The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Saturday, March 5, 2011

No super profits tax, but banks should pay a premium for taxpayer insurance

I was asked by the Fairfax-owned Sydney Morning Herald whether the banks should pay a super profits tax. My response is published in today's paper:


There is no role for a super profits tax on Australian banks, but there is a case for banks to pay a premium for the catastrophe insurance they receive from taxpayers.

We all want highly profitable, competitive banks run by the best private sector managers. Australia has these in spades. Yet we also want to avoid like the plague ''moral hazard'', which is what caused the global financial crisis, and has historically been the catalyst for previous meltdowns. Moral hazard is the problem of perverse incentives whereby one party, in this case the private sector, is given motivation to take on big risks at the cost of another party, such as taxpayers, who wear the downside when things go wrong.

More colloquially, it is the ''heads bankers win, tails taxpayers lose'' dynamic. One finds it in all insurance markets. If you take out car insurance, the provider wants to ensure you are not using it to fix a past ding, or that you will behave more recklessly because you have this protection in place. Since successful banks are a prerequisite for a healthy economy, taxpayers have little choice but to vouchsafe their survival.

To be clear, banks perform a crucial role: they take in our short-term savings and lend out that money as long-term loans that fund critical investments. Yet it is this mismatch between the maturity of short-term savings, which can be withdrawn quickly, and long-term loans that is the source of the banking system's inherent fragility.

Throughout history banks have always failed when the people who fund them suddenly demand their money back. Accordingly, governments have developed a range of protections to underwrite banks during crises. The most visible of these are central banks - in Australia, this is the taxpayer-owned Reserve Bank - which have an explicit mandate to lend to private banks when they face funding troubles. Since the crisis, almost all nations have also supplied ''deposit insurance'', which guarantees the safety of the money depositors lend to banks, and thus minimises the risk that we will unexpectedly withdraw it. Yet neither of these services is currently priced.

When Frank Lowy created his shopping centre empire, taxpayers never offered to save him if he went bust. Lowy took his risks and is entitled to the rewards. In contrast, the government has declared that taxpayers will always back the banks. A premium should be paid in return for this protected species status.

Christopher Joye is a financial economist."