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Opinion: We have a comprehensive breakdown of the banking system on our hands, says Gareth Morgan. How to respond?

Opinion: We have a comprehensive breakdown of the banking system on our hands, says Gareth Morgan. How to respond?

By Gareth Morgan

Saturday's election has occurred against the backdrop of global instability and the threat of a major meltdown.

That makes the prospects for our new government to deliver on its promises somewhat less certain than normal.

It's not their fault, it's just that the world is really struggling to deal with the consequences of 30 years of debt profligacy courtesy of the financial deregulation heralded in during the Thatcher/Reagan/Douglas era.

Three decades of sub-par central banking governance has seen an utter neglect of prudential policy and since 2008 it's been dawning on creditors that they've lent too much to those whose whole existence depends on their ability to raise ever more debt.

Meanwhile, the profits made by banks and their senior executives who organise these credit lines have been obscene and even after politicians have generously provided taxpayer funds to rescue the system, the profitability and bonuses of the bankers continue. It is one sick system.

Now that Europe, that bastion of monetary conservatism, is being rendered asunder as a consequence of the ravages of unfettered finance and the socialisation of bad lending (ie; issuing government debt to replace private debt that is "too big to fail"), we're witnessing some of the most bizarre political pressures and policy recommendations as politicians flounder to respond cogently.

Who would have thought that in Italy and Greece the politicians would have surrendered power to technocrats in the last-ditch attempt to stabilise their economies?

But the policy recommendations from the besieged politicians are getting more and more bizarre. For example, Angela Merkel and Nicolas Sarkozy are fans of a financial transactions tax apparently as a way of funding the cost of future financial crises. Desperation has descended on a political order bereft of solutions.

Taxes are either implemented to raise revenue or to correct undesirable behaviour. The financial transactions tax was conceived by Keynes (1936) and refined by Tobin (1972) to stop speculation, not to fund a kitty for state bailouts. It's never been implemented anyway, not the least because normal transactions would get clobbered as well and financial transactions would move to another jurisdiction.

If you accept that all speculators buy and sell financial instruments intending to make a profit and that such activity is vital to assure market prices reflect as much information as possible, then slowing this activity via tax is of dubious merit.

Certainly it would clearly raise the expense of conducting all financial transactions. Curiously the supporters of such a tax argue that where speculative flows are by far the greatest number of transactions, more of them would get hit and that somehow makes it okay.

Less speculation would ensue, but so would less trade. There has to be a more sensible response, even if every country in the world introduced such a tax - and that's what it would need to work - this approach would kill the patient.

Let's get back to basics. The ongoing global financial crisis has its beginnings in the "non-traditional" activities of the banks that have ventured into the murky world of shadow banking and off-balance sheet transactions. In short, they took bets on financial market prices, they supplied their balance sheets as collateral, stood as counterparties and even took primary positions themselves in forays to boost profits.

For a while they were wildly successful. Then they required a central bank and taxpayer rescue.

Even after the taxpayer bailout it's been a great ride for some, making their performance bonuses thanks to a taxpayer-provided boost to the balance sheet they can play with.

Should we be surprised about the Occupy Wall Street response? The events in Europe of late shed light on another series of banker-guzzle on the taxpayers' tab. And they can hardly be blamed for it as their windfall has arisen as a direct result of the nonsense that is the eurozone.

It seems perverse that within the single currency zone different countries can maintain different interest rate regimes, apparently to reflect differing risk on sovereign debt.

Yet under the Maastricht Treaty not just was one currency agreed on, but also that budget deficits would all be kept within 3 per cent of GDP - or the offenders would be fined - and an inevitable convergence of monetary and fiscal policy would result.

That would reduce divergence of economic conditions - and interest rates - across the region.

Well, as we know, that's been a joke. Deficits have burgeoned, and the size of risk differences between the member economies have widened, not converged. Ironically only Germany has seen its real wages fall in the face of the twin challenges of absorbing East Germany and confronting the rise of China. Accordingly, the sustainability of its economic growth has risen.

Elsewhere in the EU economic adjustment has been absent, wage rises have been given, labour practices become less rather than more flexible, and welfare benefits grown in unbridled fashion.

Such a diversity of economic management has facilitated plenty of opportunities for the financial arbitragers. For example, the nonsense wherein French banks could raise money from their own retail depositors and then invest that in Italy's government bonds, under a regime which implicitly, at least, guaranteed that no members would default on their sovereign debt.

Until now this has been a licence to print money via a handsome interest rate carry.

As we know Greece has defaulted, the French banks are up the creek, and the initial response of the eurozone governments was to guarantee those bondholders they'd get their money back. Now that guarantee no longer holds, the French taxpayer still has to bail out the once-were-massively-profitable French banks.

And what's more it's become increasingly obvious that these euro governments issuing great dollops of government bonds have no central bank behind them to be the buyer of last resort.

Oh dear, they're government bonds but not as we know them. And still Merkel says the ECB will not play that role.

The common theme through this whole post-2008 saga is that governments can't afford a run on the banks so they will underwrite the deposits no matter what the bankers do with them.

So long as the banks (owners and managers) can make enough money before it all turns to custard they're quids in.

That is the game - look for the quick buck and throw every bit of funding you can find at it, book the profits, claim the bonuses and then wait for it to all hit the wall. Once the bank is driven under, taxpayers recapitalise it to ride again so depositors are fine.

And so are managers and owners as long as they managed to make enough money while the music was playing. The taxpayer gets screwed.

We have a comprehensive breakdown of the banking system on our hands. Raising reserve ratios and improving the quality of capital required has been the response so far, but I'd suggest the sector faces an endemic moral hazard.

So long as it gets a government guarantee for depositors the government must in return dictate to the banks what they can and can't do. Otherwise you get what we all dream of - a taxpayer underwrite with no accountability required - yum.

The solution seems obvious. If a taxpayer guarantee is in place for depositors then the institutions taking in those monies should be severely restricted in what they can do - such as lend them according to old-fashioned prudential principles.

Since financial deregulation, the Bank of International Settlements and all its member central bank leaders have totally lost the plot on the practice of being prudent.

What should be beyond the scope of an institution that takes in deposits under a government guarantee is any ability to raise other monies that aren't taxpayer guaranteed, to issue bonds and subordinated debt and go and play in the shady world of derivatives.

The moronic "Quants" of the financial engineering world have blown up the financial markets by assuring their banker bosses they can quantify the risks. The bosses don't have to care, courtesy of the taxpayer guarantee.

A "back to basics" of retail banking is the place to start. If the central bank wants to control the risk to depositors in approved institutions it has to effectively control the risks that those banks take with those deposits.

This is a very simple principle that went out the window with the financial deregulation of the early 1980s.

Nationalising institutions that have a taxpayer guarantee is logical. At the very least a far more stringent, flexible and coherent prudential supervision from central banks is years overdue.


Gareth Morgan is a director of Gareth Morgan Investments.
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Looks like the banks will be back to normal practice -  running companies into the ground while avoiding most economic suffering themselves....


Your right when you say " back to basics" that means strip as much as you can out of every customer, if they can be urged to extend to even more unsustainable credit, then there is a bonus for the banker. This banking system is immoral and is destined to be scraped, tho I fear, the bankers and their Polly friends won't let go the golden goose without one hell-of a fight.

The Governments need some spine with the banks.

1 If Government has to bail out a bank to protect depositors, then at that point the bank shareholders should lose all equity in it and the Government assumes full ownership.  If that results in a few fat cats loosing any residual equity - tough, having a banking liscence is in many ways a liscence to print money; so it should be a privilage with responsibilities and significant consequences if abused.

2 Banking professionals should liscenced and require suitable training and experience to attain registration as per most other proffesions.  The sorts of failures we have seen should result in wholesale, permanent deregistration of those involved, not just a handfull of sacrificial heads either, but a good swath through senior managment. I.e. they should be kicked out of the industry for ever.

3 Creative, leveraged etc investment banking activities need to be outlawed.  (little hope of this however when we see foolish governments using just these vehicles to try and wriggle out of the mess they are in.)

The simplest solution is for the government to charge each bank an annual licence fee of $500 million to set up and operate their stall. Plus a RRT resource rent tax.

While I'm sympathetic to some of Gareth's points here, I think he is painting the world with an extraordinarily broad brush that I don't really think does his case justice.

For example, he seems to want to lump all bank behavior across the world since the GFC together, neglecting for example the fact that US banks' debt ratios now average 7:1, just off their all time low of 6:1

He also seems to want to lump all government support for the banking sector since the GFC together as essentially evil, neglecting for example the fact that in the US direct lending by the Fed is believed by many to have saved their banking system, in contrast to what seems likely to emerge shortly in Europe

And he seems to imply that deposit insurance schemes are purely a cost on taxpayers, when in fact these schemes are generally funded by premiums paid by the banks themselves.

And while improved prudential regulation may well be totally justified, claiming that bank nationalization is therefore 'logical' really looks to me like something other than logic.

If any other buisness is not able to meet their financial obligations they are bankrupted and the shareholders are at the bottom of the heap.  Why should banks be treated any differently?



I agree Gareth is pretty reactionary in this case, and clearly his article lacks a full look at the costs and benefits a nationalised banking system would offer. Sure there would presumably be less unnecessary "financial innovation" under a nationalised banking system, but it would also come with all the downsides that government/monopoly-dominated markets usually present, and presumably the taxpayer would (by construct) be on the hook for any losses suffered by such an institution.

The tax payer is already on the hook. In the U.S. and Europe the tax payers have bailed out the private banks to the tune of billions of dollars. Heads you win, tails I lose.

Mark Thomson:  says "the Fed is believed by many to have saved their banking system

Did the Fed save their "Banking System"? or did the Fed save their Banks?

That is an interesting comment Iconoclast. I have read that the US federal Bank is privately owned. If that is the case then the shareholders of the Fed are sure to also own shares in other banks in the "Banking System". The Fed therefore would have saved its shareholders and indirectly the other shareholders of all those other banks

Im not sure yet but I think not.....think of it as a cancer, its maybe in remission.  More likely, meanwhile voters have been injected with massive doses of toxic debt to try and fix things and now look sick as a pig...the cancer meanwhile has been rampently consuming even more.....


What business is it of the governments to save private companies?  This is a false assumption in my view.  Make everyday accounts first in line, and the institutional depositors and bondholders last.  This will create a prudentitial financial system very quickly.  Take away all guarantees, make the big money carry the risk, they will decide the risks are not worth taking, and the banks will fail or sort their shit out.

People cannot live within their means, governments cannot live within their means, money has been borrowed with no intention of paying it back.  The calls for the ECB to buy unlimited PIIGS bonds, will allow this to continue, most governments are borrowing just to meet the interst payments, debts are never paid they are merely "rolled over".  Borrowing to pay interest, and borrowing to repay debt plus borrowing to buy the groceries, will make the whole discussion irrelevent.  Governments should never have been allowed to tax future generations. Irresponsible borrowing by past generations is foisted on succeeding generations. The sins of the forefathers are preserved with interest to gouge the quality of life of younger people who neither decided upon nor benefited from irresponsible borrowing.

Certainly, we now see scorched-earth class warfare of the 1% against everyone else, but we are ignoring an even more profound unintended warfare by an entire generation of post-WWII world citizens against the wellness and interests of its own children. 

The only options left, are too keep borrowing, until the debt gets so high that even the interest becomes unpayable, enforce austerity and raise taxes in mind numbing beliefe that the only thing worth spending money on is interest payments, default and start over, or get a brand new plan. 


Well given that the banks that caused these problems were American and European banks, and we are neither Europe nor the United States, I’m not really sure what the point of his article is? Many of the issues that he eludes to have nothing to do with us, they did not happen here, and we can’t do anything about fixing them either, because it’s not our job or responsibility to do so.  None of our banks have failed. Shouldn’t that be the point? What are we supposed to do in New Zealand now? Get our knickers in a knot over events that happen in foreign countries and race to pass laws in NZ to make sure that our statutes fix Spain and Wall Street? Let’s keep the focus firmly on what we are doing here in NZ and what needs to be done here, based on what is actually being done in New Zealand!  New Zealand is not everywhere else, and everywhere else is not New Zealand.

Wouldn’t he be better to critique the Finance industry, rather than getting his knickers in a knot over the dodgy practices of foreign banks that may or may not be happening here, and banks that don’t even have a retail presence in New Zealand? Now that fiasco did happen here. What are his suggestions about fixing that joke, of vainglorious hobbit high finance that destroyed about $7bn of the country’s money? What regulations do we need to stop that happening again because I’m not sure that enough has been done about that to be frank. I’d be very interested to know what his views are on that.

Just a comment on "the threat of a major meltdown" in the first sentence of the article - we have been warned of this since 2008 (if not a little earlier). It's now 2011 and well, a number of financial institutions did collapse but it's hardly an Armageddon-like scenario so far. In any case, day-to-day life in NZ doesn't seem to have changed that much to me and the banks haven't closed down and stolen all my savings (yet).

Is the "comprehensive breakdown of the banking system" mentioned later in the article actually a reality? Not that I am putting my head in the sand or unaware of the world economic situation but as per above, not that much has changed really (house prices are even going up again it seems!). I'd be interested what others think of this article (titled "Why the Euro Doomsayers Are Wrong"):

"actually a reality"

There are some interviews on youtube (I think it was) saying that the Lehman crisis took us to within hours of a tsunami blasting around the world shutting down the financial inter-bank lending that is scary.

Now why would Dr Bollard want to put a safety cutout in place if this was not a real risk?  and in fact I think there is an interview with him on for me too many serious ppl think its serious.....

The piece you have is an interesting point of view of the author, he seems to think its a game of chicken and it will all work out.....rather than a game that is out of control....which I think is more accurate.  Once the interest rates get to 7% the game is long over.....private capital has fled...all that is left is the ECB buying. Govn bond markets in the EU are gone bye bye....meanwhile Govn's run around like headless chickens trying to get private investors back in the game in a super fund, fat chance......they in turn are staying over in the USA.....

I dont think the ECB is controlling anything, they are re-acting and desperate becaus eno one else is left....but thats my point of view.

Yes, NZ has been little hit.....but farming is hugely exposed to a downturn. If as happened three years ago Fonterra starts to not sell product at the margin that give dairy farmers >$5.50 then I just wonder how long before a decent % goes bust.....which means mortgagee sales.....which means dropping prices, which means the banks loan book is now over-leveraged....which means banks are bankrupt, so close doors.....I can see a chain of events that does not look pretty.  I think the US banks are already there (bankrupt) just no one is looking too closely because that is a nightmare no one wants....



Gotta admire the cajones of those Paterson Institute guys, reassuring we can all breath a sigh of relief, since parliamentarreans in Europe have acquiscinced to having Brussels foister precisely the mindless clowns who got the world in the economic mess we're in, can somehow get us out of it. priceless.

Governments need to be the borrower of last resort to stop the money supply shrinking.  It has to do with debt=money - interest, the amount owed is greater then the amount of money available to repay.  Stop governments borrowing, and making them reduce debt levels is bad.

4% GDP growth, 12% debt growth, debt to gdp doubles every 9 years, 30-40years debt to gdp is 300-400%.  GDP and money supply are linked, cut the money supply you cut gdp.

David B

"Many of the issues that he eludes to have nothing to do with us, they did not happen here..."

I think you'll find a lot of similarities between NZ's banking system and those in Europe and the US (relative size, relatively few, fractional reserve, credit expansion, asset prices etc etc).  The outcomes have been far 


S & P has downgraded all major American Banks, including Goldman Sucks...should have done it 4 years back.....


More on those S&P downgrades, including the full list, right here -

How has Gareth gone so wrong?

Private debt is not a problem, or certainly not the taxpayers problem, so long as insolvent firms (malinvestments) are allowed to fail and not bailed out by irresponsible governments. On this basis economies could have fixed themselves very quickly.

The problem is public debt racked up be huge spending welfare/warfare governments to such an extent it is now impossible to repay this debt. Gareth should have a read of this significant article (hat tip NotPC).

So the problem is with the very group that Gareth wishs to regulate the banking sector: governments.

Further, we need to be relooking at the whole central planning notion of central banks, proper.


(I'm in the Marlborough Sounds on expensive Internet, so take your best pot shots, I won't be back to defend this argument, even though it's so obvious it shouldn't need defending. Okay, start spewing the venom).

I concur

The level of private debt in New Zealand is a way bigger issue than public debt is.

Overseas public debt has quite often got to unmanageable size because it has taken on private debt (e.g. Ireland and the banks) -- maybe as consequence of a protection racket run by banks and rating agencies -- not by welfare.  Here a little bit of that has happened -- e.g. AMI Insurance, South Canterbury Finance.

Private debt is not a problem other than for the shareholders, which is where the losses should have stopped, allowing a quick correction of malinvestments. Governments have turned the whole debt issue nuclear, as central planners always have in the past.

Needless to say Steve Keen disagrees with you. Most people who predicted the crisis did so based on looking at private debt levels, in various sectors of the economy. Debt was certainly the problem for the banks which couldn't roll it over when the markets froze. Debt then became a problem for every business or deposit holder who either needed credit could not access their money (deposits are a liability or debt of the bank).

Did I leave anyone out?


And why such a high level of private sector debt? Central banks - nothing to do with laissez faire - creating artificially low interest rates, passed on to banks, and by banks leading to business and mortgage holders taking on far more debt than was prudent, or than they would have if the true cost of debt had been driving the market, rather than the central bank government distortion.

And still the same fix. No government bailouts, let the losses from those who made the malinvestments stay with them, not socialised out to the taxpayer to, now, bankrupt entire economies.

The State, central banks, unsound money thanks to Keynes, central planning was the problem from the inception. And yet this is the sector Gareth thinks we need more of to fix the problems caused by them. It's crazy.

Of course [private] debt is the problem....The problem comes when the national private debt is so large that the losses overwelme the entire system and causes a collapse....nothing to do with Govns causing it, all to do with Govn's not preventing it.....ultimately though this is the voters fault....rinse and repeat going back at least 150 years......

but of course thats what you hope for isnt matter the misery that is caused just as long as there is a small chance libertarianism will end up on top after a period of anarchy...



Read my last post steven. What caused such a high level of private sector debt/malinvestment? Why do you expect the State planners that caused this are able to fix it? They can't, because the only mechanisms that have to be pro-active, are the very factors that caused the mess.

Just free the markets, get governments to step back. Harsh implications short term, but better than what the world is headed for otherwise.

Mate it wasn't state planners that caused such a high level of pprivate debt.  It is just something intrinsic to capitalism.  Denial of this is intrinsic to flawed neo-classical economic theory.  

What part of artificially low interest rates generated by political entities known as central banks in a centrally planned, though deluded, attempt to stimulate markets 'intrinsic to capitalism'?

Maybe you haven't connected 'intrinsic to capitalism' and the way that privately owned financial institutions create money?

Gareth is bang on right....the RBNZ is nothing but a puppet dancing to a tune....but now that a National MP has crossed to the other side...don't expect one finger to be lifted...

Gareth Morgan has jumped into the Bernard Hickey camp , decrying financial de-regulation ..... the problem was , the process was halted . We never achieved the full de-regulation which would have brought in fiscal responsibility ......

..... would the " too-big-to-fail " bankers have been so reckless if their necks were really on the line ? ..... they knew they had the Greenspan ' put " to bail them out ......

When the central banks are abolished , then we'll make true progress . ..... less meddling & regulation please , not more .....