as (a) technical advisers, and (b) implementers.

It might be fine to express a view that banking system regulation should be designed on a view that there should be no major bank failure on average more than once in a hundred years   – actually about the rate in New Zealand history –  or, indeed, five hundred years.    That might (and has in the past internally) be some help in how one calibrates capital requirements for banks.  It will, however, be almost no help in deciding whether LVR restrictions are a legitimate use of coercive, redistributive, government powers.  Or whether we care much about small institutions.  Or, indeed, whether the Reserve Bank should have the power to approve (or not)  the appointment of senior staff in banks.   And even if society could express a stable preference for a regime designed to deliver no more than one failure per 100 years, it provides very little basis for that other vital strand of the governance of independent agencies –  serious accountability.    Good luck could readily deliver a 50 year run of no failures without reflecting any great actual credit on the central bankers in charge at the time (who might have been doing fine, or doing a lousy job).  And if the one in a hundred year shock happens next year, it will still be very difficult to say with any certainty that the central bankers were doing the job they were asked to do –  they may well have been, and just got unlucky, and the public is likely to want scapegoats.    Elected politicians serve that role better than unelected technocrats.

But if there is anything more to the idea the Governor is toying with, it would be good to get some material into the public domain in due course, and have it scrutinised or debated.

In his latest interview, the Governor also touched again on the calls for a royal commission into conduct in the financial sector, as underway at present in Australia.  This time he is a lot more moderate, explicitly recognising that it isn’t his call.

Against the backdrop of the unacceptable conduct coming to light in Australia’s Royal Commission on financial services, Orr doesn’t believe New Zealand needs its own Royal Commission. However, he says the impact of the Australian one is certainly being felt in NZ.

“There will be not a single bank in New Zealand that is not, at the moment, really checking every cupboard for skeletons here in New Zealand. That is without doubt. This has really put the wind up the banks to say ‘hey, what is the alternative to sound regulation, it’s a Royal Commission’. We’re meeting collectively with the CEOs, we’re meeting individually with the chairs, and we always do on a regular basis,” Orr says.

“Is a Royal Commission necessary? At the moment in my personal opinion no, but I’m not the one who would call one anyway.”

Orr says while the Australian Prudential Regulation Authority is “being held up as some [sort of] global best practice,” and works alongside the Australian Securities and Investments Commission and the Reserve Bank of Australia with all having “heavy boots on the ground,” they’re still having “this cultural challenge.” Thus more hands-on regulation than the Reserve Bank’s light touch regulatory oversight of banks isn’t necessarily the best way forward.

But it is an odd mix of responses.  On the one hand, Orr seems to come across as something of a champion or defender of the banks in New Zealand.  That is no part of his role.  He is the prudential (soundness) regulator, in the public interest –  recall section 68 of the Act, quoted earlier – and his role (the Reserve Bank’s role) has almost nothing to do with conduct standards.

And he seems to be attempting distraction on other issues by conflating prudential/systemic issues with conduct issues.  Thus, when various people (including the IMF) have argued that New Zealand should adopt a prudential regulatory regime more akin to APRA’s (which, in effect, operates here to a considerable extent anyway, because APRA is focused on the entire Australian banking groups), Orr doesn’t engage in the substance of that debate, but attempts to muddy the water by making the point that a more intensive prudential regime in Australia hasn’t prevented some of the conduct issues coming to light in the Royal Commission.  Indeed, but why would one imagine it should?   They are two quite different issues.  In the same way, an investigation into whether the local supermarket was meeting minimum wage or holiday pay provisions for its staff wouldn’t expect to shed any light on food-handling issues in the same supermarket.

Part of the legitimacy of independent central banks involves them being seen to speak in an authoritative and trustworthy way.

But the comment from the Governor that led me to read the account of the interview was on the vexed subject of deposit insurance.   The article had this as (part of) its headline

RBNZ Governor says differences between deposit insurance & minimum deposit not frozen in OBR scenario are ‘technicalities’

That sounded like an intriguing claim.  You’ll recall that the Reserve Bank has long staunchly opposed deposit insurance (eg articles/speeches referenced here), even though people like The Treasury, the IMF, and various other commentators (including me and my former RB colleague Geof Mortlock) favour it.  The new Governor doesn’t seem to share the Bank’s long-running opposition.

Asked whether the Reserve Bank should get an explicit statutory objective to protect bank depositors and/or insurance policyholders, Orr says deposit protection, or deposit insurance, is “something that’s going to be here in the future.” NZ’s currently an outlier among OCED countries in not having explicit deposit insurance.

“I think that’s something that’s going to be here in the future. We need to work our way through what it means

I’m surprised that change of stance didn’t get more coverage.  Of course, whether or not we have deposit insurance isn’t a decision for the Reserve Bank; it is a matter for the government and Parliament.  Nonetheless, if the Reserve Bank Governor is going to withdraw the bank’s opposition, that removes a significant bureaucratic roadblock.  Well done, Governor.    (To be clear, I favour deposit insurance not as a first-best outcome, but as a second-best that makes it more likely that future governments will allow troubled financial institutions to fail, rather than bail out all the creditors.)

But it was the Governor’s next comments on the issue that were more troubling, and which suggest he hasn’t yet got sufficiently to grips with the issue before opening his mouth.

I think people have been talking across each other a lot,” Orr says.

“The bank here has got a policy called Open Bank Resolution. And that is the idea that if a bank is too large to fail, we have to keep it open. But we have to recapitalise. So the current owners or investors who have largely done their dough, how do you recapitalise it and how do you have the door open the next day?”

“As part of that open bank resolution, we’ve already said there can be a de minimis around depositors money that they will have access to. We just need to speak in better English to say ‘you know you are going to have some cash there, you are going to be able to get your sandwiches, meet your bills, do all of that on the Monday. Because if it didn’t happen that way, then that one bank failure creates all banks to fail, there’s [bank] runs everywhere’,” adds Orr.

When it was put to him that depositors having access to a de minimis sum if open bank resolution was implemented on their bank isn’t the same as explicit deposit insurance, Orr suggested the difference is merely technical.

“We could have a discussion through that legislation to say ‘economically it’s the same, could we call it the same, or is it part of a failure management?’ I believe it’s the same end outcome, the technicalities behind it are just technicalities. We need to be able to say to the public ‘if we’re shutting the bank down, what do you have access to, what is the guaranteed de minimis or minimum, or protection,’ and then we need to work out how is that going to be funded.”

There is a lot of mixed-up stuff in there.

For a start, the question of how we manage the failure of a bank in New Zealand has nothing whatever to do with the idea of foreign taxpayers bailing out New Zealand depositors.  I’m not aware that anyone supposed that was very likely.  Indeed, all our planning –  including the requirement for most deposit-taking banks to incorporate locally –  has been based on the idea that New Zealand is on its own (although for the Australian banking groups, whatever happens in the event of failure is likely to be negotiated by politicians from the two countries).   Instead the general issue here is

  • should a large bank simply be allowed to close if it fails, and handled through normal liquidation procedures (few would say yes to that).
  • if not, how best can the bank be kept open,
  • it could be bailed out by the government (benefiting all creditors, including foreign wholesale ones),
  • or the OBR tool could be used, in which all creditors’ claims would be immediately “haircut”, so that the losses fall on shareholders and creditors not on taxpayers but  the bank’s doors remain open.

Within the OBR scheme there has always been the idea of a de minimis amount which might not be haircut at all.  It isn’t an issue about liquidity –  as the Governor suggests –  because in the reopened bank everyone has access to some of their money.  It is an explicitly distributional issue.   For example, a welfare beneficiary might have only $100 in their account (living almost from day to day),  such accounts in total won’t have much money in them, so it might be easier (involve many fewer creditors, and less immediate resort to eg foodbanks) and in some sense fairer just to give people with such small balances immediate access to all their money and not have them share in any losses (or have to bother about ongoing dealings with those handling the failure).  It has mostly been seen as a matter of administrative convenience, but also of realpolitik (reduce the number of voters affected by losses in a failure).   And if these very small creditors are fully paid out, it does involve a transfer of wealth from all other creditors, but the amounts involved, even cumulatively, are pretty small.

In recent years, there has been talk of this de minimis amount creeping up.    There have even been suggestions of something as large as $10000 –  in other words, if you have less than $10000 in your (failed) bank, you wouldn’t face any losses.    It must be this sort of thing the Governor has in mind when he talks of the difference between deposit insurance and the de minimis being little more than “technicalities”.

But he is still wrong:

  • first, the de minimis would only apply where OBR was used, and OBR is only one option.  Even if looks like an attractive option, in some circumstances, for a large bank, it might not be a necessary or appropriate response to the failure of a small bank.
  • second, the de minimis is being paid out of other creditors’ money (it is essentially a (small) depositor preference scheme).   That might be tolerable for very small balances –  other creditors have an interest in lowering administrative costs of managing the OBR –  but is most unlikely to be defensible, or acceptable, for larger de minimis amounts,   Perhaps the Governor has in mind, the government chipping in directly to cover the larger de minimis amounts, but relative to a proper priced deposit insurance regime that seems far inferior, and different by degree, not just by “technicalities”.
  • third, no de minimis amount I’ve ever heard mentioned comes close to the sorts of payout (coverage) limits in typical deposit insurance schemes abroad.  As the author of the interest.co.nz piece points out  “Under Australia’s deposit insurance scheme, deposits are protected up to a limit of A$250,000 for each account-holder at any bank, building society or credit union that’s authorised by the Australian Prudential Regulation Authority”.    Attempting to rely on the de minimis –  as people like the Governor sometimes do in advance of the failure –  is just a recipe for increasing the likelihood of a full bailout at point of failure, as the amount envisaged just won’t match public expectations/demands (as revealed in other countries).

To repeat, it is good that the new Governor appears to be shifting ground on deposit insurance.  But let’s not settle for half-baked responses, using a vehicle never designed to deal with the issue of deposit insurance.  Legislate and put in place a proper deposit insurance scheme, and levy depositors to pay for the insurance.

Do that and, as I’ve argued previously, the chances of being able to use OBR –  to impose losses on large and wholesale creditors, including foreign ones – will be materially increased.  Without sorting out deposit insurance properly, most likely any future government faced with a failure of a large bank will just fall back on the tried, true, and costly solution of a full state bailout.

 

 

The Reserve Bank and financial regulation

Still working my way through the various articles and documents that turned up just before Christmas, I got to a lengthy issue of the Reserve Bank Bulletin, headed “Independence with acccountability: financial system regulation and the Reserve Bank”.   It is, I suspect, designed to fend off calls for any significant reform.

The Bulletin speaks for the Bank, and although as I read through the article I noticed distinct authorial touches and tendencies, when all is boiled down the author was sent into the lists to make the case for how things are done now: powers, governance, and accountability.  He does a pretty good job of presenting the party-line, against significant odds in many areas.    Even where one disagrees with the Bank’s case, it is a useful and accessible addition, in part because the Bank’s powers and responsibilities in regulatory areas have grown like topsy over the years and are scattered across various pieces of legislation.

Much of the first half of the article is designed to make a case for an independent prudential regulator, by reference to the theory and to the writings of the Productivity Commission.  But, for my tastes, it was far too broad-brush to add much value.  Probably no one disputes that we want the rules applied fairly and impartially, with politicians largely kept out of the process.  In the same way, we don’t want politicians deciding which person gets arrested and which not –  we want an operationally independent Police for that –  or who gets convicted  –  independent courts – or which airline passes safety standards and which not, and so on, so we don’t want politicians deciding to look favourably on one bank’s risk models and not on another’s.   There are many independent regulatory agencies –  or even government departments where the chief executive exercises responsibility in independently applying the rules –  but to a very substantial extent they apply and administer the rules, while other people make the policy/rules.

The Reserve Bank wants to make the case that in its area the rules/policy shouldn’t be set by elected people (whether Parliament itself, or ministers by regulation), but by an independent agency, and that the same agency should both make and apply the rules (without any possibility of substantive appeal).  It is the “administrative state” at its most ambitious –  unelected officials (a single one at present, not even directly appointed by a Minister) are lawmakers, prosecutor, judge and jury (and quite possibly the equivalent of the Department of Corrections as well).

The Bank seeks to rest a lot on the notion of time-inconsistency, a notion from the academic literature that is sometimes used to try to explain the high inflation of the 60s and 70s, and to make the case for an independent central bank to make monetary policy.  The idea is that even though one knows what is good in the long-run, the short-term benefits of departing from that strategy (and endless repeats of the short-term) mean that the long-term gains are never realised.  The solution, so it was argued, was to remove the short-term management of the business cycle from politicians.    I’m not particularly persuaded by the model as it applies to monetary policy (a topic for another day), and it is curious to see a central bank putting so much weight on that model after year upon year of inflation below target.  But today’s topic is financial regulation and financial stability, where the Bank would have us believe it is desirable/important to have the rules themselves –  the policy –  set by someone other than politicians.

No doubt it is true that there can be some tension between the short and the long-term around financial stability.  But that is surely so in almost every area of government life and public policy?  Underspending on defence now frees up more resources for other things now, but one might severely regret doing so if an unexpected war happens later.  Skimping on educational spending now won’t make much difference (adversely) to economic performance or the earnings of anyone (teachers aside I suppose) for a decade or two.  Running big fiscal deficits now can offer some short-term benefits, but at the risk of heightened vulnerability etc a decade or two down the track.   But in none of these areas do we outsource policymaking: they are political choices, and we then employ officials and public agencies to administer and deliver those choices.     The Reserve Bank has, as far as I’m aware, never offered any explanation as to what makes their specific area of policy different.   Sometimes they draw on academic authors writing about financial regulation, but many of those specialists fall into the same trap –  they see their own field, but never stand back and think about how democratic societies organise themselves across a wide range of policy.

As it happens, the current system around the Reserve Bank and financial regulation is a bit ad hoc and inconsistent to say the least, a point that the article more or less acknowledges.     Thus, for banks the Reserve Bank can vary the “conditions of registration” to change all sorts of big policy parameters, without any formal involvement from elected politicians at all (all the variants of LVR policy, from the first Wheeler whim were done this way).  But even for banks rules around disclosure have to be done by Order-in-Council, and thus require ministerial approval.  No one would write the law that way –  such different regimes for two different aspects of  bank regulation –  if starting from scratch (the actual legislation has evolved since 1986).

For insurance companies, the Reserve Bank itself can issues solvency standards (effectively, capital requirements for insurers), but for non-bank deposit-takers capital rules (and other main prudential controls) can only be set by regulation, again requiring the involvement and approval of the Minister of Finance.   (Incidentally, this is why LVR rules apply to banks but not non-bank deposit-takers: Wheeler could regulated banks directly, but couldn’t do the same for non-bank deposit-takers.

(And, as the Bank notes, it has “no direct role in developing rules associated with AMLCFT”, even though it administers and applies those rules for banks.)

At very least, there would appear to be a case for streamlining and standardising the procedures for setting the rules.     It isn’t clear why the Reserve Bank Governor should have almost a free hand when it comes to banks, but such limited scope to set policy when it comes to non-bank deposit-takers.   And, if anything, the case for ministerial involvement in settting the rules for banks is greater than that for the other types of institutions because (as the Bank acknowledges) bailouts and recessions associated with financial crises etc have major fiscal implications, and one might reasonably expect elected ministers to have a key role in setting parameters that influence the risk of systemic bank failures.   And, again as the Bank acknowledges, it isn’t easy to pre-specifiy a charter –  akin to say the Policy Targets Agreement –  for financial stability policy.

The Bank attempts to cover itself against suggestions that it might be, in some sense and in some areas, a law unto itself, by highlighting various ways in which the Minister of Finance might have some say.   There are, for example, the (non-binding) letters of expectation, the need to consult on Statements of Intent, and the potential for the Minister to issue directions requiring the Bank to “have regard” for or other area of government policy.     These aren’t nothing, but they aren’t much either –  and as the Rennie report noted, the power to issue “have regard” directions has never been used.    Even budgetary discipline is so weak as to be almost non-existent: there is a five-yearly funding agreement, but it isn’t mandatory  (something that needs fixing in the current review), isn’t particularly binding, and doesn’t control the allocation of spending across the Bank’s various functions.   The Minister of Finance doesn’t even get to make his own choice of Governor –  and all Bank powers still rest with the Governor personally.

The contrast with the other main New Zealand financial regulatory agency, the FMA, is pretty striking.   Policy is mostly set by the Minister (by regulation), advised by MBIE (to whom the FMA is accountable), and the powers of the organisation itself rest with the FMA’s Board, all the members of which are appointed directly by a Minister, and all of whom –  under standard Crown entity rules – can be removed, for cause, by the Minister.  Employees, including the chief executive, only have powers as delegated by the Board.    The FMA model is now a pretty standard New Zealand regulatory model, and an obvious point of comparison with the Reserve Bank.

Somewhat cheekily, the Reserve Bank attempts to present their own model as providing more scope for ministerial input than for the FMA  (see footnote 16, in which they note that for the FMA there is no power of government direction).   As regards policy, it isn’t necessary, since the government sets policy and appoints (or dismisses) the Board.   As regards the application of rules, one wouldn’t want –  and doesn’t have –  powers of government direction in either case.   As regards the banking system, mostly ministers can’t set policy, can’t hire their own Governor, and can’t fire him (re financial system policy) either.   The Governor and the Bank have far more policy power than is typical –  across other regulatory agencies –  appropriate, or safe.

The second half of the article is about accountability.  As they reasonably note, when considerable power is delegated to unelected agencies, effective accountability needs to provided for.    In their words “accountability therefore generates legitimacy and legitimacy in turn supports independence”.

It is, therefore, unfortunate that the Bank’s very considerable powers are matched, in this area in particular, by such weak accountability.   After pages of attempting to explain themselves and what they see as the various aspects of accountability, even they end up largely conceding the point.     These sentences are from the last page of the article

the BIS (2011) argues that financial sector accountability mechanisms should be focussed more on the decision making process rather than outcomes per se. This is because of the more intrusive nature of financial sector policy, and the issues associated with observing outcomes (lack of quantification and very long lags). Put another way, there should be less reliance on ex post accountability mechanisms and more obligations placed on ensuring decision-makers are transparent about the basis for their actions.

I’m not sure I entirely agree –  although there is certainly the well-recognised point that absence of crisis is evidence of nothing –  but at very least a focus on strong process might argue for:

  • a more effective separation between policymaking and policy administration (as is customary for many regulatory entities, but largely not for New Zealand bank supervision),
  • a decisionmaking structure in which power did not rest simply with a single individual, who is himself not directly appointed by an elected person,
  • decisionmaking structures that involve real power with non-executive decisionmakers,
  • effective and binding budgetary accountability,
  • a high degree of commitment to transparency and to ongoing external engagement,
  • a culture that is self-critical and open to debate,
  • perhaps some more effective scope for judicical review (including on the merits, rather than just process),
  • monitors with the expertise, mandate, and resources to ask hard questions and to critically review and challenge choices being made around policy and its application.

At present, as far as I can see, we have none of these for the Reserve Bank of New Zealand as financial regulator.

Take the formal monitors for example.  Parliament’s Finance and Expenditure Committee has little time, no resources, and little expertise.  The Treasury has no formal role, no routine access to Bank materials (or eg Board papers) and is probably quite resource-constrained in developing the expertise.

And what of the Bank’s Board?   By law, they play a key role, as agent for the Minister of Finance in monitoring the Governor, and (now) obliged to report publically each year on the Bank’s performance.    The Bank often likes to talk up the role of the Board –  doing so provides them cover, suggesting the presence of robust accountability –  but the latest article is surprisingly honest.  The Board gets a single paragraph, which simply describes the legislative provisions.  There is no suggestion of the Board have actually played a key role in holding the Bank (Governor) to account – not surprisingly, since in the 15 years they have been publishing Annual Reports, there has never been so much as a critical or sceptical word uttered.  Of course, it isn’t surprising that the Board doesn’t do a good job: it has no independent resources at all (even its Secretary is a senior Bank staffer), the Governor himself sits on a Board (whose main role, notionally, is to hold the Governor to account) and the Board members themselves typically have little expertise in the areas (quite diverse) around which they are expected to hold the Governor to account for.   (Their job is, of course, made harder by the rather non-specific mandate the Bank has in regulatory areas –  there is nothing akin to the Policy Targets Agreement (which has its own challenges in monitoring).)

What of some of the other claims about accountability?  The Bank points out that it is required to do regulatory impact assessments –  but these are typically done by the same people proposing the policies, and there is (or was when I was there) nothing akin to the sort of process some government departments have for independent panels vetting the quality of the regulatory impact assessments.

They are also required to consult on regulatory initiatives, and must “have regard” to the submissions.  But, except perhaps on the most technical points, there is little evidence that they actually do pay any real heed to submissions.    For a long time, they also kept the submissions themselves secret –  even attempting to claim that they were required by law to do so.  They’d publish a “summary of submissions”, which highlighted only the issues they themselves chose to identify.   As they note, and in a small win for a campaign by this blog, they have now started publishing individual submissions, belatedly bringing them into line with, say, Select Committees of Parliament or most other regulatory bodies.  But there is no sign of much change in the overall attitude, or of any greater openness to ongoing debate and critical scrutiny.

Then, of course, there is the Official Information Act.  The Bank is subject to the Act, but chafes under the bit, is very reluctant to release much, threatens to charge requesters, and generally seems to see the Act as a nuisance, rather than an integral part of an open and accountable government.

We had a good example just a couple of months ago as to how unaccountable the Bank is in its prudential regulatory areas.  It emerged that Westpac had not had appropriate regulatory approval for some model changes used in its risk-modelling and capital calculations.   But, as I noted at the time, the short Bank statement left many more questions than it answered, and no one –  including journalists asking directly –  has been able to get straight answers from them, even though capital modelling is at the heart of the regulatory system.

And, of course, if the formal monitors are lightly (or not at all) resourced, there isn’t much other sustained scrutiny.   Banks are scared –  and more –  to speak out: this is where culture matters a great deal, as banks will always have a lot of balls in the air with the regulator, and in an open society should feel free to openly challenge the regulator, without fair of undue repercussions.   Academics with much expertise in the area are thin on the ground, as are journalists with the time or expertise.

Mostly, in its exercise of its extensive financial regulatory powers, our Reserve Bank isn’t very accountable at all.   Providing it jumps through the right, minimal, process hoops it can do pretty much what it likes in many areas of policy, and the public is left just having to take the Bank’s word (or not) that things are okay.  That needs to change –  and thus phase 2 of the current review of the Bank’s Act needs to be taken seriously.    Making the changes isn’t about one single measure, and there are plenty of details that will take a lot of work, and thought, to get right.   Part of it is about building a better internal culture, one that (from the top) really wants to engage, and which welcomes challenge and critical review.

After yesterday’s post I had an email from a reader with considerable senior-level experience in the banking sector noting just how weak much of the formal scrutiny of the Bank is in these areas.

From my perspective the Bank would benefit from independent challenge about their prudential responsibilities, and cost-benefit analysis. I am unsure if they have reviewed this post the Westpac capital model issues.

I am unsure how the Board discharges the independent prudential review role effectively given their experience – two Directors have insurance experience  and no directors have Banking, payments system or other non-bank financial experience. Likewise experience of Insurance/Banking/Payments technology systems and risks. While there are some very good RBNZ executives they are not particularly strong in banking risk experience – funding, liquidity, credit etc.

…. I think it would be useful for the RBNZ at a governance level to have experience of how financial balance sheets, and liquidity operate under stress, they will have some very important decisions to make when the next financial crisis occurs.

Much of that rings true to me.    We have typically had Governors with more experience of macro policy, and perhaps financial markets, than of banking –  and yet financial regulation is a hugely important role in what the Bank does – and now have a new Head of Financial Stability with no background in banking or finance at all.   We have a Board responsible for monitoring the Bank across monetary and regulatory responsibilities, and with little specialist expertise.   The contrast with, say, the FMA is quite stark.

Quite what the right balance of a solution is, I’m not quite sure.   I favour moving to a committee-based decision-making structure, and moving more of the policy back to the Minister (with the Bank as a key adviser), but even a Financial Policy Committee might only have three or four externals on it, and no such group is going to encompass all the right bits of expertise.   As often, I guess it is partly about the willingness to ask the hard questions, and to be willing to commission independent expertise (whether from New Zealand or abroad, from academics or people with industry background) and to engage.   If the Board remains as a monitoring agency –  as Rennie recommends, but I’m sceptical of –  it needs to be provided with resources.   And the Minister needs to be willing to use his statutory powers to commission independent reviews of aspects of the Bank’s stewardship, to enable us (and the Bank) to learn from experience by critically evaluating performance (and process).  Personally, I’m still tantalised by the idea of a small independent agency resourced to pose questions, and commission research, on the stewardship of fiscal, monetary and financial regulatory policy.

If not all the answers are clear, what is clear is that New Zealand is a long way from having got the model right: the right allocation of powers, the right accumulations of expertise in the right places, the right cultures, and the appropriate mix of formal and informal accountability that can really give New Zealanders confidence in the regulation of the financial system.

 

A trans-Tasman banking union isn’t likely

What will happens if –  perhaps “when” if we take a long enough horizon – a major Australian bank fails isn’t at all clear.

We went through a phase of failures and near-failures a generation ago, after the post-liberalisation boom and (spectacular) bust.  On the Australian side, there were the failures (in effect, bailed out by governments) of the state banks of Victoria and South Australia –  the latter bank had operations in New Zealand.  Westpac –  operating as a single entity on both sides of the Tasman –  came under some pretty severe pressures.  And on this side of the Tasman, we had the failure of the DFC and the two episodes in the failure (again bailed out by the government, the primary owner) of the BNZ.  (In both countries, some new entrant foreign banks also lost a lot of money, but they weren’t really the problem of governments and regulatory authorities in Australasia).

In that episode (or succession of episodes), handling the failures (or threat of failure) was almost entirely a matter for the home authorities –  those where the bank concerned was based.  That was so even when there were substantial losses on the other side of the Tasman (eg many of BNZ’s losses were on the loan book it had built up trying to buy its way into the Australian market).

Things were easier and clearer in that episode.  In particular, the banks that actually failed were all government-owned (wholly or primarily) to start with.  And in Australia, the failures were of second-tier institutions:  we (fortunately) never got to see how a Westpac failure would have been handled.   And at the time, the New Zealand and Australian banking systems were also much less intertwined.   Westpac and ANZ had substantial New Zealand operations, but NAB and Commonwealth Bank were hardly here at all, and we had fairly large banks that weren’t active in Australia (the Lloyds-owned National Bank, Trustbank, Countrywide).  BNZ was the largest bank in New Zealand, but although the BNZ’s operations in Australia were important to them, they were not very important to Australia.   BNZ was clearly our problem.

These days, by contrast, our banking system consists of the operations of the four big Australian banks, state-owned Kiwibank, and the rest don’t matter much at all (whether retail or wholesale).  And for the Australian banks, New Zealand exposures are typically the largest chunk of the non-Australian assets of the respective banks.  In ANZ’s case, almost 20 per cent of the group’s assets are in New Zealand.  Our problems are their problems, and their problems are our problems.

But the interdependence isn’t symmetric: not only is Australia much bigger than New Zealand, but all the banks are (ultimately) Australian-owned and based.     Things would look rather different if, say, one of the four big Australasian banks was owned and based here.   And our legislative approaches are different too: Australian had explicit statutory preference for the claims of Australian depositors (and, more recently, deposit insurance, but that is a different issue), while under our legislation all creditors are treated equally.   That longstanding depositor preference rule was one of the main reasons why some years ago (it must be getting on for 20 years now) we insisted that the local operations of Australian banks taking material amounts of retail deposits had to be locally incorporated (ie operate through a New Zealand subsidiary).  The proceeds of the New Zealand subsidiary’s assets were to be available to meet its own explicit liabilities, not just be part of a wider trans-Tasman pool.

On paper, the New Zealand subsidiary is pretty fully separable from the parent.  Should the whole banking group fail, New Zealand authorities can decide how to handle the New Zealand subsidiary independent of what the Australian authorities decide (although in both countries, legislation commits each country to take account of the financial stability interests on the other).   If the subsidiary also failed we could choose to bail it out, or not.  And if the subsidiary was strong, even though the parent was in trouble (say there had been a particularly severe shock specific to Australia), the subsidiary would be capable of keeping on operating here.   That separability comes at a cost, but it might well be technically workable.  In principle, we could apply the OBR mechanism to the (failed) New Zealand sub of an Australian bank (the stated preference of the Reserve Bank and the previous government) even if the Australian government bailed out the parent (the generally expected approach under successive Australian governments).

In practice, it isn’t very likely.   And everyone in the relevant government agencies on both sides of the Tasman knows it.    Should the whole of a banking group be in trouble, it is much more likely that the Australian government will push (very strongly) for a bail-out of the entire group, and will put a great deal of pressure on the New Zealand government to contribute to such a bailout.     What is their leverage?  Well, on the one hand, there are always large numbers of issues on the boil between the two countries at any one time –  don’t play ball on something that really matters to Australia, and we’d find ourselves exposed to bad outcomes in some other areas, and damaged relationships over time.  And on the other hand, there would be straightforward domestic political pressure here: how likely is a New Zealand government to let the depositors of ANZ New Zealand lose money, while the news headlines tell of the Australian government bailing out in full those of ANZ Australia?    And from the Australian perspective they won’t want a major subsidiary, carrying the same name, failing, even if the Australian operations themselves are ringfenced –  the headlines won’t look good with the investor base in New York, London, or Tokyo.

In sum, it is much more likely that if one of the major Australian banks fails, (a) it will be bailed out at a group level, and (b) there will be a great deal of pressure for New Zealand to participate in a bail-out in some form or other.  The details will be haggled over at the time, under intense pressure, and with active high-level political engagement.   Australia, for example, would probably prefer we put in money to help recapitalise at a group level (while the parent then recapitalises the NZ sub).  Our authorities might prefer a clean break in which we took, and recapitalised the sub, and had control over what happened down the track.  What actually happens would depend on, inter alia, the key individuals at the time, the wider state of political relations between NZ and Australia,  perhaps where the source of the failure primarily lay (NZ-centred losses or not), on the global environment, and on whether this particular failure was perceived to be idiosyncratic, or potentially the first of a sequence.

One of the issues the Europeans (in particular) have been grappling with since the 2008/09 crisis has been the ability –  fiscal capacity –  of single countries to stand behind (“bail out”) large international banks that are based in their countries.   It isn’t really an issue in the United States (for example) where the banks are not that large (as a share of GDP) and the country itself is big.  It is potentially a different issue in, say, Switzerland or the Netherlands –  and since the crisis, the Swiss authorities have been taking steps to lower the relative size of the international banks based in their country.

One of the academics who has done a great deal of work in this field is Dirk Schoenmaker, of the Rotterdam School of Management, who has been in New Zealand for the last couple of weeks as the Reserve Bank/Victoria University professorial fellow.  When the Reserve Bank has these visiting fellows, Treasury tends to “free ride” and use the opportunity to host a public guest lecture by the visitor (which used to annoy me a little when I was at the Bank –  it was our money funding the visit –  but for which I’m now grateful).

Last Friday, Schoenmaker gave just such a lecture at The Treasury on exactly this issue: can small countries cope with international banks based in their country, and the risk of them failing.  His published paper on the issue is available here.   This is from his abstract.

While large countries can still afford to resolve large global banks on their own, small and medium-sized countries face a policy choice. This paper investigates the impact of resolution on banking structure. The financial trilemma model suggests that smaller countries can either conduct joint supervision and resolution of their global banks(based on single point of entry resolution) or reduce the size of their global banks and move to separate resolution of these banks’ national subsidiaries (based on multiple point of entry resolution). Euro-area countries are heading for joint resolution based on burden sharing, while the United Kingdom and Switzerland have implemented policies to downsize their banks.

This is his trilemma

trilemma

You can, he argues, have any two of these dimensions but not all three if you are a small/medium country.   That reasoning seems sound.  I’m less sure about what follows from it.

First, what can individual countries afford to do (as bailouts) if they want to?  Schoenmaker does quite a bit of analysis of the last series of crisis (2008 and after) and concludes that the most any country can really spend on a bailout is 8 per cent of GDP.    This is his chart

schoenmaker.pngAs he notes, the first four countries on the left of the chart couldn’t cope themselves and needed either IMF or EU support, and Spain also needed external assistance.  But all these countries were in the euro-area, and thus not only lost the capacity to adjust domestic interest rates for themselves, but also couldn’t do anything to adjust the nominal exchange rate.  By contrast, the UK’s bailout costs –  not that much lower than Spain’s –  never ever raised any serious questions about the UK’s fiscal capacity.  And that was with a far higher starting level of public debt (as a share of GDP) than, say, Ireland had.

So his analysis looks to be quite useful in an intra euro-area context.   Belonging to the euro –  whatever advantages it may bring –  involves a substantial sacrifice of national flexibility in a crisis.  And so the logic of the direction Schoenmaker is calling for –  and which the Europeans are moving gradually towards –  involving (at least for big international banks) unified supervision and loss-sharing  (across national boundaries) in the event of failure and bailout, seems to make quite a lot of sense.  If I were Dutch, I’d probably be rather keen on the idea.

But Schoenmaker also argues that the model is directly relevant to this part of the world.  In particular, he shows a table in which the cost of recapitalising (ie replacing existing capital) of the three largest Australian banks (he uses the top-3 banks in each area he looks at) would be around 7.6 per cent of GDP.  That is close to his 8 per cent “fiscal space” threshold, and thus he argues that Australia may be only barely able to cope with a systemic financial crisis in this part of the world.  Part of that recapitalisation burden would, on these numbers, include the overseas operations, the largest of which are typically in New Zealand.

Schoenmaker has written a new paper specifically on the idea of a possible trans-Tasman banking union.  It is still in draft, and isn’t yet available on his website, but he has given me permission to make it available here.  Schoenmaker on Trans-Tasman Banking Union

It is worth reading, both for the coverage of the ideas, and because the current draft already incorporates comments from Wayne Byres, the head of the Australian Prudential Regulatory Authority (APRA).

I don’t really buy the potential fiscal incapacity argument in either Australia or New Zealand.  Both countries have very low levels of public debt (Australia’s even lower than our 9 per cent net government debt, properly defined), and plenty of capacity for the exchange rate to adjust in a crisis (not just against each other if necessary, but against the wider world).  Neither country is hemmed in as (say) the Irish were –  “prohibited” by various EU agencies from allowing any private sector bail-in, even of wholesale creditors, in the midst of the crisis.

But set that to one side for the moment, how might his proposed trans-Tasman banking union work?  And why is not likely at all to be established?

Schoenmaker doesn’t set out precise details in his paper, but from his various papers and presentations it is clear that he draws an important (and correct) distinction between non-binding memoranda of understanding and the sorts of binding pre-committed burden-sharing arrangements he is talking about.  As he notes, there is a lot of contact between New Zealand and Australian officials in this area, culminating in the Trans-Tasman Banking Council (TTBC).  There is probably a fair amount of goodwill, statutory provisions to encourage looking out for each other, and the various agencies even “war-game” crises from time to time.  But none of this commits anyone (or their political masters, who change) to anything in a crisis.  In crises –  as in 2008/09 –  it is largely every country for itself.

And so what he seems to envisages is a binding treaty entered into by the New Zealand and Australian governments, under which a common set of supervisory standards would be applied (at least to the big banks operating in both countries), and the two countries would agree in advance on a (binding) formula for the allocation of losses in the event of failure (and bailout).  As he notes, roughly 87 per cent of the big-4 assets are in Australia and other places, and 13 per cent are in New Zealand.  In this model, New Zealand would commit to 13 per cent of any bailout costs, enabling resolution issues to be handled jointly (by a single agency accountable to both governments/Parliaments).  On the European model (ESM), this single agency could even be given the ability to borrow to meet recapitalisation costs.  Under this sort of model, Australia would (presumably) get rid of depositor preference, and we would get rid of local incorporation requirements for Australian banks.

One can, sort of, see why something along these lines might, on the right terms, appeal in Australia.   There was long been a strand of thinking in Australia that we are (a) free-riders, and (b) more than a little crazy.  In other words, so the argument goes, the soundness of our banks mostly depends on robust APRA supervision at the group level (“after all, the RBNZ doesn’t do any ‘real’ supervision at all”).  And, as for OBR, well “you can’t really be serious, can you……..?  We hope not…………”  So from an Australian perspective, arrangements that tied us into a pre-commitment to share the cost of bailouts would be a win –  a (pretty modest) fiscal saving, but removing the uncertainty that perhaps the crazy New Zealanders might actually use OBR and thus (in some thinking) further damage the wider banking group.

But on what terms would it be attractive to Australia?  Presumably terms on which the Australian authorities got to determine, finally, what banking regulatory standards were applied, and what action would be taken at the point of (actual or impending) failure.  New Zealand might be represented on a regulatory agency board, but with 13 per cent of the financial contribution, it might perhaps get 13 per cent of the vote.  13 per cent of the vote on a two-country entity is no power at all.

When I asked him, Schoenmaker suggested that perhaps the arrangement would have to be one in which New Zealand had a veto.  If so, it would rather dramatically change the nature of the arrangement –  more attractive to New Zealand, but (almost surely) totally unacceptable to Australia.  Is it even possible to conceive of an arrangement under which an Australian government would commit, by treaty, to giving New Zealand a veto on (a) bank supervisory policies, and (b) crisis resolution?  I wouldn’t if I was them.

And even if, somehow, such an arrangement were put in place in a mutual fit of bonhomie and trans-Tasman togetherness, there is no certainty that it would be honoured in a crisis (perhaps by then under different –  more mutually distrustful politicians).     This was the big point on which Schoenmaker and I differed at his seminar.  I argued that if, say, New Zealand wanted to let the bank fail and Australian wanted to bail them out then whatever the treaty said, Australia could –  and probably would –  just do so anyway.  Sure, there might be a binding treaty with dispute resolution provisions, but they would take years to get to a determination (think of the WTO disputes) and the crisis needs dealing with tonight.   Schoenmaker argues that it just doesn’t happen, but (a) we don’t have examples in banking crisis resolution, and (b) his mental model is one of the EU where there are (i) lots more countries, not just one big one and one small one, and (ii) a shared elite commitment to working towards political union.  There is nothing similar here.

Perhaps the Australians wouldn’t renege, but we’d have to take account of the possibility.  And with all the banks based there, not here, the issues and risks aren’t remotely symmetrical.  If, one day, New Zealand and Australia are working towards a political union, something along the lines of what Schoenmaker suggests might well be one part of that progress.  For now, it isn’t an idea that is likely to go anywhere, and nor should it go much beyond the seminar room (and any associated public debate).

If it doesn’t happen, Schoenmaker warns that we may well find ourselves on a path that will eventually make the Australian parents reconsider the benefits of operating in New Zealand at all.  As he notes, in eastern Europe many countries are putting up higher and higher barriers (eg very high capital requirements) to assure themselves of an ability to manage foreign-owned subsidiaries of western banks in a crisis.   If it were to come to that point in New Zealand, I personally think it would be unfortunate (we gain from having at least modestly-diversified banks), but it isn’t clear that New Zealand voters would necessarily see it the same way.  And if the two countries really wanted to deal with the potential costs of high New Zealand local capital requirements, they (Australia) could at last do something about mutual recognition of trans-Tasman imputation credits.  The inability/unwillingness to resolve that issue after 30 years is a salutary reminder of why we should not count on being able to easily pre-specify rules for handling a major economic and financial crisis hitting the two countries.  Crises, and loss allocations in particular,  are almost inherently nationa, and –  for now anyway –  these two nations aren’t merging.

(And, of course, the politics of banking in the two countries remains quite different.  We weren’t the country that almost nationalised the banks in the 1940s, and –  whatever the unease in some quarters now about Australian domination of the banking system –  we aren’t the country where the possibility of a Royal Commision into banking –  to what possible substantive end –  is in the headlines day after day.)

(There was an attempt by the Australians to take over all supervision back when Michael Cullen was Minister of Finance.  Alan Bollard –  rightly in my view –  fought back strongly and eventually persuaded the government not to accede to the Australian government bid.  Much of the reason for resistance comes down to the ability to manage crises in the interests of New Zealanders.)

Exporting to a large communist state

One of the things that seems to worry establishment people in New Zealand is a belief that our economy is somehow very vulnerable to anything that disrupts the trade of New Zealand firms with China.  It is a more-than-slightly puzzling concern, since only around 20 per cent of our exports go to China, and exports themselves aren’t an overly large share of GDP in New Zealand.   For the firms involved –  even if not the wider economy –  there are clearly somewhat greater risks, since China has a demonstrated track record of being willing to use targeted trade sanctions for “punishment”.   Those are the risks you take, as a private company, when you choose to play in that particular sandpit.

For the world economy, of course, any serious dislocation of China’s economy is a significant risk.  With interest rates in most of the world not much above zero, any serious downturn in one of the world’s two largest economies could be quite problematic (as the US recession/financial crisis in 2008/09 was).      But such downturns generally do even more damage to the economy at the centre of the problems than to everyone else.  We all have a stake in a better-managed Chinese economy, even if the Chinese authorities are showing increasingly autarckic tendencies, and even if China isn’t anywhere near as internationally connected as the major Western economies are.  But that interest isn’t a good reason to orient foreign policy around deference to China, or to refuse to have an open debate about Chinese government interference in the domestic affairs of other countries.

One case study that sometimes get mentioned when people talk about the vulnerabilities of trade with China is Finland.   After a rather difficult time in World War Two –  gallantly losing to the Soviet Union in 1939/40, and then ending up on Germany’s side –  Finland spent the post-war decades in an awkward position.  A new word was added to the international vocabulary: Finlandization

the process by which one powerful country makes a smaller neighboring country abide by the former’s foreign policy rules, while allowing it to keep its nominal independence and its own political system.  The term literally means “to become like Finland” referring to the influence of the Soviet Union on Finland’s policies during the Cold War.

And largely, no doubt, just because of geography, much of Finland’s foreign trade was with the Soviet Union during those decades (it was a highly managed and regulated trade).  Eyeballing a long-term chart, over the post-war decades to 1990 around 20 per cent of Finland’s exports were to the Soviet Union. And in the 1970s and 1980s, total exports as a share of GDP averaged just over 25 per cent in Finland.   In other words, exports to the Soviet Union were averaging about 5 per cent of Finland’s GDP, pretty similar to New Zealand exports to China today.  (A century ago, by contrast, New Zealand exports to the United Kingdom in the 1920s were 20-25 per cent of our GDP.)

The Soviet Union ended messily, at least in economic terms.   Here is a chart, using Maddison data, of real per capita GDP in the (once and former) Soviet Union.

USSR GDP

In the slump, and associated disarray, imports plummeted, including those from Finland. In fact, in 1992 Finnish exports to Russia (the largest chunk of the former Soviet Union) were less than 1 per cent of Finnish GDP.

At the time, Finland itself was going through one of more wrenching recessions seen until then in post-war advanced economies.  The unemployment rate rose from 3 per cent to over 17 per cent in just three years, and real per capita GDP fell by 11 per cent from 1990 to 1993.

The collapse of the Soviet Union wasn’t the only thing going on at the time.  There were recessions in many western economies (including New Zealand and Australia) around 1991, but Finland’s experience was particularly savage (and also worse than the experiences around the same time of other Nordic countries).

One distinctive was house prices.

finland real house prices

Real house prices rose by about two thirds (across the country) in just a couple of years, and then more than fully reversed the increase.  The 50 per cent fall in real house prices involved a very sharp fall in nominal house prices, only matched in recent times in Ireland.

To some New Zealand readers it will all seem like just the sort of stuff they worry about.  Isn’t our economy heavily dependent on trade with China, which could easily but cut off or otherwise implode, and aren’t house prices extraordinarily high?  Isn’t the great Finnish recession exactly the sort of thing Graeme Wheeler and the Reserve Bank were warning of?

No doubt there are some similarities in what they were warning about.  But if Finland offers lessons for us, they aren’t about who our firms trade with, nor even really about house prices and housing lending exposures.  Instead, they are the (now) age-old lesson about the risks of severely overvalued exchange rates, with an overlay of a warning about the transitional risks of financial liberalisation (readers will recall that New Zealand and Australia also had a tough time in that transition in the late 1980s).

Finland had had quite high inflation even by the standards of many other European countries during the great inflation of the 1970s.    Persistently high inflation, in a fixed exchange rate system, is typically accompanied by a succession of devaluations.  We went through almost 20 years of something similar in New Zealand.   But in Finland in the 1980s they decided to break the cycle, and set out to maintain a “hard markka” –  the fixed exchange rate holding down imported inflation and, supposedly, imposing domestic disciplines that would lower domestically-sourced inflation.    Much of the advanced world was disinflating at the same time, and so for a while the approach looked pretty successful.  Core inflation was 12 per cent in 1980, and not much above 3 per cent by 1986.

But the Nordic economies, including Finland, were also liberalising their domestic financial systems in the 1980s.  And a necessary corollary of a fixed exchange rate system is that, with an open capital accounts, your country’s interest rates are heavily influenced by those abroad.   And German interest rates, which had been 7.5 per cent in 1980, just kept on falling –  the Bundesbank’s discount rate was 2.5 per cent by 1988.

In process –  fixed exchange rate, falling global interest rates – what followed was a massive speculative credit and investment boom in Finland. Lending and asset prices surged.  Inflation picked up, and Finnish industry became increasingly uncompetitive internationally.  That in turn created doubts about the stability of the exchange rate peg, prompting increases in domestic interest rates.

Here is what happened to the real exchange rate

fin rer

And a measure of real short-term interest rates

fin int rates

Real interest rates didn’t peak until well into 1992, two years after the recession began.  Why? Not because inflation was a particular problem –  it was back down to not much above 3 per cent in 1992 and falling fast –  but because of the extreme reluctance of the authorities to float the exchange rate.   There had been grudging periodic adjustments under pressure, but it wasn’t until September 1992 that the markka was finally allowed to float.

In the process –  the boom over the late 80s and the subsequent bust, both heavily linked to the fixed exchange rate  –  the Finns managed to bring on themselves a very severe domestic financial crisis.   And there had been huge shifts in the shares of various components of the economy.  Here was the export share of GDP.

exports finland

Investment as a share of GDP fell from around 30 per cent at the end of the boom, to around 19 per cent at the trough.

Floating exchange rates can be messy, but unless you economy is very closely aligned to –  and integrated with –  the currency of some other country, they are usually better than the alternative.  That was certainly Finland’s experience over the crisis of the early 1990s.

And what of the financial crisis?  Surely with house prices falling by that much, residential mortage losses must have been a big part of the story?  In fact, the overwhelming bulk of the problem loans were to businesses and although many residential borrowers did get into trouble –  rapid increases in unemployment and rising real interest rates in combination can be a toxic brew –   in the end only 1 per cent of household loans were written off.   That isn’t particularly surprising, is a point made in numerous studies, and is consistent with a survey of financial crises done a few years ago by the Norwegian central bank.  As they put it

We look at a wide range of national and international crises to identify banks’ exposures to losses during banking crises. We find that banks generally sustain greater losses on corporate loans than on household loans. Even after sharp falls in house prices, losses on household loans were often moderate. The most prominent exception is the losses incurred in US banks during the 2008 financial crisis . In most of the crises we study, the main cause of bank losses appears to have been propertyrelated corporate lending, particularly commercial property loans.

And thus it was in Finland (and neighbouring Sweden for that matter).  It is a point I’ve been making about New Zealand: when severe adverse shocks hit, provided your exchange rate is floating, not only does the exchange rate fall, but interest rates typically do too.  Those are typically very powerful buffers, especially in the case of an adverse shock that isn’t global in nature.

And what of the role of the collapse in Finnish exports to the (now) former Soviet Union.  I found various books and articles on my shelves about the Finnish experience –  it was one of the handful of defining post-war crises.  None of them regard that sudden drop as a particularly important part in the Finnish recessionary story.  For anyone interested, there is an interesting recent paper by a couple of Finnish researchers.  Their summary is as follows

It is shown that empirically, the strong credit expansion resulting from the simultaneous liberalization of the domestic financial markets and international capital movements has played the most important role in explaining the changes in real economic activity in Finland during the time period analyzed. In fact, over a longer time period (1980-2005) exports to Russia emerge as a countercyclical variable: slightly contractionary after the crazy years, and expansionary during the following depression [exports to Russia recovered somewhat after the first chaotic year or two].

Exporters were fairly soon able to find alternative markets for their products, helped –  after 1992 –  by the much lower real exchange rate.

And what of the overall Finnish economy itself?  After freeing the exchange rate and allowing real interest rates to drop sharply, the economy itself rebounded quite rapidly.  By 1997, real per capita GDP was already 4 per cent above somewhat flattering boom-exaggerated 1990 levels.

finland real pc GDP  And consistent with a story I’ve run here in various posts over the years, through all that disruption and dislocation, here is the path of Finnish real labour productivity (real GDP per hour worked).

fin real gdp phw

As was the case with the numerous US financial crises in the 19th and early 20th centuries, there isn’t much sign of any enduring damage to productivity (levels or growth) from the Finnish crisis.  That’s reassuring, if not terribly surprising.

(Finland’s economic performance in the last decade has been pretty shockingly bad, including a productivity performance that –  like the UK’s –  is even worse than New Zealand’s over that period.  But that is a story for another day.)