Friday, October 22, 2010

Hock-onomics and co-operatives

It would be cruel to use the term "Hock-onomics" to make fun of the shadow treasurer if it weren't for the fact that he invented the term himself.

His latest embarrassment is over calls for what seemed to be regulation (though he changed it to a social compact) of the banks to stop them increasing interest rates by any more than any increase in "official" rates. In doing this Hockey continues his ongoing confusion that low interest rates are necessarily good.

History records that one factor that contributed to the GFC was Alan Greenspan's determination to keep rates artificially low. Not only did it help cause the debt binge, it also meant the US was extremely limited in the monetary stimulus it could provide.

More importantly, the RBA sets its official rate with the spread between official and retail rates in mind. They know that it is the retail rates that affect the level of economic activity. If the retail banks increase the spread by 0.25% then that is one rise the RBA simply doesn't need to make.

What lies behind Hockey's concerns, and indeed Treasurer Wayne Swan's, is that as a consequence of the GFC there was a further concentration of the retail banking industry. The Oz reports;

Bank chiefs such as the Commonwealth's Ralph Norris and Westpac's Gail Kelly have gone to great lengths to explain that in a new world, post-global financial crisis, the cost of raising funds on the international markets is increasing as investors take on a tougher view of risk, thanks to a range of ill-advised investments by banks thousands of kilometres away from Australia.

But this story is totally inconsistent with the suggestion that one source of the strength of the Australian dollar is capital inflows seeking Australia's already high (by global standards) interest rates.

Ultimately the concern is that policy makers have no real way to discern the difference between collusive rate increases to capitalise on market power and genuine need to reflect increased costs of funds. At least ACCC chair Graeme Samuel is alert to the potential for the banks to collude by public signalling of their intention on rates.

Against direct intervention on rates, a potential solution is to resolve the market structure issue. Some have bemoaned the loss of the mortgage originators like Aussie and Rams, forgetting of course that their model of securitised mortgages created the market for un-valuable and ultimately valueless derivatives.

There has been some suggestion that Australia Post could go the route of its New Zealand counterpart and get into banking. David Murray's call for AP in banking stopped well short of that. His vision is more about the opportunities for Australia Post to exploit its distribution network as a financial services "supermarket". However, Australia Post already provides many of these agency services for bank and non-bank financial institutions.

Certainly it would seem mighty strange for the CEO of the Commonwealth Bank at the time of its privatisation to be now calling for effectively a Government owned bank. In any case Australia Post already provides a range of agency services for non-bank financial institutions.

Others have bemoaned the loss of the mortgage originators like Aussie and Rams, forgetting that their business model of securitised mortgages created the underlying product from which the un-valuable derivatives emerged.

At core though, the real concern with the "big banks" is the for "for profit" model. No one objects to the shareholders in banks getting a reasonable return on capital invested, except for the fact that the shares traded on the stock-market bear no relation to actual investment, and the returns seem excessive.

The not-for-profit "bank" sector in Australia (Credit Unions and Building Societies) suffered discrimination by the "system" for many years, most notably their exclusion from direct participation in the payments system. Far worse they lost their income tax exemption in the mid 1990s.

The loss of that exemption was argued by the banks as a requirement to remove the other barriers affecting the not for profit sector. But the logic of the income tax exemption is still valid. The for-profit banks face income tax but they pass profit on to shareholders as dividends which are "franked" - that is the shareholder is credited with the tax already paid. The not-for-profits provide their profits to members in lower prices or higher deposit rates the consequence of which is to mean the full benefit is effectively taxable for the shareholder.

Any not-for-profit whose constitution prohibits the distribution of profit to shareholders/members/customers as dividend or capital return should have its tax exempt status restored. That, combined with the aggressive expansion by AP of its agency facilities, has the potential to dramatically change the dynamics of the Australian retail (consumer) banking market.

There is no need for AP to vertically integrate into being a Deposit Taking Institution to leverage its distribution strength, but this valuable public asset should be used to service a revitalised not-for-profit banking sector.

Novae Meridianae Demetae Dexter delenda est

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