Banking: something not quite right

Peter Lyons attempts to shed some light on the murky and poorly understood business of banking. 

As I am an economist, my emotional range is generally limited to lust and greed. Yet a recent news report did provide a hint of wry amusement.

Several bank spokesmen were on the telly bemoaning a threat to the profitability of their institutions.

They stated that mortgage-holders in New Zealand would have to pay the price.

Banking in New Zealand is a very profitable business. The banks emphasise they operate in an extremely competitive industry. Yet their spokesmen were on national TV saying they could easily pass any extra costs on to their borrowers. Something doesn't make economic sense.

The bankers are protesting against proposed moves by the Reserve Bank.

These will require the banks to have a lot more skin in the game in the form of extra capital.

This would mean that if a bank went bust, the bank owners would pay more to clean up the mess, rather than the New Zealand taxpayer.

The banks are saying if the Reserve Bank tries to make them safer, they will make sure their customers pay the price. For those who have a blind faith in the efficacy of competitive markets this is a bit disturbing.

Our banking system was deregulated in the 1980s.

This means there are few controls on bank lending. The banks decide how much they will lend based on the availability of borrowers with sufficient credit worthiness and collateral.

The banks police themselves. They determine the level of risk they will take.

But banking is not like growing tomatoes. If a major tomato grower goes bust, this has little effect on the wider economy.

If a major bank goes bust, this can drag the entire economy down with it. If people lost confidence in the banks and demanded their deposits back, the banking system would quickly implode.

This is what precipitated the 1930s Great Depression. The 2008 Global Financial Crisis was a near miss.

To put it simply, banks can and do stuff up big time.

Ironically, fierce competition for market share can actually lead to disaster through poor risk assessment.

But economic theory suggests competition is meant to improve efficiency.

Governments are aware they cannot allow the banking system to collapse. Since 2008, the bankers have also been very aware governments will not allow this to happen.

Banking is a murky, poorly understood business.

Banks make their money by creating and lending money in the form of debits and credits in bank accounts.

The bulk of their lending in New Zealand is for mortgages for housing.

As house prices rise this allows banks to lend more, creating more money.

This helps push up house prices, which allows further lending and more money creation.

The debits and credits keep piling up. The 1950s villa in Mount Albert that sold for $25,000 in 1975 now sells for $2 million.

It's a very profitable process for banks and real estate agents and speculators.

The Reserve Bank is trying to ensure that if debt-driven housing inflation turns ugly, the bank owners pay more of the costs.

The other option is you and I pay more to clean up the mess. Either way it will be ugly.

Maybe that feeling of wry amusement was more a mild sense of belated relief.

 - Peter Lyons teaches economics at St Peter's College in Epsom and has written several economics texts.



Mr Lyons appears to have a tenuous grasp on the difference between victim and perpetrator. That somebody who apparently teaches economics to high school students thinks that banks were in some way responsible for the Great Depression is concerning, to put it mildly.

They were just bad managers. Unlike 2008, banks could not be bailed out by the State, in the '29.

The NZ banking system is NOT like the US system and so the risk carried by the banks is considerably less.
If you hold a morgtage in countries such as NZ, Australia or Canada, you carry the risk when property values drop. That means that if you can not make the repayments and the bank decides to foreclose, they will continue to chase you for any losses they incure. That is what the Morgtage Insurance, low income morgtees, are required to pay for. It's not for your protection! It is for theirs!
Therefore the rise factor for banks in NZ is less, hence their profitability and yes, it has added to house inflation, just as it has in Australia and Canada.

Neither borrower nor lender be.

The multi year artificial low interest has been a primary enabler of realestate speculation. When bidding at auction, with a compliant bank manager bending over to give you debt, you go for debt. Home is where happiness is.

Reserve External debt: Loans from overseas entities are a real risk. Internal debt the crown fires up the photocopier. External debt, the photocopier causes Weimar inflation, or Venezuelan inflation.

The next GFC will leave many looking like KFC. Australia heading for a recession lead by housing... see no evil hear no evil say no evil


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