Deposit insurance

Michael Reddell Banking, deposit insurance, Financial stability

Late on Friday afternoon, Stuff posted an op-ed piece calling for the introduction of a (funded) deposit insurance scheme in New Zealand.  It was written by Geof Mortlock, a former colleague of mine at the Reserve Bank, who has spent most of his career on banking risk issues, including having been heavily involved in the handling of the failure, and resulting statutory management, of DFC.

As the IMF recently reported, all European countries (advanced or emerging) and all advanced economies have deposit insurance, with the exception of San Marino, Israel and New Zealand.   An increasing number of people have been calling for our politicians to rethink New Zealand’s stance in opposition to deposit insurance.   I wrote about the issue myself just a couple of months ago, in response to some new material from the Reserve Bank which continues to oppose deposit insurance.

Different people emphasise different arguments in making the case for New Zealand to adopt a deposit insurance scheme.  Geof lists four arguments in his article

  • providing small depositors with certainty that they are protected from losses up to a clearly defined amount;
  • providing depositors with prompt access to their protected deposits in a bank failure;
  • reducing the risk of depositor runs and resultant instability in the banking system;
  • reducing the political pressure on government to bail-out banks in distress – deposit insurance would actually make Open Bank Resolution more politically realistic.

Of these, I emphasise the fourth.  I’m not convinced that there is a compelling public policy interest in protecting depositors, small or otherwise (many schemes cover deposits of $250000, sometimes per depositor per bank).   There are plenty of other bad things in life that we don’t protect people from (the economic consequences of) –  job losses, fluctuating house values, road accidents, bad marriages and so on.  The ultimate state safety net is the welfare system, which provides baseline levels of income support.  Should “deposits” or “money” be different?  I’m not sure I can see good economic arguments why (although there are good reasons why in the market debt and equity instruments co-exist, and debt instruments generally require less day-to-day monitoring by the holders of those instruments).

And there is a  variety of ways of providing depositors with prompt access to funds following a bank failure.  A bailout is one of them.  OBR is another.  And deposit insurance, in and of itself, doesn’t ensure prompt access to funds; it just ensures that the insured amount is fully protected (minus any co-payment, or deductible).

I’m also not persuaded that deposit insurance reduces instability in the banking system.  International historical evidence has been that in many or most cases,  depositors can distinguish, broadly speaking, the weaker banks from the stronger banks in deciding whether to run (I would argue that the UK experience with Northern Rock is one recent observation in support of that proposition).  And anything that weakens, albeit marginally, market discipline (in this case, by reducing the incentive on deposits to monitor risk and respond accordingly) can’t be likely to contribute to greater stability in banking systems.  Deposit guarantees for South Canterbury Finance only postponed, and probably worsened, the eventual day of reckoning.

But I find the political economy arguments for deposit insurance (at least in respect of large banks) compelling.  I outlined the case more fully in my earlier post.  If we don’t want governments bailing out all the creditors of a failing bank (large and small, domestic and foreign), we need to build institutions that recognize the pressures that drive bailouts and take account of that political economy.  It is futile –  and probably costly in the long run  –  to simply pretend that those pressures don’t exist.  In its recent published material, the Reserve Bank again just ignores these arguments, but they know them.  In fact, I found a quote from Toby Fiennes, their head of banking supervision, who correctly observed a few years ago that

some form of depositor protection arrangement may make it easier for the government of the day to impose a resolution such as OBR that does not involve taxpayer support – in effect the political “noise” from depositor voters is dealt with,” said Fiennes

As I’ve noted previously, in the last thirty years:

  • The BNZ was bailed out by the government
  • Finance company (and bank) deposits were guaranteed by the government
  • AMI was bailed out by the government
And each of those bailouts/protections was done on the advice of the Reserve Bank and Treasury.  Two were put in place by National governments and the other (the 2008 deposit guarantee scheme) was done with the support of the then National Opposition.
We have let other institutions fail, and creditors lose their money.  Wholesale creditors of DFC lost material amounts of money in that failure (the few retail creditors were protected, mostly for convenience in dealing with the main creditors), various finance companies failed before the guarantees were put in place, and one other insurance company failed after the Christchurch earthquakes and was not bailed out.   So our governments have a track record of being willing to allow people to lose their money when financial institutions fail, if the number of people involved is quite small, or the creditors are foreign. But they have no track record of being willing to allow large numbers of domestic depositors/policyholders to lose money in the event of a financial institution failing –  and it is not as if these examples are all ancient history; two were resolved under the current government.

And it is not as if governments in other advanced countries have been any more willing to allow retail depositors to lose money.  Most of our major banks are Australian-owned, and Australia has relatively recently adopted a deposit insurance scheme, reinforcing the longstanding statutory preferential claim Australian depositors have over the assets of Australian banks.  In the event of the failure of an Australian-owned banking group, why should we suppose voters here will tolerate losing large proportions of their deposits when they see their counterparts in Australia –  in the same banking group –  protected?    The Australian government  –  in the lead in resolving such a failure – is unlikely to be receptive to such a stance either, and if they can’t force us to protect our depositors, there are lots of strands to the trans-Tasman relationship, and ways of exerting pressure if our government did choose to make a stand.

A deposit insurance scheme heightens the chances of being able to use OBR, and thus to impose losses on wholesale creditors, many of whom will be foreign.

But it doesn’t guarantee it.   I noticed that Geof’s article included this paragraph

Since the global financial crisis, many countries, including New Zealand, have developed policies that enable even large bank failures to be handled in ways that minimise the prospect of a taxpayer bail-out, by forcing shareholders, then creditors (including depositors), to absorb losses.

I am less optimistic than Geof here.  Countries have been moving in the right direction, of trying to establish resolution mechanisms that would enable bank failures to occur without taxpayer bailouts, and in which large and wholesale creditors would face direct losses.  But none of these mechanisms has really been tested yet.  I’m yet to be convinced that the authorities in Britain or the US would be any more ready to let one of their major banks fail, with creditors bearing losses, than they were in 2008.

I’m reminded of a story Alan Bollard once told us about his time as Secretary to the Treasury. Faced with the prospect of Air New Zealand failing, the Prime Minister of the time asked if Treasury could guarantee that if Air New Zealand failed the koru would be still be flying the following week.  Unable to offer any such assurance, the government decided on a bailout.  Faced with the prospect of the failure of one of our larger banks, the Prime Minister might reasonably ask the Reserve Bank and Treasury whether they could assure him that, if he went ahead and allowed OBR to be imposed, other New Zealand banks and borrowers would still be able to tap the international markets the next week.  At best, officials could surely only offer an equivocal answer.  Bailouts remain likely for any major institution (especially as, in our case, resolution of any major bank involves two governments).

I hope I am too pessimistic in respect of wholesale creditors.  And we shouldn’t simply give up because there is a risk that governments might blanch and bail out the entire institution.  But the best chance of governments being willing to impose losses on larger creditors in the event of failure, is to recognize that the pressures to bailout retail depositors will be overwhelming, and to establish institutions that internalize the cost of that (overwhelmingly probable) choice.  A moderately well-run deposit insurance scheme does that, by imposing a levy on banks for the insurance offered to their depositors.

As Geof notes, he has changed his stance on deposit insurance.   Looking around the web, I stumbled on  “Deposit insurance: Should New Zealand adopt it and what role does it play in a bank failure” a 2005 paper, by Geof and one of his colleagues (now a senior manager at TSB) on deposit insurance, which has been released under the OIA.   It is a useful summary of some of the counter-arguments.

One of the issues it covers is the question  of whether, instead of adopting deposit insurance, we could achieve much the same outcome by using the de minimis provisions in the OBR scheme.  Under those provisions (built into the prepositioned software) deposits up to a certain designated amount can be fully protected, and not subject to the haircut.

As I’ve noted previously, this provision might be useful if it was only a few hundred dollars –  effectively, say, protecting the modest bank balance of a very low income earner or superannuitant, who needed each dollar of a week’s income to survive.  It might be tidier to have all these small balances protected than to have all these people turning to food banks. It might also keep down the ongoing administrative costs of the statutory management, by keeping many very small depositors out of the net   But the de minimis provisions are not a serious substitute for deposit insurance, on the sort of scale that it is typically offered at.  Any preference for very small depositors comes at the expense of the rest of the creditors.  That might be tolerable for small balances in a large institutions with lots of funding streams.    It is much less so in a bank that is largely retail funded, and quickly becomes impossible in such banks once the level of protection rises above basic weekly subsistence levels.  And, of course, no one knows what the de minimis level is, so the risk (facing other creditors) cannot be properly priced.  By contrast, a deposit insurance scheme can be set, at priced, at pre-specified credible levels.

If we were to establish a deposit insurance scheme in New Zealand, there are many operational details to work through.  One, of course, is the pricing regime.   In his article, Geof notes that

‘the cost is small –  no more than a small fraction of a percentage point per annum on each dollar of bank deposit”

I’m less convinced that that is the correct answer.  There is a market price for insuring against the risk of bank failure, and associated losses on debt instrument.  That is what credit default swaps are for.  Historically, in the decade or so prior to the crisis, premia on Australian bank CDSs were very low.  We used them in setting the price for the deposit guarantee scheme in 2008, and from memory they had averaged under 10 basis points.  That isn’t so any longer,  and for the last few years the average premium has been more like 100 basis points (fluctuating with global risk sentiment) –  nicely illustrated here. Bank supervisors would, no doubt, tell us that these premia far overstate the risk of loss –  and I would probably agree with them (and certainly did in 2008, when we used historical pricing) –  but it is the market price of insurance.  Is there a good reason why government deposit insurance funds should charge less?

It is time to adopt a deposit insurance scheme in New Zealand –  not, in my view, because people necessarily should be insulated against losses, but because governments will do so anyway.  In the face of such overwhelming pressures (and track record here and abroad) we are best to build institutions that help limit and manage that risk, and which charge people for the protection that governments are offering them, while making it clearer and more credible that others –  outside that net –  will be expected to bear losses in the event of a bank failure.

A question for Steven Joyce

Michael Reddell Immigration, New Zealand economic performance

A reader pointed me to an article on the NBR website in which Science and Innovation Minister [isn’t there something wrong when we even have a government “innovation minister?]  was quoted as telling a business audience yesterday that:

more migration is the only way to bridge the current skills gap for ICT companies in New Zealand.

and

“That’s one of the reasons I’m leery of calls to halt immigration – apart from the fact there’s not much reason to because of the economic gains,” he said.

In the last fifteen years, we have had huge waves of immigration,  under both governments, and yet there is not the slightest evidence of economic gains accruing to the New Zealand population as a whole.  Tradables sector production per capita has gone nowhere in fifteen years, productivity growth has been lousy, and there is no sign of any progress at all towards meeting Mr Joyce’s own government’s (well-intentioned but flawed) exports target.

And yet the Minister’s answer is even more immigration.

My simple question to Mr Joyce would be along the lines of “what evidence can the Minister point to suggesting that the very high rates of immigration to New Zealand in recent decades have done anything to lift productivity in New Zealand, or lift the average per capita incomes of New Zealanders?”.

MBIE officials and Ministers of Immigration talk of immigration as a “critical economic enabler”, but in the papers they released last year, there was nothing remotely akin to evidence that the programme has enabled anything very much –  we have a bigger New Zealand as a result, but no evidence that it is a richer or more economically successful one.  Mr Joyce and the other MBIE ministers have huge resources, staff and budgets, at their disposal.  Surely they should be able to point to clear demonstrated economic gains for New Zealanders as a whole from such a large government intervention.  Our non-citizen immigration programme is already one of the largest (per capita) in the world.  Citizens might reasonably ask for evidence that such an outlier programme has benefited them before considering calls from Ministers for “even more immigration”.

In the last 100 years of New Zealand economic policy history there has been a weird disinclination to trust New Zealanders and their ability to take on the world and succeed themselves.  The Labour Party from 1938 put in place huge protective barriers, as if we could only prosper by turning inwards and producing everything from tennis racquets, TVs, and cars here just for the domestic market.  It took decades to unwind that policy.  And for the last 25 years, National and Labour governments have seemed discontented with the New Zealand population, and the skills, energies and expertise of our own people, turning instead to large scale immigration programmes as some sort of enabler/transformer.  25 years on, there is no more evidence that this unfortunate experiment has been much more beneficial to New Zealand than the protective barriers of earlier decades (or for that matter the Think Big programme of an earlier rather-too-interventionist National government).

But perhaps Mr Joyce can point us to the evidence that guides his interventions?

Kiwibank: a retrograde step

Michael Reddell Banking, Privatisation

I wrote about Kiwibank last week, noting that there had never been a good economic reason for the Crown to have established it, and that there was not a good economic reason for the Crown to continue to own it.   Doing so undermines (modestly) the efficiency of the financial system, and poses unnecessary risks for taxpayers.

I take it that the Minister of Finance agrees.  Listening to him on Morning Report, unable to give any reason why the government should own a bank other than “it is government policy that we do so”, one almost felt a little sorry for him.  Then again, he is the Deputy Prime Minister.

What to make of yesterday’s announcement from New Zealand Post?  The plan is that NZ Post will sell 45 per cent of its stake in Kiwi Group Holdings (KGH) to ACC (20 per cent) and the New Zealand Superannuation Fund (25 per cent), at a price which values KGH at $1.1 billion.

In some ways, the price tells us what we need to know about Kiwibank.  The book value of shareholders’ equity in KGH as at 31 December 2015 was $1.304 billion, and yet the sale is going to go through at the equivalent of $1.1 billion (or perhaps lower if due diligence shows up some problems).   That is around 85 per cent of book value.

When I checked yesterday, the four Australian banks appeared to be trading on the stock exchange at anything from 1.2 to 2.1 times book value.  And the Reserve Bank of Australia ran this nice chart in their last Financial Stability Review

graph-1.17

Note where the Australian and Canadian banks have been trading.  By contrast, banks in much of the rest of the world, where there have been real doubts about asset quality or earnings potential have been trading at or below book value since the 2008/09 recession.

The deal also values KGH at eight times last year’s earnings ($137 million).  A quick check suggests that five listed Australian banks (the four operating here and the Bank of Queensland) are trading, on average, at prices around 11.5 times last year’s earnings.

Kiwibank just isn’t a very profitable bank.  Last week I showed this slightly-dated Treasury chart:

bank roa

But, of course, there are other reasons for a fairly low price:

  • Given the government’s determination not to privatize Kiwibank (even partially), there were no other possible takers.  ACC and NZSF no doubt knew that.
  • ACC and NZSF will, apparently, be locked in for the first five years (beyond the next two elections), unable to sell out, and yet without effective control (individually or jointly).  Some finance guru could no doubt value that (loss of) option, but I wouldn’t have thought it would be a trivial amount.

As Michael Cullen noted yesterday, if there had been a sale into private ownership it would have “almost certainly led to a higher price” for NZ Post.

At one level, the price of the transaction does not matter unduly, as all the buyers and sellers are ultimately owned by the New Zealand government.  In fact, the price should probably be the least of the worries.

The cleaner alternative approach to deal with Kiwibank (KGH) would have been for the government itself to have simply purchased KGH from NZ Post, and established KGH as a proper SOE, subject to proper SOE monitoring and accountability arrangements.  In the short-term, it would have made little or no difference to Kiwibank which option was chosen.  And it would have had the advantage of totally and immediately separating NZ Post and Kiwibank, enabling the directors and managers of NZ Post to focus solely on their troubled business.   But, of course, doing so would have involved immediate Crown cash outlays (to NZ Post, even if much of it came back shortly thereafter as a special dividend), while yesterday’s clever wheeze involves cash flowing into the Crown accounts (from those other government entities, ACC and NZSF) via the special dividend NZ Post will pay.  The cash flows don’t change the economic value to the overall Crown balance sheet.

Although the deal has been presented as making it easier for the owners to provide any future capital injections to Kiwibank that might be thought warranted (beyond what retained earnings –  the way most banks grow –  would allow), that isn’t an argument for the particular form of yesterday’s deal, as opposed to simply taking KGH directly into Crown ownership as an SOE.    After all, central government has considerably deeper pockets than either ACC or the NZSF.   At least on the basis of last year’s Annual Report, the proposed KGH investment (at $210m) will already be ACC’s largest single equity investment.

acc

It would also appear to be the largest equity holding for NZSF.  These don’t seem like organisations with sufficiently deep pockets that they would (or should anyway) be wanting much more exposure to a single entity, a minor (not overly financially successful) player in its own sector, than they will already have if this deal is completed.

I’m extremely wary of the state owning a bank, but if we are going to own it, I’d rather the question of any additional capital was being decided by the elected representatives of the owners, who we can kick out.

The deal has been presented by NZ Post as offering benefits to Kiwibank through the “long-term investment horizons” and “expertise” of ACC and NZSF investment managers.  For better or worse, the central government has actually tended to have a longer-term investment horizon than either institution (NZ Post in its current form was set up almost thirty years ago, the predecessor Post Office based bank ran under central government for well over 100 years).   And as for investment expertise, well, yes no doubt.  But Kiwibank is a retail bank, and neither ACC nor NZSF has any particular expertise in retail banking –  and nor would one expect, or want, them to (after all, as NZSF’s head of investment’s noted in last year’s Annual Report, NZSF is statutorily prohibited from having control of operational businesses).  Both ACC and NZSF are funds managers.  They seem to do that job moderately well (I’m much more skeptical of NZSF, but that is a topic for another day), through some mix of strategic asset allocation and tactical stock selection, but that isn’t the sort of expertise that helps generate a strong profitable retail bank.

Curiously, the sorts of expertise ACC or NZSF might have already seem rather well represented on the Kiwibank board, not one of whom has retail banking experience or apparent expertise.  Perhaps the Board will change under the new ownership, but why should we suppose that government funds such as ACC or NZSF will be better able to nominate suitable directors than NZ Post was (and in any case, for now NZ Post will retain the majority shareholding).

The paper-shuffling doesn’t have the feel of a long-term arrangement.  ACC, in particular, seems unlikely to be a natural holder of a 20 per cent stake in any company, and NZSF probably shouldn’t be.  A constant risk around NZSF has been that it would be used for political purposes: a large pool of money just waiting for people with “good ideas”  –  and a major ownership stake in a politically totemic, modestly performing,  bank is just an example of that sort of risk.

And so this deal has the feel of short-term opportunism.  Immediate cash inflows for the government rather than immediate cash outflows (with no difference in economic value between the two), and a way of making it perhaps just a little easier to privatize the bank if political conditions were to change.  No doubt for now, if ACC and NZSF wanted out, the Crown would repurchase the shares.  But if the political winds change a little, then, for example, the five year minimum holding periods could be waived if it suited the Crown to do so, and it might be rather easier for NZSF and ACC to dribble their shares out into private institutional hands gradually, at one remove from the decisions of politicians, than for politicians to choose a trade sale, or even a modest IPO.

I favour privatization, but also favour good government, and clear transparent lines of accountability.  This deal doesn’t look the way we should be running things.  We have a fairly good framework for Crown-owned operating businesses, the State-Owned Enterprises Act.  It should be used for Kiwibank (and KGH) and when the time comes the debate around privatization, partial or full, should be had directly and openly, between politicians, and citizens (as was done with the power companies, and all past privatisations), not by reshuffling holdings of major Crown assets into arms-lengths agencies that can offer little or nothing new to Kiwibank, and face neither market discipline, or effective public accountability themselves (indeed, in the case of NZSF, that lack of effective political accountability was the whole point of the governance structure).

Having said that the SOE Act has been a pretty good framework over 30 years for governing Crown-owned operating businesses, I was somewhat disconcerted to note yesterday how politicized the NZ Post press statement was.    The statement from Bill English and Todd McLay headed “Kiwibank to remain 100 per cent Govt owned” was fairly factual and descriptive in nature.   Michael Cullen’s statement, by contrast, was considerably more rhetorical: “Stronger circle of Crown owners proposed for Kiwibank”,  “these two Crown investors –  both essential parts of the New Zealand fabric”, “time to broaden the bank’s support base within the wider public sector”, “a rare opportunity”.      (Mind you, where the NZ Post statement really overstepped the mark for me was when they compared assets under management at ACC ($32bn) and NZSF ($28bn) with the sum of assets and liabilities of Kiwibank ($38 billion).  I’ve never heard anyone previously refer to the size of a bank by adding together than assets and liabilities.)

Overall, it seems like an unstable model (perhaps deliberately so).  We have a small underperforming bank that will be owned by three government owners, instead of one, none with any great expertise in the business the bank is actually undertaking.  One will still have effective control, but less so than previously.  And if things go wrong, no one of the direct shareholding parties will be able to call the shots to sort things out, and the risks are likely to fall back on central government anyway.

UPDATE: My unease has just been increased reading these comments from Bill English on the ending of the NZ Post guarantee.

“It wasn’t really an effective guarantee, but now that’s been replaced by an arrangement where the Government underwrites any capital requirements related to the bank coming under pressure,” he said.

“That’s yet to be finalised in detail, but there’ll be a capital facility there so that depositors know that if anything went wrong with Kiwibank then the Government is able to stand behind it,” he said.

“It’s a capital facility. It’s not like a deposit guarantee because in New Zealand we don’t have deposit guarantees, but it is a facility that Kiwibank can call on if in extreme circumstances it needed to repair its capitalisation,” he said.

Perhaps it just makes explicit the reality, and we will need to see the details (will this facility be priced?).  Better to have a properly priced deposit insurance scheme across the entire system, and get the state out of owning –  or underwriting the equity of – banks.

 

Productivity: where do we now stand?

Michael Reddell New Zealand economic history, New Zealand economic performance

This post is mostly a brief follow-up to yesterday’s, with its comparisons between the performances of Uruguay and New Zealand.  I concluded that post noting that it wasn’t obvious what would prevent our continued slow relative decline.

Comparisons of material living standards across time and across countries are fraught with measurement problems.  No one seriously questions that 100 years ago we had some of the very highest material living standards, and equally no one really questions that we are long way off that mark now (some want to focus instead on wellbeing indicators: that is a topic for another day, but a country that has as many of its own people leaving as New Zealand has had shouldn’t be seeking to rest on any sorts of laurels).

Historical estimates are fairly imprecise, and only available for a small number of variables (typically GDP per capita). For more recent periods, we have much more, and better-measured, data –  although always less than researchers and analysts might want – but even then we face problems in comparing outcomes from country to country.  All of which suggests one shouldn’t put much weight on small differences – they might just represent imprecise measurement and translation.

The most common comparative metric is still GDP per capita.  It has all sorts of problems, but one in particular is that there is huge variation across countries in how many hours the population works on average.  If people in one country on average work twice as many hours as those in another country then, all else equal, the people in the first country will have higher incomes.  That provides greater consumption opportunities, but isn’t much of a reflection of the productivity levels being achieved by firms in the countries concerned.  For that, the best indicator that is reasonably widely available is GDP per hour worked. It is also much less affected by business cycles than GDP per capita.  For international comparisons, one needs to convert the various estimates into a common currency, not at market exchange rates but at (estimated) purchasing power parity exchange rates.

For many countries there are no worthwhile estimates of GDP per hour worked.  But the OECD has data for all its member countries (and a few others) and the Conference Board produces estimates for a wider range of countries, going back a little further in history. For the most recent years, they now have estimates for 68 countries.   Here is a (long) chart of the 2014 estimates.

real gdp phw 2014 levels

I’ve highlighted New Zealand and the countries estimated to have had GDP per hour worked 10 per cent either side of us.  That range both recognizes the inevitable measurement imprecision, but also highlights the countries that have a broadly similar level of labour productivity to our own.   It is a mixed bag: Cyprus, Japan, Slovenia, Slovakia, Malta, Israel, Greece.  But none were ever –  well, perhaps not for a couple thousand years in Greece’s case –  world leaders.  (I haven’t shown the OECD version but the rankings are similar –  and Cyprus and Malta aren’t in the OECD).

If the New Zealand numbers are not perhaps quite “middle income” country levels yet, they seem uncomfortably close to them.  And they are a huge distance behind those (mostly Northern European) top-tier countries,  from Belgium to Switzerland.

If it had always been so, that might be one thing.  Many of the middling countries have always been middling countries.  But we weren’t.  GDP per capita isn’t GDP per hour worked, but it is fairly safe to assume that our productivity levels 100 years ago would have been among the highest in the world.  And much more recently than that, the Conference Board has estimates for a reasonable range of advanced and emerging countries going back decades.

real gdp phw 1960

By 1960, New Zealand experts were already writing serious reports on our disappointing productivity growth performance.   But then only United States and Venezuela (all that oil) were estimated to have had GDP per hour worked more than 10 per cent higher than New Zealand.  In the space of less than one lifetime –  and this is more or less my lifetime –  our productivity levels have gone from still among the best in world, to lost among the rest.  These sorts of declines aren’t normal phenomena.   They typically happen when countries mess themselves up badly –  think of Venezuela or Argentina, or even Zimbabwe.  And, critical as I am of economic policymaking in New Zealand over 50 years, we’ve been a moderately well-functioning country (stable democracy, rule of law etc).

It isn’t that nothing has been done in response to our decline.  We stopped doing a lot of what a commenter yesterday aptly called “dumb stuff” –  the protection and subsidies that shaped our economy from the late 1930s to the 1980s.  But we’ve done our share of other dumb stuff –  all well-intentioned.  The Think Big energy projects of the 1980s were an example.  I class throwing open the immigration doors again 25 years ago in that same category –  a new Think Big.  A catastrophic decline in relative productivity here was, surely, a signal for resources to go elsewhere –  and New Zealanders responded to that signal en masse (as, within New Zealand, people have moved away from places –  perfectly pleasant places – like Invercargill, Wanganui, or Taihape as the relative returns have changed).    So what possesses our bureaucratic and political elites to think that a path back to prosperity and higher productivity involved searching out and bringing lots and lots more people?  If it was perhaps a pardonable error 25 years ago, it is an inexcusable policy failure now.

And then there are the totally flaky ideas that never actually amount to much: turning New Zealand into a financial services hub, R&D subsidies, becoming rich on back of wealthy Europeans fleeing terrorism, and so on.  And if that looks like a criticism of the current Prime Minister, he isn’t obviously worse – more practically indifferent to the real issues –  than his predecessors, or his potential successors.  I watched Q&A interviews with James Shaw and Andrew Little at the weekend, and there was nothing there which gave me any hope that our political leaders even care much any more about our precipitous decline.  Bank-bashing seemed easier no doubt.

We can’t, and shouldn’t try, to turn back the clock to 1910, or even (worse) 1960.   But we shouldn’t lose sight of what we once had here, or give up believing that we can produce incomes for our people once again as good as those almost anywhere in the world.  Governments don’t make countries rich –  firms and individuals, ideas and opportunities do that –  but governments can stand in the way.    I’ve been asked a few times in the last few days what policy remedies I’d suggest.  There are lots of smaller issues, but here are my big three:

  • Stop bringing in anywhere near as many non-New Zealand migrants.  At a third of our current target for residence approvals, we’d still have about the same rate of legal migration as the United States.
  • Stop taxing business income anywhere near so heavily.  We need more business investment to have any hope of reversing our decline, and heavy taxes on returns to investment aren’t the way to get more of it.  The tax system should rely more on consumption taxes.
  • Stop stopping people using their own land to build (low rise) houses, pretty much as and where they like.

It is a mix that would produce lower real interest rates (relative to the rest of the world), a lower real exchange rate, a lower cost of capital, lower population growth, and lower house prices.  Plenty more innovative outward-oriented New Zealand firms –  I heard Steven Joyce talking about them on the radio this morning –  would find that a rewarding climate to invest and export, supporting better productivity and income prospects for all of us.  Will we match Belgium, the US, and Ireland (see first chart)?  Well, perhaps not, but who knows –  for all our locational disadvantages, we do plenty of things better than those countries.  But we certainly really  should be able to do much better than Cyprus, Malta, Slovenia and Greece, if we are willing to take the issue, and challenge, seriously.

 

 

Big banking systems and house prices

Michael Reddell Banking, Housing

On Saturday afternoon I found myself in an email exchange with a couple of people about how the composition of bank lending had changed since 1984.  I wasn’t quite sure where the table I was responding to had come from, but when I eventually got to the business section of Saturday’s Herald I found the answer.  Brian Gaynor had devoted his column to a discussion of the changing significance of banks in recent decades, portentously headed  “Banks’ long shadow over New Zealand economy”.   I found myself agreeing with almost none of his interpretation.

My alternative story has two key strands:

  • the institutions we label “banks’ have become more important in the financial system as the incredible morass of restrictions built up since the days of Walter Nash were removed, first (too) slowly, and then in a great rush over 1984/85.  That has allowed the financial system to become much more efficient.  Financial intermediation is now undertaken mostly by those best placed to do it, rather than increasingly by those either subsidized by the government to do it, or just outside the network of controls and so still free to do it.
  • total credit to GDP (and especially the housing component) has risen mostly because of regulatory restrictions on building and, in particular, on urban land use. Higher housing credit is mostly an endogenous response to this policy-created scarcity.

There are all sorts of caveats to the story.  In some respects, banks are much more heavily and directly regulated now than they have ever been (and that burden is only getting heavier with LVR controls which threaten a new wave of disintermediation).  The “too big to fail” problem probably skews things a little too far towards banks (but adequately price deposit insurance and banks will still remain dominant), and at times banks get over-enthusiastic about increasing lending to particular sector and sub-sectors.  But, fundamentally, the rising importance of banks (relative to other intermediaries) has been a good thing not a bad one, and if one might reasonably be ambivalent or even concerned about the rise in household credit, that has been an almost inevitable consequence of artificial shortages created by central and local government.  Given the determination of our leaders to mess up urban land supply, in a country with a fast rising population, it would have happened in one form or another, and it is better that it has been done by efficient intermediaries.  Concerns should be addressed to central and local government politicians who keep the housing supply market dysfunctional, not to bankers.

At this remove, it is probably hard for many to appreciate quite what the New Zealand financial system was like in the heavily regulated decades.  Old New Zealand Official Yearbooks will give a good flavour, and the Reserve Bank published in 1983 a 2nd edition of its Monetary Policy and the New Zealand Financial System, which has lots of detail (the 3rd edition is a quite different book –  a weird confusion, which I take responsibility for).

In addition to the Reserve Bank  –  which lent, not just to its staff, but also to the major agricultural marketing bodies –  we had:

  • trading banks (each established by statute, with no new entrants for many decades)
  • private savings banks (savings banks subsidiaries of the trading banks, introduced in the early days of deregulation in the 1960s)
  • trustee savings banks (a different one in each region, some large and strong, some tiny)
  • the Post Office Savings Bank
  • the Housing Corporation (government mortgage finance)
  • the Rural Banking and Finance Corporation (govt rural finance)
  • the short-term official money market
  • finance companies
  • the PSIS
  • building societies (terminating and permanent)
  • life insurance and pension funds (large and fast-growing supported by a tax regime, and fairly large lenders)
  • the Development Finance Corporation
  • stock and station agents

And that was just the institutional entities –  almost all with different statutory and regulatory powers and restrictions.  And there was a very large non-institutional market in finance –  notably, the role of solicitors’ nominee companies in mortgage finance.

Trading banks had never been dominant providers of finance in New Zealand –  since they had not historically provided mortgage finance, whether to farmers or for households –  but even in their role as providers of, typically, short-term finance to business, they had been withering (under the burden of regulatory restrictions) for decades. As the Reserve Bank noted in its 1983 book, “trading bank loans and investments have fallen from being around 50 per cent of GNP in 1930 to around 25 per cent of GNP in 1981”.    As far as I can tell –  it was my impression back then, when writing an honours thesis on the disintermediation process, and it is my impression now –  that the only people who benefited from this state of affairs were the people running the entities subject to a lighter burden of regulation.  My schooling was mercifully free of so-called “financial literacy” education, but the one message I recall being drummed in repeatedly (reinforcing the one from my father) was that it was very difficult to get a mortgage, and one had to spend years building a track record that might allow one to go, on bended knee, to a lender, seeking as a special favour access to such credit.  But if you were on a lower income, the state would provide.  Alternatively, coming from a well-off family, or getting a job in an organization with concessional staff mortgages, was the way to go.  (Reserve Bank concessional loans were very good, although in the end I had one for only 2 months.)

Gaynor quotes statistics showing that trading bank housing lending was 14 per cent of total lending in 1984 and is 52 per cent now.  But look who did housing lending back then.  This chart is drawn from the 1984 New Zealand Official Yearbook, and shows the flow of new mortgages (on properties less than 2 hectares, so largely excluding farm mortgages) in the year to 31 March 1983.

mortgages 1983

Trading banks barely figure at all (and this includes their private savings bank loans, and loans to staff).  Most mortgages by then were being made through the Housing Corporation, within families, or through solicitors’ nominee companies.  Neither of the latter two offered much diversification, a key way of making available affordable finance.  Call me a relic of the 1980s if you like, but I count it as huge step forward that large and efficient private sector entities are now the main vehicle for residential mortgage finance.

I mostly want to focus on housing lending, but Gaynor also notes in support of his case

The first point to note is the huge fall in lending to the manufacturing sector, from 24.5 per cent of total bank lending 30 years ago to only 2.8 per cent at present. This reflects the deregulation and demise of manufacturing, which was also the result of policy initiatives by Sir Roger Douglas and the fourth Labour Government.

Yes, the relative importance of the manufacturing sector in the economy has shrunk –  perhaps more than it would have in a better-performing economy  –  but by my calculations drawn from Gaynor’s table, trading bank lending to manufacturing ($1.6 bn) was around 3.5 per cent of GDP in 1984 and at $11.4 bn is around 5 per cent of GDP now.  Across all the financial intermediaries that existed in 1984, the share would have been higher, but the overall picture is a quite different one from that Gaynor paints.

But what about housing lending?   Gaynor asserts that

The clear conclusion from this is that anyone who bought a house in the early 1980s has been extremely fortunate because aggressive bank lending has been a major contributor to the sustained rise in house prices over the past few decades.

Since 1980/81 was the trough of a very deep fall in real house prices, there is no doubt that it was an ideal time to have bought.  And there is also no doubt that there has been an aggressive (and almost entirely desirable) process of re-intermediation.  Some entities that weren’t trading banks became trading banks (or ‘registered banks’ as we now know them) – think of Heartland, SBS, ASB, PSIS –  or were directly purchased by banks (think of the United or Countrywide building societies, or Trustbank or Postbank), and in other cases banks just won market share away from other participants in the market (no need for a solicitor’s second or third flat (short-term interest only) mortgage when you could get a 80 per cent table first mortgage at the local bank branch).

But is there any evidence that “aggressive lending” by the financial sector (now mostly ‘banks’) has been a “major contributor” to the huge rise in real house prices in recent decades?    I think the evidence is against that claim.  Why?

First, “aggressive lending” usually ends badly.  It did for the banks when they lent on the massive commercial property and equity boom post-1984.   It did for the finance companies with aggressive property development lending in the years up to 2007.  It did for the banks with dairy lending (both in 2008/09 with a surge in NPLs and perhaps again now –  going even by the Reserve Bank’s own stress test).  Housing lending, by contrast, has not ended badly, even though the push by banks into housing lending has been going on now for more than 25 years, through several economic cycles and one very nasty recession.  It is easy to say “just wait”, but history is strongly against that proposition.  Inappropriately aggressive lending goes wrong much faster than that.

Second, while the lending terms of banks have become easier than they were 25 years ago –  when banks were just finding their way in this new market for them, and nominal interest rates were still extraordinarily high – they are not noticeably looser (at least in asset-based terms) than the terms applied by other housing lenders in earlier decades. 80 or 90 per cent 30 year mortgages from the Housing Corporation weren’t uncommon (or inappropriate for a young couple with decades of servicing capacity ahead).  Banks, including the Reserve Bank, had long lent those sort of proportions to their own staff.  And, on the other hand, we have not had any material amount of mortgage business written with LVRs above 100 per cent, or with terms of 100 years or beyond (things seen in various European markets at times).  Overall, credit conditions are probably easier than they were, but not in way that is self-evidently inappropriate or overly risky for either borrowers or lenders.  The Reserve Bank’s housing stress test backs that conclusion  – taking account of the joint risk of losses in asset values, and losses in servinig capacity (if unemployment were to rise sharply).

Third, there is a simpler explanation for high house and urban land prices.  Regulatory land use restrictions combined with population pressures (including policy-driven immigration ones) are a more persuasive story, including in explaining why house prices in Auckland have increased so much more than those elsewhere.  In New Zealand we have only one fairly large city, but think of the situation in the United States: there is a fairly unified financial system (albeit with some state level differentiation in restrictions) and yet we find huge increases in house prices in places like San Francisco (with tight land use and building restrictions) and very modest real increases in large and growing places such as Houston, Atlanta, Nashville and so on.  High house prices, and high house price to income ratios, are not an inevitable feature of a liberalized financial system.  They aren’t an inevitable feature of tight land use restrictions either, but the correlation across cities is pretty good.

demogrpahia 2016And if finance were primarily responsible, finance would also have brought forth lots of new supply.  That is way markets work –  it is part of the reason why credit-driven booms don’t last that long.  Instead, prices have been bid up largely as a result of regulatory constraints: there are not consistently excess profits lying around that developers can readily take advantage of.

Of course, higher house prices typically mean that buyers of houses need more credit than they otherwise did.  If house prices suddenly double because some regulatory change makes land scarcer, then with incomes unchanged either people can wait (much) longer to buy, saving a larger deposit, or they can borrow more to complete the purchase.  If the people who wanted to buy, but are reluctant to take on more debt, do hold back, someone else will buy the property.  And that person will need finance –  either debt or equity.  If banks are reluctant to lend on houses, then houses will tend to be owned by people who are least dependent on debt: those with large amounts of established wealth already.  All else equal, since few people get into the owner-occupied housing market without debt, that would be a recipe for even larger falls in owner-occupation rates than we have already seen.

Much of the overall increase in housing debt in New Zealand (and other similar countries) in recent decades has been the endogenous response to the higher house prices, rather than some independent factor driving up prices.  And these forces take a long time to play out.

In the chart below I’ve done a very simple exercise.  I’ve assumed that at the start of the exercise, housing debt is 50 per cent of income, house prices and incomes are flat, and people repay mortgages evenly over 25 years.  Only a minority of houses is traded each year, but each year the new purchasers take on new debt just enough to balance the repayments across the entire mortgage book.

And then a shock happens –  call it tighter land use regulation –  the impact of which is instantly recognized, and house prices double as a result.  Following that shock, house purchasers also double the amount of debt they take on with each purchase, while the (now rising) stock of debt continues to be repaid in equal installments over 25 years.

In this scenario remember, house prices rose only in year 1.  There is no subsequent increase in house prices or incomes.  But this is what happens to the debt to income ratio:

debt to income scenario

In this particular scenario, 100 years after the initial doubling in house prices, the debt to income ratio is still rising, solely as a result of the initial shock, converging (ever so slowly by then) to the new steady-state level of 1.  One could play around with the parameters, but a permanently higher level of real house prices will, in almost any of them, produce a permanently higher level of gross housing debt, and it will take many years to get to that new level.  The flipside, which I could also show, is the deposit balances of the other parts of the household sectors – the young who have to save for a higher deposit (even for a constant LVR) and the older cohorts who extract more money from the housing market when they downsize or exit the market.  Higher house prices do not, of themselves, require banks to raise more funding offshore.

This is deliberately highly-stylized, but it is designed to illustrate just two main points: higher debt ratios can be primarily a symptom of higher house prices (rather than any sort of cause) and the adjustment upwards in debt levels following an upward house price movement can take many years to work through.    And there is one more important point: this a process that mostly reallocates deposits and credit among participants in the housing market: it needn’t materially affect the availability of credit, or economic opportunities, in the rest of the economy.

None of which is to suggest that higher house prices, as a result of some combination of regulatory measures (eg land use restrictions and high non-citizen immigration), are matters of indifference.    They have appalling distributional consequences, and prevent the housing supply market working remotely efficiently.   But the banks aren’t the people to blame: that blame should be sheeted home, constantly, to the politicians responsible for the regulatory distortions.   We get bigger banks as a result –  more gross credit has to be distributed from one group in society to another –  but if we are going to mess up the housing and land supply markets, bigger banks are almost an inevitable, perhaps even second-best desirable, outcome. The alternative would be whole new waves of disintermediation, and a housing stock ending up (even more) increasingly owned by those not dependent on debt.

The preferable path would be one in which land use restrictions were substantially removed, and house and urban land prices once again reflected market economic factors rather than regulatory impositions.  That would be a path towards smaller banks –  but just as in my chart above, the adjustment would take many years.

Governance of the Reserve Bank: an inadequate release

Michael Reddell Governance

Just before the Easter break last week, the Reserve Bank partially reversed its position and released a few papers on the work it had been doing on possible reforms to the governance of the Reserve Bank.  I made some initial comments on that change of stance here, including noting that citing an Associate Minister’s response to an Opposition MP’s supplementary question in the House six months ago as the basis for a change of heart now was singularly unconvincing.

I’ve now had a chance to read the papers the Bank has released.  Having done so, I’m more puzzled than I was before.  Perhaps they are hoping for some brownie points for a slightly greater degree of openness than previously?  But as the project has come to an end, something rightly lamented by The Treasury, and the government has made clear that it has no intention of reforming the governance of the Reserve Bank, there should be no basis for withholding almost anything from the work done, and the advice submitted, on possible reforms to the governance of the Bank. It is official information, and there is a statutory presumption in favour of release.  It should, among other things, be a useful contribution to outsiders’ thinking on these issues.

The Bank has released a grand total of six papers.  Four are released with no omissions, one has a handful of short omissions (on “free and frank” grounds) and one omits a paragraph on another matter altogether.     In other words, processing the request for these particular papers will have taken no time at all.  And yet it took two months to refuse the initial request, and six months after the Associate Minister’s comments to release this handful of papers.  Not exactly a sign of an organization with a commitment to openness, transparency, not to speak of compliance with the law.    Now the Reserve Bank may claim – as it did back in July – that their initial (no doubt very coarse) filter produced 9000 documents inside the scope of my request.  I’m sure there are nothing like that number, but most of what is in scope has still been withheld.

What have they released?

The first paper is a descriptive note, dated 11 May 2014, by one of the young analysts in the Economics Department on “Governance arrangements: decision making committees”. It is a mildly interesting piece, with some discussion of arrangements in other countries.  It has a couple of paragraphs on decision making in other sorts of bodies, but why the author chose local councils (which are wholly elected) and DHBs (generally regarded as having one of the less satisfactory governance models in the New Zealand public sector), rather than (say) central government Crown entities such as the FMA or NZQA or EQC is beyond me.

The second paper, dated 25 June 2014, is a brief note, also from one of the teams in the Economics Department, to the Governing Committee identifying “Sections of the RBNZ Act subject to revision with a change in decision-making framework”.   There is little of note there, although it is consistent with the Governor’s apparent preference for a minimalistic reform (legislating  the role of the Governing Committee in setting the OCR).  There is no sign of the authors having stood back and thought about the larger issues of institutional design and governance.

The third paper, dated 4 July 2014, also to the Governing Committee from Economics Department staff, is headed “Best practice structure and governance of central bank decision-making committees”.  They are obviously a bit uneasy about the “best practice” description, because in a note with three pages of text and one table, the released version of the document has repeated four times the following inscription “Please note that the “best practice” referred to in this paper is as per the literature (specifically Blinder), and not subjective opinion of the paper’s authors”.    Weirdly, in a paper on (Alan Blinder’s “subjective” view of) “best practice” central bank governance, there is no sign that the authors recognize that our central bank is responsible for rather more than just monetary policy.    It isn’t an example of best practice policy analysis or advice.

The fourth document is an email to Gabs Makhlouf and Graeme Wheeler, dated 17 September 2014,  from Simon Duncan, a Treasury secondee in Bill English’s office.  It is a follow-up to a meeting Wheeler and Makhlouf had held with English a couple of days earlier.  The relevant paragraph is as follows:

On the Governance paper, I read that as the Minister being generally comfortable with the proposal as long as his concerns around the Committee model not embedding a strong independence culture on the financial stability side were addressed.  Opening up the RBNZ Act would be contingent on the political landscape following the election.

Which is interesting on a number of counts.

First, by September 2014 there was a specific proposal that had been put to the Minister, not (apparently) just orally but in the form of “the Governance paper”.    The Minister was apparently generally happy with whatever this proposal was.     And yet none of the material has been released, even though it would all have been within the scope of my request.  I’m at something of a loss to understand what anyone has to hide at this late date, when the project has been terminated.  And if the Governor simply does not want his proposal (or the supporting analysis) to get wider public scrutiny, that isn’t a good reason, in law let alone good governance in an open democracy.

But the email is also interesting because it highlights the ongoing tensions between the Bank on the one hand, and the Minister and Treasury on the other hand, around just how much autonomy the Reserve Bank should have in setting financial regulatory policy.   Our Reserve Bank has an (internationally) unusual degree of autonomy on that front, with very little effective accountability, and any suggestion that the powers should move from the Governor (who at least the Minister has some say in appointing) to an internal committee, dominated by people appointed by the Governor, would further (and inappropriately in my view) weaken the Minister’s relative position.

The fifth document released is by Dean Ford, a manager in the Economics Department, dated 15 October 2014 and is “Terms of reference: Moving to committee decision making at the Reserve Bank”   It is the terms of reference for a “joint Treasury/Reserve Bank work program” on these issues.  It is a working level group of named Treasury and Reserve Bank officials, designed to lead to “a common understanding of the advantages and disadvantages of the various committee design features”.  The intention was to host various roundtable discussions (I went to several of these) as a prelude to advancing the work “aiming to produce material suitable for briefing the Minister of Finance and Cabinet, and subject to Cabinet agreement, moving the project through the parliamentary process.  This could include material for select committee or public release”.

But, reflecting those longstanding tensions over the governance of the financial regulatory functions, this working group (wholly composed of Economics Department people from the Bank side) was supposed to focus on monetary policy where “initial discussions  … revealed many areas of agreement”.  Not so much on “financial policy”.   But “to allow the insights from the work to be more easily applied to financial policy when we reach that point, it will be necessary for the project team to understand how the Bank’s policy roles fit together”.  Indeed, one might have supposed that reaching that understanding was a precondition to taking a view on the appropriate governance model for any of the Bank’s major functions.  There are important differences of view, in international practice and in the literature, on to what extent the sorts of functions our Reserve Bank undertakes should be governed jointly or separately (or with overlaps).

The final document they released is an internal memo, dated 4 December 2014, and just addressed to one of the teams in the Economics Department, on “Central bank decision making committee design” , is no more than a (slightly abbreviated) version of the 4 July 2014 paper discussed above.

My presumption is that not too long after this the Minister of Finance told the Governor that he was no longer interested in pursuing governance reforms, perhaps particularly not along the lines the Governor was proposing.  This is consistent with the fact that (a) there is no reference to governance reforms work in the Minister’s letter of expectation to the Governor dated 2 March 2015, and (b) that the Treasury’s advice to the Minister of Finance on the Reserve Bank’s draft 2015 Statement of Intent, dated 5 June 2015, noted that the governance workstream had been discontinued.

Significant amounts of public resources were used to undertake the Bank’s work on possible governance reforms.  If the quality of the analysis they’ve released is fairly disappointing, at least this material makes clear that plans were fairly well-advanced.  And yet the Reserve Bank refuses to release the paper that must have gone to the Minister on these issues in September 2014  or anything of the work that was done after the Treasury/Reserve Bank working party was set up.

When the Bank originally withheld everything I requested they invoked a laundry list of excuses, including these two provisions of the OIA

9(2)(d) to protect the substantial economic interests of New Zealand.

9(2)(f)(iv) – to maintain the constitutional conventions for the time being which protect the confidentiality of advice tendered by Ministers of the Crown and officials.

The first excuse was always laughable, and has now disappeared.  But I was also interested that they are no longer invoking 9(2)(f)(iv).  In which case, why can we not see the advice the Bank did tender to the Minister on governance issues, and file notes of any discussions with the Minister on these issues?

It just isn’t good enough, but sadly it is par for the course with the Reserve Bank –  an organization in which the culture of secrecy has unfortunately become ingrained, beyond what is helpful, appropriate, or lawful.

In this case, it is doubly unfortunate because almost everyone –  perhaps with the exception of the current Minister –  thinks that changes should be made to the governance of the Reserve Bank.  Market economists canvassed by Treasury thought so, the Treasury itself thinks so, the Governor thinks so (unlike his predecessor who was strongly committed to the current model), Opposition parties appear to think so (the Greens certainly).

We have a system that was set up 27 years ago which (a)  doesn’t adequately deal with the range of issues the Bank is now responsible for, and actively wielding power over, (b) is out of step with international practice for monetary policy and financial regulation, and (c) is out of step with how we run other central government autonomous agencies in New Zealand.    Reasonable people can differ, perhaps quite strongly, on what the best alternative model might be. Personally, I think the Governor’s own preference is not at all the right response, and I laid out my alternative model here, but these are issues where we need good quality analysis from a range of perspectives, and some considered debate and discussion drawing not just on bureaucrats (inevitably skewed towards insider models) but on external analysts and, indeed, politicians.     These debates shouldn’t be about individuals –  Don Brash, Alan Bollard, Graeme Wheeler and any successors will all no doubt have strengths and weaknesses, and none walk on water –  but about the best institutional design for the governance of these important functions in New Zealand for the next few decades.  Openness on the analysis and advice already tendered would (should?) be a useful step to advancing the necessary discussion and debate.

 

 

 

Kiwibank

Michael Reddell Banking, Privatisation

I’m still puzzling over the academic who told Radio New Zealand’s listeners yesterday that he didn’t agree with me that New Zealand was remote: “we are, after all, in the middle of this great ocean, the Pacific”.    I keep looking at the globe, conscious that perhaps I have a eurocentric view of the world, but….we still look about as remote as they come.  And it is a sort of remoteness which, historically, hasn’t been conducive to really high levels of economic performance for lots of people (see Tristan de Cunha, St Helena, Bouvet, and even Samoa, Kiribati, or Fiji).  Henry Kissinger is reported to have described Chile as “a dagger pointed at the heart of Antarctica”.  Much the same could be said of New Zealand, one of the Antarctic Rim countries.

But, on another topic, I noticed that Kiwibank and NZ Post were in the news this morning.

Late last week, Radio Live was reporting a story that Kiwibank was being prepared for sale, and they asked for my thoughts on that.  That interview is here.

There was never a good economic case for setting up Kiwibank.  Our banking market was, and is, pretty competitive, and there were few material regulatory barriers to new entrants.  And the historical track record, here and abroad, is that government-owned banks are more prone to getting into costly trouble than private-owned banks (and some of them cause quite enough trouble).  In a modern New Zealand context, think of the Bank of New Zealand, DFC, and the (different sort of case of the) Rural Bank.  Overseas, examples abound.

But, of course, the case for Kiwibank was never mostly about economics.  It was mostly about nationalism, and some mix of political product differentiation and the political circle turning. Jim Anderton has resigned from the Labour Party in 1989, having been suspended from Labour’s caucus when he refused to vote for the sale of the Bank of New Zealand (then still predominantly government-owned).   And now Jim Anderton was back, as Deputy Prime Minister in a Labour-Alliance government.  Not only could the government own businesses, but it could –  so it was claimed –  build good new ones.  This speech by Jim Anderton captures the flavour.  This centre-left government would be different from its predecessor, and the establishment of Kiwibank would be one important marker of that difference.

The Reserve Bank and (more importantly) Treasury opposed the establishment of Kiwibank.   There weren’t obvious gaps in the market that other new entrants couldn’t fill, and establishing any new business is risky.

The National Party opposed the establishment of Kiwibank, but has never been willing to commit to selling it (in full or in part), even when Don Brash was leader in the 2005 election.

The actual track record of Kiwibank has been less bad than many of the opponents feared.  NZ Post was able to recruit some capable people who have built a reasonably substantial bank, that now has around $19 billion of assets.  Kiwibank grew very rapidly in its early years, and when institutions –  especially new entrants –  grow rapidly, it is wise to worry about the credit standards: it is most easy to write loans to people whom other lenders are reluctant to lend to.  Kiwibank had a few ill-judged forays into particular market segments, but appears to have built a reasonably self-sustaining bank, which came through the recession of 2008/09 with little more damage than the larger banks sustained.   My own reaction to that record was that, as taxpayers, we should be thankful for small mercies, and take the opportunity to sell before something went wrong.

But it has never been quite clear how much money Kiwibank has really made, and in particular whether it has ever sustainably succeeded in covering the cost of the taxpayers’ capital invested (and reinvested) in the bank.  Banking is a highly leveraged business, and since the government’s finances are already heavily directly exposed to the overall health of the New Zealand economy, there were no obvious diversification gains for it in establishing a bank in New Zealand.  We needed a good rate of return to justify the risk.

One of the reasons it has never been clear just how profitable Kiwibank has been is that Kiwibank and its parent NZ Post were intertwined, operating (most obviously) from the same physical locations.  During the early years in particular, there was a lot of incentive for NZ Post (with its government appointed Board) to help ensure that Kiwibank was a success, and to err in favour of Kiwibank in any allocation of costs or charging for shared services.  I got involved with these issues briefly in my time at Treasury and even then it seemed impossible for outsiders to know whether costs were being allocated appropriately.  Several years on one might have hoped all these issues were adequately resolved, so I was a little surprised to see this comment from Bill English in the Herald this morning.

He said there had been discussions over whether NZ Post was subsidising Kiwibank.

“Certainly through the start-up phase it has been but NZ Post can’t afford to keep cross-subsidising the bank,” he said.

Which doesn’t give one a great deal of confidence that, even over the last few years, the Kiwibank accounts give a full representation of the returns from a standalone banking business.  I don’t read the literature as suggesting that the economies of scale in retail banking are huge (so a small bank could be profitable) –  and we have both big and small banks co-existing in the New Zealand market –  but I doubt it could be shown that Kiwibank had been a good investment for the taxpayer.  Fortunately, it hasn’t been a disastrous one.

So I’d be all in favour of Kiwibank being sold.  There is just no good reason for the government to be involved in the business of retail banking.  Even today, the barriers to new private sector entrants are quite low, and even if there is some independent concern  about New Zealand-owned banks, then we have SBS, TSB, Co-op, and Heartland.

One key strand in New Zealand’s approach to banking is the idea that no institution, and no depositor/creditor, is totally immune from failure and the risk of losing one’s money.  I don’t think that is a politically tenable stance, and am among those who favour New Zealand adopting some form of deposit insurance (as most other countries have done).  But it is a particularly difficult model to sustain in respect of a government-owned bank.

Yes, governments have been willing to allow creditors of SOEs to lose money –  the banks who had lent to Solid Energy most notably among them –  but a handful of banks, mostly foreign, is a rather different matter than hundreds of thousands  (800000 apparently) of retail depositors (and voters).   Governments can say all they like that no one is guaranteed, but it isn’t obvious why anyone would –  or should –  believe them.  After all, a standard element in the Reserve Bank’s approach is that if a bank gets into difficulties, the Reserve Bank will look to its shareholders to recapitalize the bank concerned.  The  New Zealand government owns all the shares in NZ Post, the immediate (struggling) parent of Kiwibank.   The credit rating agencies also take that view: S&P, for example, noted last year that

we consider that Kiwibank has a “high” likelihood of receiving extraordinary support from the New Zealand government, reflecting the bank’s “very strong” link and “important” role to the government.

The unpriced implicit support Kiwibank has from the government skews the domestic banking market and undermines the efficiency of the financial system, all while continuing to pose material financial risks for the New Zealand taxpayer.

And it is not as if the governance of Kiwibank looks particularly strong either.  I was quite surprised to find, looking through the list of directors, that not a single one of them has a background in retail banking.

At very least I think it would make sense to restructure the NZ Post group, removing Kiwibank and making it a standalone SOE in its own right.  Going by the comments from the Minister, if the story Radio Live ran had anything behind it, that was the mostly likely form.

A sale would also make sense, but I don’t see any chance of it happening under the current government.  One could conjure up all sorts of imaginative options that might mitigate the political uproar –  recall the size of the petition around the partial sales of the government stake in three power companies –  but I can’t see why this government would regard it as worth the political risk.  And no potential coalition partner really cares enough to want to make a sale a “bottom line” in any deal –  while NZ First might well care enough on the opposite side.

Kiwibank shares could, for example, be distributed to all adults –  on current book value that might be around $300 each –  so that it was truly the “people’s bank”.  But then there would no single dominant shareholder, and the rating agencies would get nervous, and so would the Reserve Bank.  It would have quite high direct costs, and the opposition parties would no doubt sell it (accurately) as prelude to those individual parcels being bought up by one or another of the other banks.

I’ve seen suggestions that perhaps the New Zealand Superannuation Fund should become a key shareholder in Kiwibank.  I reckon that would be even worse than direct state ownership, since the NZSF faces neither market nor political disciplines.

I don’t really like the idea of a partial privatization, with the government retaining the majority shareholding.  It still has most of the moral hazard/bailout risks associated with the current ownership model, with more risk that the private shareholders would seek to aggressively (and quite rationally) exploit such advantages.  It was, more or less exactly, the model used with the Bank of New Zealand in the late 1980s.

In truth, the best value for the taxpayer probably lies in what is the least politically attractive option: a straight trade sale, probably to one of the existing large participants in the market. That was how the previous Postbank was sold, back in 1988.  It is what happened to Trustbank in 1996, and to Countrywide a couple of years later.  And, of course, Lloyds concluded that the best value from the National Bank was through a trade sale to ANZ.  The government might get a price well above book value in such a sale, even recognizing that banks are less inclined to aggressive expansion than they were a decade ago, and that some of the Australian banks might be uneasy about overweighting their exposure to New Zealand.  But even to propose such a sale would surely be seen by the government’s political advisers as an unadulterated gift to the Opposition.

And so it seems likely that, for the foreseeable future, the government will not just be the largest owner in New Zealand of dairy farms, funds managers, trains and planes, power companies, and legal firms, but will remain the owner of a modest-sized, not outstandingly successful, retail bank.

UPDATE:  In casting around for any summary analysis that has been done/released on Kiwibank’s long-term performance, I found this chart of return on assets (not equity) in a Treasury report from a couple of years back.

bank roa.png

The results shouldn’t be very surprising, but they do reinforce the point that even if Kiwibank is currently earning reasonable rates of returns (eg in the most recent year), it has a long way to go to deliver the sorts of cumulative returns to taxpayers that private sector shareholders might have expected (especially as none of the private comparators were start-ups).

 

Switzerland of the South Pacific: cargo cult thinking?

Michael Reddell New Zealand economic performance

One of the odder articles to appear in the local media over the holiday weekend was Fran O’Sullivan’s piece in Saturday’s Herald, headed “Key’s vision: Switzerland south”.  I’ve been critical of the Prime Minister in a few posts recently, but when I first saw the O’Sullivan piece I wondered if she was really reporting the Prime Minister or building up a creation of her own.  But after several re-readings, I think she must really be reporting the views of our Prime Minister.

Of course, we have been this way before.  In the midst of the 1980s reforms, before the commercial property and equity bubble burst leaving us with a serious financial crisis, people like Michael Fay and David Richwhite used to give speeches talking of building a Switzerland of the South Pacific here in New Zealand.  Implausible as it may have been, my memory was of a positive vision – a liberalized economy would stimulate investment and entrepreneurship (and probably a large financial sector led by Fay, Richwhite?), enabling us to generate once again per capita incomes more akin to those in Switzerland(we’d matched or exceeded them as late as the 1920s).  In the climate of the times, in the early post-ANZUS days, Switzerland’s armed neutrality probably added to the appealing imagery.  Of course, it all came to pretty much nothing.  Switzerland remains one of the most prosperous advanced economies, while we languish as the slightly embarrassing poor relation.  Fay and Richwhite, as it happens, ended up relocating to Switzerland.

But John Key’s image is a much less positive one – New Zealand as a “beautiful and wealthy bolthole for high net-worthers seeking to escape from an unstable world”.

We are told that

Key believes that free-flowing terrorism is here to stay. To the Prime Minister, this simply makes New Zealand more attractive and will result in more high net-worth consumers wanting to come here

and

But Key contends it is the fear of terror – which has been happening over a long time – which is the driver for Europeans to up sticks and leave.

complete with talk of

If Donald Trump is elected President (assuming he first gets the Republican nomination) there may be a new outflow if his political bombast becomes reality.

Haven’t we heard all this before?  People allegedly about to flee the US if, say, George W Bush was re-elected.  Or people fleeing to New Zealand in the 1980s to escape the nuclear peril of the late Cold War tensions.  And where are we today?    Our per capita incomes and productivity relative to the rest of the world just keep on drifting slowly further behind.

And what about terrorism?  Tyler Cowen included a link the other day to this chart of annual terrorism-related deaths in Western Europe since 1970

chartoftheday_4093_people_killed_by_terrorist_attacks_in_western_europe_since_1970_n

Hardly a pattern suggesting that the rich and powerful  –  with much better protections than the masses – should flee to little old New Zealand.  If New Zealand didn’t prosper through a century in which Europe went through two savage wars and a prolonged Cold War, an exodus of the elites seems unlikely to be our path to renewed prosperity now.

The great age of European emigration was in the 60 or 70 years prior to World War One, not now.

Ah, but O’Sullivan points out, then there are the Chinese

New Zealand has also become an attractive destination for Asian high net-worthers who have invested in property here – particularly Auckland. Chinese investors are relatively open that they are seeking to de-risk their own exposure to the China market, get capital out and buy residential property in a pollution free environment.

Auckland, and Sydney, and Vancouver, and London and Houston and…..anywhere more or less safe without heavy tax and regulatory restrictions.  The Chinese capital outflow story is a real one, and a historically anomalous one –  about fear, corruption, and lack of secure property rights in China.  But there is little no basis for thinking that it will a basis for transforming New Zealand’s specific economic prospects.  We don’t have difficulty attracting foreign capital, but we haven’t (it appears) created a climate in which business investment here is sufficiently attractive to begin to lift our relative productivity and income performance.  And as China’s own GDP per capita is about a third of ours, it isn’t obvious that one would look to mainland Chinese as a source of sustained domestic prosperity. (Taiwan or Singapore might be different, but then those countries have rather more respect for domestic property rights and, not unrelatedly, more success in generating  domestic prosperity).

And if foreigners really were wanting to build a top-notch global business (as distinct –  and it is an important distinction – from protecting what one already had), you almost certainly wouldn’t start from here if you had any other choice.  No serious observer ever pretends that New Zealand is better than fifth choice even among the Anglo countries: try the US, the UK, Canada, or Australia, and if you can’t get in there, then there is always New Zealand.  For a similar population, higher incomes, and rather better location I’m never quite sure why Ireland doesn’t appear in those lists.

O’Sullivan also tells us tax plays a part.  We don’t, she tells, us compete with Switzerland’s (now somewhat attenuated) banking secrecy laws

But it is notable that one of the reasons why New Zealand has yet to follow Australia and bring in rigorous laws to clamp down on multinationals which are not paying significant tax here is because this country is competing for investment.

Perhaps, but this is the same Prime Minister who, interviewed by TV3 a week earlier, reckoned that the tax paid by multinationals in New Zealand was “not fair”, and whose government is part of the OECD-facilitated BEPS process.

If we were really serious about promoting business investment in New Zealand, and in turning lifting our incomes and productivity performance, one of the best things we could do is to remove taxes on capital incomes altogether.  Taxes on business incomes are, largely, taxes on wages, precisely because they discourage the business investment that, for example, New Zealand has been so short of.  This isn’t a popular line to run in New Zealand, or perhaps anywhere, but a government that was serious about creating the conditions under which its own people could prosper, and in which foreign investment would assist us in that process, would not still be presiding over a company tax rate of 28 per cent and talking of finding ways to raise more money from foreign companies operating here.

[This is not the post for a lengthy treatment of tax issues, but a standard response is that much lower company tax rates would be a windfall gain to existing foreign investors, with no benefit to New Zealand.  That might be so if most foreign investment here were in tradables sectors (since selling prices of tradables are largely determined in international markets), but in fact the largest components of foreign investment here are in the non-tradables sectors, where lower company taxes would be expected to result in lower domestic selling prices (eg for banking or telecoms services), benefiting New Zealand consumers and businesses.  I outlined some thoughts on tax a few years ago here.)

As the O’Sullivan moves towards her conclusion she notes

If the Key Government keeps its nerve, the wealth transition will continue. For instance, New Zealand is becoming a magnet for high net-worth Chinese tourists and for students from Saudi Arabia – markets which are growing rapidly. That interest will bring with it investment in hotels, airports, and housing.

Both –  Chinese tourists and Saudi Arabian students –  are surely welcome, but is there any reason to think they are a probable basis for a reversal of our decades of income decline?  Our universities aren’t exactly Harvard or Oxford –  or even on a path to getting there –  and although I’m loathe to criticize tourism (we want holidays, so do foreigners), there is no advanced country of any size that has managed to support or sustain top-tier incomes based on tourism.  France is perhaps the most-visited country in the world, but it isn’t tourism that keeps it rich.

Finally

Annual net migration reached an all-time high of 68,840 people. And net migration from Australia was positive for the 11th consecutive month. These positives underline that John Key’s vision of New Zealand as a Switzerland of the Asia-Pacific has indeed the potential to become reality.

Key won’t be doing anything to destroy that wealth effect.

It gets boring to keep pointing it out, but over the last year around a net 4000 New Zealanders left New Zealand.  If we can’t even persuade the New Zealanders to stay, let alone create conditions that make the huge diaspora population want to come back,  it is a pretty unpromising foundation for the creation of a Switzerland of the South Pacific.

As for that “wealth effect”, O’Sullivan repeats the claim that the Credit Suisse Global Wealth Report demonstrates that New Zealand households are the second wealthiest (behind only Switzerland).  If she got this from Key (with all his advisers) it is inexcusable: the claim was widely reported at the time, but Credit Suisse themselves acknowledged that they had made a mistake, using the wrong exchange rate to convert New Zealand data in to US dollars.  I suspect someone else has pointed this out, as the detailed reference in the hard copy edition of the Herald has disappeared from the online version of the article.

It was, in any case, an odd statistic to trumpet.  Even on the corrected basis, New Zealand household wealth looks quite high.  But it does so because (a) our exchange rate is very high (they use market exchange rates, not PPP ones) and (b) because house prices, especially in the third of the country that is Auckland, are ridiculously high.   The average middle-aged homeowner in major cities such as Houston or Atlanta probably has a better house than the average middle-aged Aucklander, but it does not have a $1m price tag attached to it.

Which brings me to my final comment on the article itself.  The Prime Minister is reported as

He is frankly unapologetic about the massive increase in Auckland residential property values, which has resulted in many established Aucklanders becoming relatively rich, but younger people being locked out of the market. It is a trend which is not going to stop anytime soon, given the immigration figures.

They aren’t presented as direct quotes but if these lines are representative (and they are consistent with what he said in his TV3 last week) it is surely a disgraceful indictment of a failed government.  The sheer indifference to the plight of ordinary New Zealanders is breathtaking.    While his government continues to preside over land-use restrictions that limit the ability of Auckland’s physical footprint to grow, then continued high immigration would continue to hold up Auckland house and land prices.  But those land-use restrictions could be changed, and should be, especially if we are going to continue with anything like recent population growth rates.

The breathtaking indifference might be slightly less inexcusable if there were any sign that the Prime Minister’s Switzerland “strategy” (or just “this week’s talking point”?) was working.  If, for example, incomes were growing rapidly and steadily closing the gap on the rest of the advanced world.  But they aren’t.  New Zealand continues to do badly, and recent data suggest that over the last 15 years Auckland has done worse than the country as a whole (per capita incomes growing less rapidly).

The Prime Minister is surely mostly right when he says

“They look at us and think it is a highly developed first world economy, unbroken democracy, stable government, independent judiciary

But in Switzerland they get all that, and more.  Beauty and stability, rule of law and wealth, and all that in the heart of one of the largest and most populous regions of  prosperity and innovation anywhere on earth.    Boltholes tend to be places of comfort and luxury but not of great economic dynamism and entrepreneurship.  And I’m pretty skeptical that it is “bolthole” tendencies that have enabled Switzerland to get, and stay, rich –  that is more down to the innovative products and services of its firms and peoples – but there seems no more basis for thinking that New Zealand is on any sort of path towards being a Switzerland of the South Pacific than there was when Fay and Richwhite were championing the idea 30 years ago.

Countries get and stay rich mostly on the skills and talents and energies of their own people.  Natural resources can help.  Really remote countries, even with able people and natural resources, face considerable challenges.   But to keep on looking for our salvation to come from abroad –  as the Prime Minister seems to in this article –  seems no more promising than the Melanesian cargo cults.

 

Cross-party support for high immigration policies

Michael Reddell Immigration

My post yesterday about the Prime Minister’s immigration interview at the weekend prompted a few comments from people keen to pin the responsibility for the current policy on John Key and offering thoughts on what electoral motives National might have for favouring high rates of non-citizen immigration.

Now, of course, any incumbent government (especially one that has held office for more than seven years) must accept some responsibility for current policies.  Especially on matters that don’t require legislation, if they didn’t like the current policy, they could have changed it.

But, as I’ve pointed out on various occasions, current policy is not some bold new innovation of the current government.  It is, more or less, a continuation of the policies of previous governments since at least the start of the 1990s.  A couple of weeks ago, I linked to the 2014 immigration policies of the various smaller parties, not one of which suggested any material disquiet with the regime. (I didn’t link to the 2014 Labour policy, and they now appear to have taken down their 2014 policies, but here is a 2014 summary of the various party immigration policies. Labour seemed then to favour more use of immigration policy in a counter-cyclical way, but there is no obvious disquiet with the overall target levels.)

And what of the practice?  The MBIE website has a series for residence approvals for each year back to 1997/98.  Here is a chart of that data, including averages for the previous Labour-led governments (2000/01 to 2008/09) and the current National-led governments (2009/10 to 2014/15).

residence approvals

The target number of approvals (45000 to 50000 per annum) has not changed from one government to the other, and the average number of residence approvals has actually been slightly lower under the current government than it was under the previous government (probably largely reflecting the fact that labour market conditions have been more difficult in recent years).  As the population is now 20 per cent larger than it was in 2000, annual residence approvals as a share of the existing population are now quite a bit lower than they were back then (albeit still very high by international standards – roughly three times, per capita, legal immigration to the United States).

There have been plenty of refinements of policies over time –  some for the better, others not.  We’ve had changes in the eligibility for parent visas, changes in the points offered for people moving to places other than Auckland, and an increased orientation in granting entry to people with specific job offers (an approach criticized – I think rightly – in the new Fry and Glass book).  But the overall approach to residence approvals has had much more continuity than difference from one government to the next.  And only people who get a residence visa can stay here permanently.

What of some of the other visa types?  Foreign students are a reasonably significant export market, and if there has been some (material) change in policy over the granting work rights to longer-term students while they are here, overall student visa numbers haven’t changed much from one government to the other.

student visas.png

Ideally, one might have hoped that we’d be seeing more students than 10-15 years ago, but mediocre universities and a high exchange rate are obstacles to that.

The number of working holiday scheme visas granted has increased hugely.

whs visas

But (a) if you didn’t know the dates of the change of government, you couldn’t tell from the chart, and (b) much of the more recent expansion of working holiday programmes seems to have been in pursuit of votes for the Security Council seat, a goal shared and pursued by both main parties.  Moreover, although 60000 visas were granted last year, these people are typically only in New Zealand for a few months.  I don’t have any strong views on working holiday schemes, although in papers released last year, even Treasury expressed some unease.

The number of people granted work visas has also trended up very strongly –  most strongly when the unemployment was very low –  over the period since 1997/98.

work visas.png

But again, there is no obvious difference between the experiences under National and Labour led governments.  Much of the trend reflects the change of approach under which most people who obtain residence visas do so from within New Zealand. In the 1990s, most people who got residence visas did so directly from abroad, but now the most common model is for someone to come on a work (or student) visas, get established in a specific job here, and then apply for a residence visa.  That aids the integration of the people who do come but, as Fry and Glass note, may not help attract the very best people.

The point of this post so far has been to illustrate the substantial continuity, and commonality of approach, from one government to the next.

But on the off chance that anyone thinks ‘but Winston is different’, recall that Winston Peters was Deputy Prime Minister and Treasurer in the National-New Zealand First government from 1996 to 1998, and was Foreign Minister in the Labour-led government of 2005 to 2008.

I tracked down a copy of the (very long) 1996 coalition agreement between National and New Zealand First.  Immigration policy is dealt with on page 45. Here is what it said:

Statement of General Direction:
The goal is to have an immigration policy that reflects New Zealand’s needs in terms of skills, ability of the community to absorb in relation to infrastructure and recognising the diversity of the current New Zealand population. Such a policy will take into account the capacity of this nation to meet the general economic and social needs of New Zealanders.

Key Initiatives of Policy:

To maintain current immigration flows as per the last quarter of 1996 until the Population Conference has been held in May 1997.

  • Introduce a strict four year probationary period.
  • Introduce a limited overstayer amnesty following agreement upon appropriate definition and objectives of the amnesty
  • Health screening of overseas visitors.
  • Population Conference/strategy.
  • Clamp down on refugee scams.
  • Increased resources to policing immigration policies

Whatever you make of the specifics, it doesn’t have the ring of something dramatically different from what had gone before (or what came after).  (And for those of a historical bent, here is the programme –  with comments from the then Prime Minister and the then Minister of Immigration –  for that Population Conference.)

By 2005, confidence and supply agreements were rather shorter, but this is what the Labour-New Zealand First agreement said about immigration

Immigration

• Conduct a full review of immigration legislation and administrative practices within the immigration service, to ensure the system meets the needs of New Zealand in the 21st century and has appropriate mechanisms for ensuring the system is not susceptible to fraud or other abuse, and taking note of other items raised by New Zealand First.

Again, not suggesting any very material changes of policy.

Of course, minority parties have to prioritise.  My point is only that over 25 years in practice our high levels of inward non-citizen migration have been the result of a widely-shared consensus among our political parties (and bureaucrats). Some might have been zealous for it, and others just not that bothered.  Perhaps that outcome has been a good thing, leading to real economic gains, or perhaps not (it would nice if the advocates could show us the evidence of those gains), but it certainly isn’t a Key innovation.

 

 

 

Central bank communications

Michael Reddell OCR leak, Reserve Bank

I had not been going to write any more now about the Reserve Bank’s investigation into the possible OCR leak (I voluntarily passed them hard but partial information; what conclusions they are able to draw from that information is up to them)  and the related, more important, issues of how they handle releases, lock-ups etc.  But overnight Marek Petrus, former communications director at the Czech central bank, got in touch and drew my attention to a couple of posts on the issue which he had put on his own very interesting blog, Lombard Rates.  He has also left a substantial comment on my earlier post on reforming Reserve Bank releases.

Petrus’s two posts are here (more specific) and here (more general).  He argues as follows

Based on my experience, organizing lock-ups for interest rate-decision releases is not a standard, wide-spread practice among central banks.

As far as I know, few central banks provide information on rate decisions under embargo, be it via lock-ups or other means (the Czech National Bank, where I set up that lock-up regime for news agencies some years ago, is one of those few).

Still, lock-ups do make sense, but mostly for technical, complex matters that require a lot of explanation (a specific example is releasing Inflation Reports or Financial Stability Reports). Providing information on a rate decision and the main reasons behind such decision under an embargo longer than, say, 5-10 minutes is not worth the risk.

My suggestion for the RBNZ, or any central bank considering ways to employ or redesign an embargo technique, would be to organize the standard lock-ups only to provide detailed explanations on complex publications or complicated technical, regulatory matters. The most market sensitive information (such as the rate announcement) should either be released under no embargo at all, or be made available to a small group of journalists via a tight, 10-15 minute lock-up. That would help reporters get the facts right and avoid making a factual error under stress.

No market participant or analyst should have access to this sensitive kind of information before the official release. That to me is the first line of defense against an embarrassing information leak. Afterwards, an open press conference could be held for journalists and TV cameras, and a separate background seminar organized for analysts, to explain the decision and answer detailed questions. However, this press conference and the background seminar are, as rule held, only after a rate decision has been published, and has thus become part of public domain.

I agree with the gist of these comments, although I’m not sure about holding background briefings for analysts after the release.  When we first did Monetary Policy Statements in New Zealand we did exactly that, but the sessions were not popular (clients wanted immediate explanations, and after that the market economists wanted to move on to other things).  Perhaps more importantly, comments on the monetary policy outlook and projections should be made openly and on-the-record or not at all.

UPDATE: Petrus has got in touch to clarify what he meant about an analysts’ briefing:

I did not mean to suggest that a seminar for analysts should be organised behind closed doors (i.e. only on background).

Quite the opposite: It should be made public, streamed live as a video webcast and later made available online as a video recording. By writing about “background seminar”, I meant to say that background and detailed information about a policy decision and the latest forecast should be routinely provided by a central bank via such analyst meetings.

The most transparent central banks, such as Sweden’s Riksbank and the Czech National Bank, make such analyst meetings public by providing a live webcast and making the video recording available via online services such as YouTube for every member of the public to watch.

See for instance: https://www.youtube.com/playlist?list=PL7V-SFaHLX4LcIZjld51kktczHEj36hJ9

That would appear to be an excellent approach for our Reserve Bank to consider adopting.