all know you can’t insure a car for more than it’s worth. This is because insurance companies understand something called moral hazard. Moral hazard is a concept saying that people will take risks if they have an incentive to do so. Ergo, if my car is valued at $10,000 but is insured for $20,000, I might be tempted to torch it.
Moral hazard can entice individuals insulated from risk to behave differently than they would if fully exposed to the risk. Examples include tenured professors becoming indifferent lecturers, insured drivers being less vigilant about car theft, protected managers making poor decisions and unemployed workers being less inclined to look for a job while on government benefits.
The subprime crisis is another example of moral hazard. Many US financial institutions recklessly lent money to people with poor credit histories to buy overpriced houses. They deliberately lowered their credit assessment standards knowing that they could package dodgy loans into mortgaged backed securities and pass off the risk of default to unsuspecting investors.
Moral hazard is commonly associated with any type of safety net including deposit insurance. At the height of the Global Financial Crisis (GFC), governments around the world guaranteed the deposits of citizens in banks and other financial institutions. Most commentators believe that this unprecedented intervention was necessary to protect the global financial system from meltdown.
As the crisis passes, the OECD is urging Australia to fulfil its promise to remove its deposit guarantee which, it argues, is a moral hazard. Nevertheless, the OECD acknowledges that both depositors and banks now believe the Federal Government will always come to their rescue in times of trouble.
The belief that a bank is too big to fail represents a classic moral hazard. If the public and the management of a financial institution believe it will receive a financial bailout to keep it going, management – in theory – may take more risks in pursuit of profits. Yet, there’s no evidence that the deposit guarantee has actually encouraged Australia’s Approved Deposit-taking Institutions (ADI’s) – i.e., banks, building societies and credit unions – to behave recklessly.
We have a strong prudential regulatory system governing ADIs in Australia. While there’s no doubt that moral hazard in financial services is real, our robust regulation and good practices prove that this risk can be mitigated.
The GFC shows that governments will act to save banks which are too big to fail. This gives our ‘Big Four’ Australian banks an implicit guarantee and an unfair advantage over smaller credit unions. That’s why I believe the current retail deposit guarantee scheme should be maintained after its proposed review date in October 2011.
As someone who is a staunch believer in free markets and survival of the fittest, I can fully understand why the Reserve Bank of Australia opposes the extension of the deposit guarantee. I too accept that governments should not be the first port of call in times of crisis. However, some form of depositor safety net for all ADIs is essential to provide a more level playing field for Australian credit unions and building societies.
The deposit guarantee scheme provides protection for ordinary depositors, fosters competition in banking and doesn’t cost the taxpayer a cent. In short, it’s a necessary evil if we are serious about the mutual sector being a viable alternative to the Big Four banks.
Posting Date: 6 September 2010
Stop the pandering
Everyone has theories. We all have our own explanation for why things work the way they do. I’ve had a theory for as long as I can remember and it relates to short-term thinking. Whenever we make decisions based on quick fixes, instant gratification and populism, we suffer long-term consequences. We see this time and time again in politics, business and even our homes.
We all intuitively know that true leadership is not a popularity contest. This is why prime ministers, CEOs and parents must be capable of making unpopular decisions at times. The good news is that most constituents, employees and children will respect you in the end for making the right choice.
To do and say what is right – as distinct from popular – means that you sometimes have to stand alone which takes strength of character. But if you have a clear vision of the future and how it ought to be, then you can drive change in the face of opposition through the courage of your convictions.
Regrettably, such bold leadership is increasingly difficult to find in politics as politicians have become scared of upsetting the electorate. Opinion polls and minority groups now unduly influence policy formulation resulting in long-term economic credibility being sacrificed for short-term populist reforms.
Paradoxically, when political leaders make decisions based on opinion polls they end up being followers, not leaders. They also become reactive rather than proactive. Moreover, inspired leadership gives way to emotive and ill-informed slanging matches.
The end result is the public gets policies that are against their own best interests, particularly those that threaten business. There are many examples of this in Australia. The Australian Retailers Association branded the government’s push to ban plastic bags as populist politics.
The Business Council of Australia believes the immigration debate has descended into populist rhetoric, noting that we need continued, sustainable growth to ensure that our children inherit a strong economy. The ANZ Bank boss recently warned that populist policies were spooking foreign investors.
For my money, former Western Australian Premier, Geoff Gallop, got it right in a recent article, When populism raises its ugly head, wherein he stated that populism:
... prefers nationalism to internationalism, protectionism to free trade and fundamentalism to multiculturalism. Populists want politicians to support “us” as against “them”... They distrust business and support local environmental activism but don’t like... the philosophy of economic rationalism.
Okay, here comes the sting in the tail. Brace yourself – it’s largely our fault if we end up with poor political leadership. As French political philosopher, Alexis de Tocqueville said: In democracy, we get the government we deserve.
We all “have a say” in voting governments in and politicians should be worthy of the people they serve. Equally, we have an obligation to behave responsibly and to avoid short-term community hysteria just because we don’t get our way on a particular issue.
For example, when it comes to rising interest rates, I know, politicians know and every first-year economics student knows that they are a sign of economic growth and prosperity. Yet many in the electorate expect the government to say the opposite – and it does – as it knows mortgage rates are a political hot potato. Boy, I’m glad I can speak the truth.
Posting Date: 16 May 2011
Modern day Greek tragedy
Is it a case of life imitating art? We’ve had the Big Fat Greek Wedding, now we’ve got the Big Fat Greek Debt. Unlike the light-hearted movie, the drama that’s unfolding in Greece is a sobering tale of the crippling impact of government largesse and corruption.
This sorry saga – let’s call it The Art of Political Deception – started long ago. While Greece’s economic mismanagement does not date back to the time of her famous sons, Socrates and Plato, it can be traced to the establishment
