The visible hand in economics

Comic: NZ deposit insurance for finance companies

Posted on: October 15, 2008

Mike Moreu is on the money again! The link is here.

Why is there no haircut for the insurance? Why are the fees not linked in inherent risk?

I agree that in some countries governments need to “recapitalise” banks by buying parts of them. I agree that a deposit insurance scheme can avoid bank runs (and can do so in a way the private sector may struggle with because asymmetric information leads to “too little” insurance). However, effectively charging the safe institutions more for insurance (which is what is happening to the banks) is RIDICULOUS – and will lead to too much risk being taken on in the future, at the taxpayers expense.

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7 Responses to "Comic: NZ deposit insurance for finance companies"

[…] Read more:  Comic: NZ deposit insurance for finance companies […]

Matt

I commented here in similar vein

http://adamsmith.wordpress.com/2008/10/14/8274/

The NZ scheme seems to have a number of problems. As I construe the scheme at present just about all forms of investment including Kiwisaver are going to be covered after an announcement yesterday.

No account seems to be taken of moral hazard.

The banks, essentially Australian, are in effect being charged fees to cover the excesses of small and in a number of cases poorly run and regulated NZ institutions.

This is not right. Furthermore, I suspect that the consequences in terms of attitudes towards NZ down the line will not be positive.

Having agreed to cover Kiwisaver and the finance companies what is the exit strategy? Is there an exit strategy?

Is the policy being driven by the RBNZ, the Treasury or politicians or a camle comprised of all three. At present they do not appear to be making a very good job of it at all.

Moral hazard?

We are talking about banks here.

But seriously, just as competitive pressures ar partly responsible for the rush to extend credit to obviously high-risk borrowers in the subprime collapse the rush to “shore up” the banks and the shadow financial system was done because … er well, K Rudd was doing it (and Gordon “not Gecko” Brown and the the folks with the funny accents a bit further east).

The hope is that two years will be long enough for the interbank markets to resume normal operations. But then, if two years isn’t enough, moral hazard is gonna be the least of our problems.

Did they do it on purpose?

The poison pill budget and now this steaming pile?

Hi Adam and Dismal,

Ultimately, it is apparent that there is some type of problem in the credit markets – ergo why countries are recapitalising banks and offering insurance, both of which help to steady the ship and dampen any existing information asymmetries in the marketplace.

Neither of these policies look like they would provide moral hazard, as they are not bailing out the people who took on undue risk when taking out the loans.

However, when the bank guarantees deposits, if only for 2 years it, it creates a moral hazard problem.

Say that we are scared the credit market will fail, so we say we will guarantee deposits for 2-3 years for all institutions. The risk taking institutions will use this guarantee to load up on risky, high return assets, knowing that in 2-3 years time the same government that bailed them out would be worried about getting rid of the guarantee if it would lead to the same problem.

Such guarantees, if preformed in a blanket way over the entire credit market, don’t do anything to help the market move towards equilibrium.

Personally, I think recapitalise banks and offer insurance at a rate that represents the risk inherent in the institutions balance sheet. Also use the additional information the RBNZ receives through this insurance process to help the market function more efficiently. The losses that the market has to face from the fact that expectations are out of whack with reality will HAVE to happen – we are only trying to avoid overshooting this point.

“Did they do it on purpose?

The poison pill budget and now this steaming pile?”

I see now that they are doing “a just before the election” budget – but not telling anyone how much their promises will cost. If Labour wins, how can they claim to have any mandate given there refusal to actually give voters accurate information.

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