Richard Meade on banking and competition

Prudential regulation requires banks to hold more capital than they would otherwise like to, so that there's less risk of default and less risk that the bank imposes bailout risk. 

New Zealand does not have deposit insurance, but some are of the view that there's an implicit guarantee of at least some sort - that the government would not let depositors be too badly hurt. The open-banking resolution mechanism would impose haircuts on depositors if there were still a shortfall after unsecured creditors and equity were burned through, and I don't think anybody really knows how big a haircut might prove politically intolerable. In that view, deposit insurance then just winds up requiring up-front payment for the insurance they're probably already getting for free. 

In any case, high capital requirements mean that banks have to hold a lot of capital; they have to compete for that capital against other potential uses of it. So you'll wind up with high nominal reported profits. And politicians will then point to high profit levels as reason for windfall taxes and the like, while ignoring return on equity. 

Those big numbers generate political demand to do things. And so it seems near-certain that the Minister of Commerce is going to ask ComCom to run a market study on the banks.

Over at The Conversation, Richard Meade raises a few points that need to be kept in mind:

• The OCR sets a coordination point for pricing that could be considered price-fixing in other sectors; 
• RBNZ's cheap wholesale funding during the worst part of Covid reduced the risk of meltdowns while preserving bank profitability;
• RBNZ restrictions on entry, aimed at ensuring financial stability, also prevent competition.

He concludes with a few questions:

First, are growing bank profits due to banks acting anti-competitively, the Reserve Bank fighting inflation and preserving financial stability, or both?

Second, if bank profits are indeed excessive and due to anti-competitive behaviour, are there measures the commission could recommend and practically implement that would improve outcomes?

Finally, if bank profits are excessive, and at least partly due to the Reserve Bank doing its job, would interventions by the commission to improve competition worsen financial stability or frustrate the fight against inflation?

Answering these questions will need both the commission and the Reserve Bank to have serious conversations about how competition policy and banking regulation can be made to work together to achieve better outcomes for both bank customers and the wider economy. Little would be gained by improving bank competition if that reduces financial stability or worsens inflation.

I still think that a market study focused on barriers to entry, including account portability, could do some good. 

And I still think that that will not be what the Minister of Commerce asks for. I expect instead that the Minister wants show-trials of bank executives during the election campaign, during which they can be harangued just as the supermarket CEs were during that market study, with any report coming after the election. That kind of market study would focus on interest rate margins, mortgage interest rates and the like. 

The point would be to make it easier for the government to blame the banks, rather than bad government policy, for poor outcomes during the election - while trusting that ComCom wouldn't issue any final report until after the election. 

And the risk would be a whipping up of appetites for very bad policy and rash promises during an election campaign. The draft supermarkets report was poorly done, and created an anchor point for populist expectations - and for legislation.

If I'm right, I hope that ComCom is able to push back on any weak terms of reference and propose something that could add value rather than do harm. 

And for a bit more on New Zealand's monetary policy mess, Bryce Wilkinson's report, out today, is a must-read. 

Cash for CluNZkers

The US Cash for Clunkers programme was a mistake. Intended as stimulus programme for the auto industry, it failed. 

Almost all of the effect was a bringing forward of purchases that would have happened anyway, so the effect was very short-lived. 

It also failed as an environmental programme. Looking only at the CO2 reductions, the cost-per-ton was $106-$335, USD, 2009. Inflation, exchange rate, tons to tonnes: that's $245-$772/tonne in current NZD. Or between three and ten times the going price of carbon abatement in the ETS.

The US didn't and doesn't have an ETS, so the scheme could reduce net emissions - albeit at very high cost. NZ has an ETS, transport is in the covered sector, and there's no domestic auto industry to stimulate even if you wanted to, so a cash-for-clunkers scheme here would be especially stupid. 

Richard Meade had a chat with Sean Plunket over on The Platform yesterday. 

Sean had got wind of that a cash-for-cluNZkers scheme is here in the offing, and could be announced at the budget. 

It'll be fun to see how the legislation handles this one, and whether they even try putting a cost-per-tonne on it. 

Whoever drafted the leg will have to have lots of things to think about. On a few short chats with others on it:

Could I buy a clunker now, expecting a voucher that's worth more than the cost of the car? Should the legislation anticipate that and restrict the voucher to cars purchased at least a year ago? 

Sounds like it'll be means-tested: only poorer households can do it. But they can on-sell any EV they buy to a higher income household right? And that higher-income household might help them front the rest of the cost? 

If you have a university-aged kid, could you strike a deal with that kid's household? Like, buy the kid the clunker now, let her turn it in for the voucher, loan the kid the rest of the money for the car (or top up a zero percent student loan), and have occasional use of the car that would, for convenience, be regularly parked at your house? It could quickly undo all the effort at means testing, and policing could be interesting. 

It'll also be fun to watch the price of used cars, and of EVs, given supply chain issues. 

Oh - and remember - because the ETS has a binding cap, the scheme achieves precisely nothing for emission reduction. The only thing that cuts net emissions covered by the cap is a reduction in the cap. The regulations aren't necessary to cut the cap, and cutting the cap is sufficient to reduce net emissions - and presumably does so for a fraction of the cost of a Cash-for-CluNZkers scheme. 

It just keeps getting stupider. 

Covid loans?

The excellent Richard Meade makes the case for Covid loans instead of wage subsidies. You can read the journal article on it, or his column over at The Conversation. 

Richard and I independently came up with the idea way back in March/April. I'd included it in our first comprehensive pandemic response policy paper, 26 March, with a bit more detail in a second short policy piece on 27 March. and he emailed me his two-pager on it about a week later. He'd not seen my version of it beforehand; his was better worked-up than mine was. Richard cites our version in his journal article. 

I'd liked it as a complement to the wage subsidy programme. We'd pitched a slightly different version of the wage subsidy scheme, based on Germany's short-time work scheme (see our short piece of 27 March), but given the time pressure it's impossible to fault the government for putting out the system it did put up. They made it work incredibly quickly, and the officials who got it through deserve medals. It avoided a pile of scarring. 

At the time, we all expected far worse employment outcomes, even with the wage subsidy programme. You can't just turn off tourism for what looked likely to be at least a year without having a pile of problems right? 

I'd figured that opening the student loans scheme to non-students, for borrowing up to a capped amount, with penalty interest applying ex post to any amount of borrowing that was above realised income losses, would likely work. 

There would be huge admin cost in trying to expand the student loans scheme; I'd thought this way of backloading a lot of the administration would make it more feasible. Easy approvals up front, but knowledge that penalty interest (recouped through the tax system, just like student loans) applies if you borrow more than your income loss would discipline. And it would mean that a lot of the admin would come at the end of the tax year, rather than while the bureaus were up to their eyeballs in trying to sort through the wage subsidy scheme. What those folks got done late March - just amazing. 

The big advantage in relying on something like extensions of the student loan scheme is that it automatically targets assistance to where it is needed, if you apply penalty interest for borrowing above realised income losses, and because it lets the government deliver more assistance in a hurry for any amount of cost it is willing to front in providing that assistance. If the government gives out a dollar as a grant, that costs a dollar plus the deadweight cost of taxation. If the government gives out a dollar as a loan, it gets some of that back. And that means it can loan out rather more than a dollar for the same expected one-dollar cost. 

Richard has it up as a substitute for the wage subsidy scheme. And I expect that's where policy has to turn over the longer haul: credit support rather than wage subsidies if we get more lockdowns, but government-funded Covid leave (now in place!) so workers and firms don't bear the costs of workers staying home while waiting on test results. 

Here's Richard:

Furthermore, since any firms and households borrowing against their own future incomes will ultimately be repaying their debt, COVID loans represent an asset on government balance sheets.

This offsets the extra liabilities governments take on by borrowing to finance these loans — something wage subsidies do not do. This increases the affordability of a loans-based approach from a government perspective (even allowing for defaults and subsidies implicit in student loan schemes).

Using illustrative data for New Zealand, my paper shows COVID loans are 14% cheaper than wage subsidies (and small business loans) in terms of their impact on net government debt.

More importantly, they are almost 2.5 times as effective in terms of the level of support they offer. And since 67% of the cost of COVID loans ultimately falls to those who make use of them (allowing for defaults and implicit subsidies), they place less of a burden on future taxpayers than deficit-funded wage subsidies.

The point of the wage subsidy scheme was to make sure firms could have a rapid reboot after lockdown. Making it the go-to in any outbreaks risks providing too much support in places like tourism where resources should shift to other uses. 

Hopefully this will all soon be irrelevant. But it is fun looking back through the email correspondence on it from back then. 

The COVID and the damage done

Wednesday's Law & Economics Association of New Zealand lunchtime panel discussion on limiting the economic fallout of COVID included Andreas Heuser, me, and Richard Meade. 

Panel Discussion on Limiting COVID Economic Fallout – 27 May 2020 from Andreas Heuser on Vimeo.

Richard made the case for running something like the student loan scheme for non-students, and for business. Richard and I independently hit on the idea of extending the student loans scheme to non-students. I'd pitched it back in March as part of our initial COVID-response batch of papers. I still think it rather preferable to helicopter-money options.

I went through the importance of scaling up contact tracing as alternative to future lockdowns, suggesting we use a structure like the Army Reserves. Get trained in it, spend a weekend a year on a refresher course, and be ready to be called into service if needed. Then I went through the case for safely reopening the borders before re-emphasising the need to maintain fiscal prudence if we want to get out from under the debt COVID makes us take on.

Andreas covered impending liquidity crunches and contrasted NZ's business support regimes with some of those found abroad. I still need to wrap my head around the idea that IRD is acting now as a bank.