Not all populism

This blogger has just finished reading the hansard of Glenn Stevens' parliamentary appearance on Friday. Although completely unreported, there was this excellent exchange between Kelly O'Dwyer and the Gov:

Ms O’DWYER
—Our task is to draw you out!

Mr Stevens
—Indeed it is—and my task is to try not to be drawn too much!

Ms O’DWYER
—Indeed. I will change tack to give you some respite. Australian taxpayershave furnished private banks with $850 billion worth of guarantees, and the RBA has providedthem with unprecedented liquidity facilities. Can you tell us whether this raises the risk of moralhazard in Australia, and can you explain for the benefit of the committee your understanding of ‘moral hazard’.

Mr Stevens
—It is a good question because it goes to the future as well as the past and thepresent. Let me see if I can set out a few facts. The $850 billion you refer to, I take it that isdeposits. The government made available a guarantee for wholesale funding, which was of course priced. The government took some risk here, but it was very well paid to take that risk. Itis earning about $1 billion a year in fees. Sometimes we hear people say, ‘The government didn’tgive it. It sold a guarantee, and at quite a nice price.’ That is closed and the stock of guaranteedliabilities which got to around $170 billion or $180 billion is actually starting to come down nowvery slowly. It will come down more quickly as the guaranteed debt matures over the nextseveral years. It is the same for the state governments. That is about to close, if it has not already.I do not think that will be disruptive.The remaining part, as you say, is the guarantee on deposits of over $1 million. One of thethings that does have to be done in the next six months or so is for officials—and we areworking with the Treasury and the Council of Financial Regulators and others—to try to figureout what the world should look like after that guarantee finishes, which is at the end of Octobernext year. It would be improper to speculate too much, but the size of the cap is obviously anissue that has to be considered carefully.On ‘moral hazard’, there is a moral hazard everywhere in the world because governments andcentral banks did extraordinary things. Some of the things we did were unprecedented for us butby the standards of what some other countries did were pretty mild. So there is a huge moralhazard because governments and central banks did these things. They had to be done, becausethe system faced a catastrophe in the absence of these measures. But them having been done, andeven though we are withdrawing them, the issue we will face—and this is what you were gettingat, I guess—next time there is some pressure is whether there will be another guarantee. My veryfirm view is that we ought to try to get to a position where at that time, whenever that daycomes—hopefully not soon—our government will be in a position to say, ‘No, we are not goingto give a guarantee and the system can cope with that.’ I think we are much closer to being ableto say that than most countries, but we still have some work to do to get a permanent set of arrangements, particularly for deposits, which can stand the test of time. That is on our agenda atthe moment and for the early part of next year. I expect that at future meetings we will probablycome back to that. It is a very important question.This is why, to hark back to the questions Ms Owens asked about the global regulatory work that is being done, people are very conscious of this, very conscious of the need to try to lessen the moral hazards surrounding some of these very big global banks by making them safer, lesslikely to fail and easier to resolve if they do fail and so on. It is very much, though, still a work in progress. That is the best I can tell you at this point.

Ms O’DWYER
—Governor, would you consider that these guarantees are contingentliabilities—that they increase the risk profile of the Commonwealth prior to its position pre thecrisis?

Mr Stevens
—We are getting into areas where it is very difficult to talk about this publicly, soI will be a little bit guarded. But, from a strictly accounting point of view, they have taken on acontingent liability that they did not have before. What is the probability that you would actuallyhave to make good on the entire deposit base of the banking system? It is extremely low. So, if you were trying to measure this obligation, it would be the size of that times some probability of having to make good on that, and that is very low number. I think you would also, to be honest,have to in the back of your mind pose the question: in the previous world, without thisguarantee, would a government stand by to let the system collapse and do nothing? I cannotthink that they would. There was always some unspoken, unquantified support. But it is a veryinteresting question: should that be made explicit and priced or shouldn’t it? That is one of theissues that I think would probably have to have a discussion about, but today is probably notquite the moment.

Ms O’DWYER
—That leads pretty nicely into my next question, which is: can you tell uswhether there is a risk in the fact that Australia has four ‘too big to fail’ banks that effectivelybenefit from implicit taxpayer guarantees.

Mr Stevens
—We have four large institutions, but the number in a crisis is not necessarilylimited to four because in crisis conditions, if people are panicked enough, even a smaller entitycan end up being quite disruptive if it is in distress. The other side of that, of course, is that thoseinstitutions are supervised very intensively by the supervisor, who is quite prepared onoccasion—and has done so—to require banks to do this or that additional thing over theminimum, if they think that is appropriate from an individual risk or even a systemic risk pointof view. But this is the nature of banks. It is a tricky area because banking just is not like anyother business. A bank failure, even for a not-so-big bank, is not like the failure of any otherbusiness, where someone else comes in, buys the assets, employs the people and everythingkeeps going. It is not that simple in banking, which is why we have regulation that is much moreintrusive on a bank than it is on your average industrial company. It is for that reason. It is whythere is this very difficult, delicate balance with the problem of moral hazard. To make moral hazard go away entirely is probably impossible. It is a tricky area.

Ms O’DWYER
—I want to refer to the new statement on the conduct of monetary policy thatwas signed in September 2010. As I understand it, the RBA added the following new text, which has not appeared in previous statements since the first one was signed by the former Treasurer.That statement is:

The Reserve Bank’s mandate to uphold financial stability does not equate to a guarantee of solvency for financialinstitutions, and the Bank does not see its balance sheet as being available to support insolvent institutions.

As you of course know, the RBA has a responsibility to serve as a lender of last resort to deposit-taking institutions that are adversely affected by these liquidity shocks, as it did during the globalfinancial crisis. If a bank can no longer fund itself because of an external shock and the RBA isthe only counterpart in the world willing to lend to it, how can this not represent the RBA usingits balance sheet to support insolvent institutions?

Mr Stevens
—The distinction, though, is between illiquid and insolvent, so, in the classiccentral banking setting, if an institution is illiquid but it does have assets it can pledge ascollateral the central bank, on the assumption that it has some reasonable look at the quality of those assets, can lend against them at an appropriate rate of interest. This is Bagehot’s classic—in a liquidity crunch, lend freely at a high rate to sound banks. We would do that. Nothing in thisstatement on the conduct of monetary policy changes that fact. The Reserve Bank will alwaysplay the role of provider of liquidity against collateral at an appropriate interest rate.The statement about not seeing the balance sheet as being available to support an insolventinstitution is making a different point. It is saying that we do not regard it as proper, and nocentral bank would, for a bank which is actually insolvent to be bailed out by the taxpayerthrough us. If it is going to be bailed out by the taxpayer, the government should make thatdecision and should fund it itself. We would probably have some role in facilitating that in theevent it occurred, but the government would have the credit risk, not the central bank. I think that would be, in central banking circles around the world, the way all central banks would think about it. So our role is in liquidity and we will always be prepared to do the right thing there bythe system and by participants in the system in a crisis, and we have done that and we basicallydoubled our balance sheet in 2008-09, for a brief period, for that very purpose. As to thefinancial rescue of an institution which is not solvent, there may or may not be a public policycase to do that but that is a government call. We would obviously give them our views if theyasked, but that would be their call, I think quite properly.

The full hansard has been Scribd by Peter Martin.