Category Archives: Regulating the banks

It is critical to control banks so they can’t lend for speculation.

Our submission supporting our petition to Parliament on bank stability

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I have been following the twitter discussion of Jesse Colombo’s Forbes article on why the New Zealand economy will crash. I realised I hadn’t ever posted our submission made in November last year to the Finance and Expenditure Committee. The petition has never been heard. Must be gathering dust on some shelf somewhere. They have more important things to do no doubt than worry about the banks increasing exposure to derivatives and the increasing globalisation of the investment banks. Looks as though the big four Australian banks these days have directors from HSBC, JP Morgan, Citibank and so on. To say they are Australian banks is no longer accurate.

But back to our submission. Here it is. You will see the graphs of the rise of derivative exposures of Australian banks.
To The Chairperson and members of Finance and Expenditure Committee

Re Petition 2011/78 of Deirdre Kent and 877 others

Thank you for the opportunity to present my submission.
I wish to appear before your committee in a session open to the public.

Submission on the Petition of Deirdre Kent and 877 others, which asked:

We respectfully request that the House initiate a Parliamentary Enquiry into the best options for securing the ongoing stability of NZ registered banks to ensure they never need to be bailed out by their customers or NZ taxpayers. We also request this enquiry should include:-
1. An examination of The Chicago Plan Revisited by Jaromir Benes and Michael Kumhof on the IMF’s website.
2. The ways New Zealand can initiate or support this important reform.

Who I am
My name is Deirdre Kent, from Otaki. I have a BSc in mathematics and have been a secondary school teacher and full time campaigner for tobacco control. I have been a Tauranga city councillor and for many years a community activist for a strong, resilient economy. I am the co-founder and co-leader of the New Economics Party of New Zealand. I am the author of the 2005 book Healthy Money Healthy Planet –Developing Sustainability through New Money Systems. I was a co-founder in an organisation called NZ Banking Reform which operated in Wellington around 2000 to 2002. I was a founding trustee of Living Economies Educational Trust.

I represent 190 people from the New Economics Party, together with a further 200 on our Facebook page and a further 107 on our Facebook petition page.

Structure and contents of this submission
I outline why some of the public is losing faith in economists. I explain how the way the global monetary system including New Zealand as now structured is inherently unstable, (that is not reaching the desired state of a dynamic equilibrium). I describe how our petition arose from Open Bank Resolution. I explain why we decided to ask for a Parliamentary Enquiry. I look at who the enquiry might attract. I discuss what the enquiry could include. Finally what an enquiry might turn up.There are links to graphs, articles and a slideshow. (For those with minimum time may I suggest you peruse the headlines plus the charts of Jesse Colombo in 2.9 and read the short transcript of IMF economist Michael Kumhof at the end of 7.5 and anything here on the Rentenmark.)

1.0 Summary of this submission
We are asking for a Parliamentary Enquiry on the best way to make banks stable because it appears we have to choose between a government bailout and depositor bailout and neither is acceptable. If banks are so unstable as to have the Reserve Bank set up a system where depositors bail out the banks, then it is high time for a concerted effort to make banks more stable in the first place.

A full enquiry is the way to draw out all the relevant information on banking stability in New Zealand.

New Zealand has watched a series of distressing economic crises in the Eurozone and USA and witnessed a range of fraudulent behaviour from banks. It appears that the central bankers of the world are themselves gravely concerned about the stability of the current financial system.

We know we live in a hyperconnected world but are collectively unable to do anything about the lack of effective regulation of the big four US investment banks. We know that there are three bank lobbyists for every elected member in the US Congress and the banks’ campaign contributions are very high. Hence the plea to do what we can in New Zealand in the time available. It is time to take stock and better insulate our economy from the shocks in the global financial system.

Given the risk of another major financial crisis when the triple threat of worldwide housing bubbles, commodity bubbles and derivatives bubbles eventually burst, we believe it urgent to set aside Parliamentary time and resources and engage the public in an exploration of how we can make New Zealand banks safer.

In the Global Financial Crisis of 2008 our government had to act very quickly to guarantee our bank deposits, but the scheme has now finished. The last thing New Zealand needs is for chaos to break out when depositors discover they are having their money confiscated.

I also point out that housing bubbles are all occurring within the context of a tax system that taxes income but not land. So there is a connection to the tax system.

2.0 Many have lost a great deal of faith in the economics profession after the Global Financial Crisis.
2.1 As lay people, we have been told that our banks are safe yet we have observed a massive Global Financial Crisis which mainstream economists had not predicted. We saw the too-big-to-fail banks getting even bigger and nobody go to jail for fraud. With all these adverse financial events happening we have lost faith in economists. While we appreciate the work of the Reserve Bank of New Zealand to keep our banks safe, we believe they have underestimated the public outcry and the potential of the public to make a contribution. We have all witnessed the invention of a wide range of new financial products and a blow out of credit the world has never seen before. We can all see that the ‘shadow economy’ is $700 trillion while the global economy is $70 trillion and we are worried.

2.2 We don’t want either the taxpayers or the individual depositors to bail out the banks. We know banking crises are very serious and something must be done very quickly to avert social unrest and keep the economy going. According to a book by his spin doctor Damian McBride, UK Prime MInister Gordon Brown said, “If the banks are shutting their doors, and the cash points aren’t working, and people go to Tesco [a grocery chain] and their cards aren’t being accepted, the whole thing will just explode. If you can’t buy food or petrol or medicine for your kids, people will just start breaking the windows and helping themselves.”

2.3 It is clear it is not financially viable for the taxpayers to bail out the banks ever again. Also according to President Obama in his remarks on the Dodd-Frank Act on July 15, 2010, “Because of this reform, . . . there will be no more taxpayer funded bailouts – period.” But the arrival of a bail-in proposal, where depositors have their deposits confiscated to help the failing bank, brings with it serious consequences. Financial crises are socially and politically dangerous events and can happen within a very short timespan. We now know that martial law was being considered in UK during 2008. But perhaps bail-ins and martial law should really be seen as the last desperate thrashings of a dinosaur. It is time to get banks less vulnerable in the first place.

2.4. One cannot help come to the conclusion that the financial system, especially after the spawning of a range of exotic innovative financial “products”, is inherently unstable. It was derivatives after all that were at the heart of the Global Financial Crisis of 2008 and, despite some regulation, yet the same financial asset bubbles are redeveloping as a symptom of growing private debt as before the crisis. As long as excess money is going into real estate or other bubbles, it will not be going into productive enterprises.

2.5 Most people are completely surprised by financial crises. People in Iceland, Cyprus or Thailand can wake up and find the banks closed, ATM machines not working and their relations stuck overseas unable to get home. Investors suddenly find they are worth less. Shortly after the Global Financial Crisis, the Queen of England asked bankers why nobody saw it coming.

2.6 Since only a handful of economists actually predicted the Global Financial Crisis it is not surprising that the public is losing faith in economists. Dutch economist Dr Dirk Bezemer researched those who did and found Dean Baker, Wynne Godley, Fred Harrison (UK), Michael Hudson, Eric Janszen, Steve Keen (Australia), Jakob Madsen & Jens Kjaer Sørensen (Denmark), Kurt Richebächer, Nouriel Roubini, Peter Schiff and Robert Shiller. Subsequently Bezemer had the list at three dozen, but out of a total profession of at least 20,000 it is a very poor record. If any other profession (e.g medicine) was so wrong in something that affected millions they would be sued. The universities who train economists should be ashamed of themselves to have such a poor record.

Economists in the Real World Economics Review 2010, voted for Australian Professor Steve Keen first, ahead of Professor Nouriel Roubini by a 2 to 1 margin for their Revere Award. This is for the economist who best foresaw the crisis and warned and gave a full explanation. So it is not surprising that Steve Keen’s analysis, based on the work of Hyman Minsky and including the use of dynamic modelling to prove how growth in debt drives instability in economic cycles, is gradually becoming more mainstream.

Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. He said we moved from a hedging stage where risk is low to a speculative stage and finally to a Ponzi stage. Minsky said a key indicator was the growth of private debt as a fraction of GDP, but when I ask I can’t find this graph on the Reserve Bank site. The “Bezemer 11” quoted above had in common that they were concerned with the distinction between the financial economy (making money from money) and the real economy. Keen wrote in 2009 “Unfortunately after the crisis everything is being done by policy makers around the world is instead trying to restart private borrowing.” Wikipedia notes that Minsky’s theories have enjoyed some popularity, but have had little influence in mainstream economics or in central bank policy.

Regulators like Brooksley Born (head of US Commodity Futures Trading Commission) warned that derivatives trading needs stronger regulation and when her concerns were dismissed she resigned. In his book Bailout, Neil Barosky, regulator of TARP warned that the big banks must be broken up.

2.8. The failure to constrain the derivatives market has made the public mistrust big banks and those who regulate them. Derivatives can be useful tools for managing risk, but they’ve often had hugely negative, albeit unintended, consequences. All the big four American banks of the world are knee deep in derivatives, because like banks everywhere they found they could make huge profits from tiny margins. As a Forbes Magazine contributor wrote in March 2013, “The derivative bubble is a gigantic financial accident waiting to happen; it’s the “mother of all bubbles”.”

Although the official figure for notional derivatives contracts from the Bank of International Settlements was $633 trillion as at December 2012, it may be larger still. According to one of the world’s leading derivatives experts, Paul Wilmott, who holds a doctorate in applied mathematics from Oxford University, $1.2 quadrillion is the so-called notional value of the worldwide derivatives market. In contrast the World’s Gross Domestic Product was $71.8 trillion in 2012. Whatever the actual figure, it is clear it has got out of control and that the financial economy is overwhelming the real economy. Moreover the growth of OTC (Over the Counter) derivatives continues unabated.

So what about the Australian banks exposure to derivatives? The graph above shows the growth of derivatives since 1998. The graph below shows how large the notional value of derivatives is in relation to assets or deposits. The third graph shows how the Global Financial Crisis scarcely made any difference to the vertical trend.

2.9 In addition to a rapid rise in derivatives, the worldwide housing bubbles have continued, mostly in the big cities, even though there was a dip in some countries during the Global Financial Crisis. The housing bubble is no different. The series of charts by Jesse Colombo showing the housing bubbles continue unabated in a wide range of countries. We now have worldwide asset bubbles in derivatives, housing and commodities happening at the same time.

The French bank Societe Generale’s Albert Edwards, seeing housing bubbles especially in London and China wrote to his clients (Oct 24, 2013, Business Insider Australia) “I keep reading that, despite central banks spewing money into our financial system, there isn’t a bubble in asset prices. And in any case if one appeared central banks, having learnt the lessons of 2008, will head it off with macro-prudent policy measures. Are you kidding me? Exactly the same bozos who missed the last bubble deny there is one now.”

1.10 We now have a growing segment of educated, informed and networked public.
Given the importance of economics and the devastating effect it can have on the lives of millions when it goes wrong, it is natural that many concerned individuals are becoming informed, largely through the internet. Economics is about “household management”. Multiple tools are needed to ensure flows of resources and services within the household of the biosphere and within human communities, and money is a symbol of value. So economics is too important to be left to economists. When high status economists like Ben Bernanke did not forecast it, and after the event said that the basic theory was correct, it is clear they high priests of economists have a way to go. Bernanke even said “Do these failures of standard macroeconomic models mean that they are irrelevant or at least significantly flawed? I think the answer is a qualified no. Economic models are useful only in the context for which they are designed. Most of the time, including during recessions, serious financial instability is not an issue”

The public knows there is huge risk. The World Economic Forum now has regular conferences to address global risks, and produces a report each year. One risk was “systemic financial failure” and one of the graphs on their site showed that of all their listed risks, systemic financial failure has the biggest impact if it were to occur. It was connected on their charts with items like global governance failure and food shortage crises.

3.0 The way the money system as structured now is inherently unstable.

3.1 The very money system we all use insists that total debt increase. When money is created as interest bearing debt as it is, the total supply has to keep on increasing and that inevitably means more loans. The amount of money in the system is never at any time sufficient to pay off all the debt owing along with interest. Even though money circulates many times, at any one point there is only so much in the total system. There is always someone who can’t pay their interest so they have to go back to the bank for another loan, so the money supply has to keep increasing. In this system, which we have come to accept as normal, the alternative to economic growth is unfortunately collapse, not stability.

If the banks stopped making loans tomorrow, there wouldn’t be enough money in the system for all existing debts and the interest to be paid. Our money supply would virtually disappear if all debt were paid off. When the power to create credit is given to private banks, they control the amount of credit in the system and central banks have difficulty regulating their excesses. The current Greece debt crisis after two bailouts and austerity programmes illustrates you can never solve debt with more debt. As Professor Michael Hudson has noted, “it is simply a mathematical fact that the debt that can’t be repaid, won’t be.”

3.2 While we appreciate the Reserve Bank has been bold in their experiment of limiting loans by imposing new Loan to Value Ratios in response to the Auckland housing boom, it doesn’t address the fundamental problem that the government allows private banks to create 98% of the country’s money supply as interest bearing debt, and this means that total money supply will have to go on increasing. It is a fundamentally unstable system made worse by derivatives. The unwanted side effects of restrictions on loan to value ratios (LVR) are minor in comparison with the bigger problem.

4.0 This petition originated when we heard about Open Bank Resolution
4.1 In early February this year I received a letter from the Hon Bill English, Minister of Finance in reply to my letter asking him if they would consider implementing the Chicago Plan Revisited, published by two IMF economists on their site in 2012. This plan would eliminate the risk of bank runs and monetary crisis.

Mr English’s letter assured me it wouldn’t be necessary as the Reserve Bank was putting in place a new scheme for dealing with banks in trouble. It was the Open Bank Resolution scheme. But when we examined this on the website of the Reserve Bank of New Zealand, we found it rather alarming.

4.2 We had never heard of Open Bank Resolution in the media and it seemed to us to be rather important. Nobody wants to wake up in the morning to find their bank had failed overnight and find their account had been reduced (or a certain unknown fraction of it frozen). Admittedly it is one step better than having banks close for 12 days but it shouldn’t be necessary.

4.3. In the light of their inadequacy at telling the public that their bank accounts were at risk and the money in the bank actually legally belongs to the bank, it does call into doubt the willingness and/or ability of the Reserve Bank of New Zealand to keep the public properly informed.

4.4. When we enquired of the Reserve Bank why we weren’t told, we were informed there had been publicity – they had put it on their website. We consider this to be either a fundamental mistake made by their communications department or a deliberate error in order to keep people in the dark. It doesn’t look good either way. Putting something on a website does not alert the ordinary people. We consider they need to ‘up their game’ if they were genuinely trying to inform the public.

4.5. Because the Open Bank Resolution didn’t get passed in Parliament, there has been no opportunity for scrutiny of the details. Little is known by the ordinary depositor of what risks their banks take or whether or not their banks sell covered bonds. The level of public knowledge is too low, but is increasing.

4.6 Unfortunately, according to the Reserve Bank of New Zealand, Open Bank Resolution did not require a new law, so the public has never been given an opportunity to examine it. Here is one thing that could have been pointed out if a bill had gone to a Select Committee: Open Bank Resolution has a design flaw. Depositors in a failed bank, once it has been through its process in the crisis, will have their deposits guaranteed by the government. This will cause customers of other banks to move their accounts to that bank.

5.0 Why we decided to launch a petition asking for a Parliamentary Enquiry
5.1 Because of a fundamental fault in the design of money, financial crises have been happening for decades. According to IMF data, there were 145 banking crises, 208 monetary crashes and 72 sovereign-debt crises between 1970 and 2010. This represents a total of 425 systemic crises, an average of more than 10 countries getting into trouble each year. So financial crises are not new and they demonstrate that there is a fundamental structural error in the money system.

5.2 After consideration we decided to run a petition and decided that the matter of bank stability was so important that the public should know. A Parliamentary Enquiry would flush out all the facts, draw out all the experts and pool a great deal of knowledge held in many sectors of the community.

5.3. We believe that the public should be informed and a Parliamentary Enquiry would help. The publicity which resulted after the Cyprus events was actually largely due to us alerting journalists and organising a key letter to the Dominion Post at a critical time. The fact that this letter featured at exactly the time of the Cyprus bank closures stimulated thorough coverage in the print media and public radio at the time. Then the politicians publicised it still further with announcements about policy. However we believe only a tiny fraction of the public still knows that their bank account is at risk.

5.4. It has been argued that the big four Australian banks are safe. But business is now hyperconnected. An analysis of the relationships between 43,000 transnational corporations of the world has identified a relatively small group of companies, mainly banks, with disproportionate power over the global economy. When the team further untangled the web of ownership, it found much of it tracked back to a “super-entity” of 147 even more tightly knit companies – all of their ownership was held by other members of the super-entity – that controlled 40 per cent of the total wealth in the network. So is New Zealand not part of a global system or did a little country in the South Pacific somehow get left out of this network? We have been told that the big four banks are relatively safe, but taking just ANZ alone, we find that HSBC Custody Nominees owns 17%, JP Morgan Nominees owns 14.15% and Citicorp Nominees has 3.8%. The other three Australian banks have similar shareholder structures.

5.5 Even though we don’t see it practicable or realistic to implement, and we see its limitations and risks, the Chicago Plan Revisited should be examined seriously. This proposal, based on the work of Irving Fisher, Henry Simons, Milton Friedman and others in 1936, was written by two IMF economists Michael Kumhof and Jaromir Benes. Kumhof was a Barclays Bank manager for five years. His most recent slideshow describing the plan is here. The scheme involves the government creating sufficient indestructible reserve money to provide 100% backing for all deposits. There are several further steps which are outlined in this summary, but the consequences are that money creation no longer requires debt creation and the quantity of money is controlled by the central bank, not by private banks. Private banks become true intermediaries. The scheme also reduces or eliminates public debt and dramatically reduces private debt. However here is why we believe it not to be practical. As it just replaces a privately created monopoly currency with a publicly created monopoly currency it is not as resilient as an ecosystem of currencies. Nor does it prevent monetary crashes. It also involves huge risk and is pragmatically impossible to implement, given the relative power of the big banks in the US.
One of the contributions that Michael Kumhof has made to the debate is that as a former bank manager he said he knows that he created the loan and then the deposit – in that order. He also says that the main function of banks is to create money. A transcript of a talk where he said that is here.

6.0 Who the enquiry might attract
This will widen your pool of advisors. Thanks to the benefits of the internet, there are a huge number of people now following the troubled hyperconnected global financial system and there is a great deal of knowledge that you as a Finance and Expenditure Committee probably don’t yet know about. This enquiry would bring out a range of people including financial traders, home based researchers, people who administer public payrolls who are concerned about the implications of Open Bank Resolution. It would bring out brokers, investment advisors, farmers, bankers, fund managers, real estate analysts, academics in fields other than economics, accountants, investors, market analysts and public interest organisations.

7.0 What an enquiry could include

7.1 The whole field of Australian banks’ exposure to derivatives needs to be investigated and understood.

7.2 Why are banks making record profits even though interest rates are so low?

7.3 How many mortgages of New Zealanders have been securitised, and packaged up and sold to pension funds and other investors and what effect this would have on the New Zealand mortgage holder in a banking crisis.

7.4 The upgrading and improving of communications coming out of the Reserve Bank.

7.5 Review the applicability of the observations made in the Chicago Plan Revisited. The scheme involves government creating sufficient indestructible reserve money to provide 100% backing for all deposits. There are several further steps which are outlined but the consequences are that money creation no longer requires debt creation and the quantity of money is controlled by the central bank, not by private banks. This is exactly the outcome required.

7.6 The main issues of course are “Should banks be in charge of how much credit is created? If banks stopped issuing loans tomorrow, would there be enough money in the system for everyone to pay back their debt with interest?”

7.7 Is there a lesson to be learnt from history that tells us we must connect fiscal policy with monetary policy? e.g. the successful Rentenmark currency in Germany in 1923 may have been successful because it was the nearest in history of the ideal of combining a full land rental with money spent into existence by a publicly owned agency.

7.8 Are there any other successful models in history other than creating one national currency by banks as interest bearing debt?

7.9 Has the financialisation of the economy since the delinking from the gold in 1971 had in it the seeds of its own destruction?

7.10 What should the role of banks be – creating the country’s money supply or mediation between depositor and borrower?

7.11 Are there other models for protecting savings? e.g. the reinvention of mutual savings funds.

7.12 Should banks be involved in insurance and investment at all?

7.13 Should the national currency be issued by an arms-length agency of government and backed by land, now that it is no longer possible to back it with gold?

7.14 Are there cases in history like the German Rentenmark which in effect combined a land backed currency with a land tax, resulting in stability?

8.0 What the Enquiry might turn up
8.1. A range of suggestions from those who believe the Reserve Bank should create the country’s money with no interest. This will include the suggestions of the Chicago Plan Revisited, Democrats for Social Credit, Positive Money and other monetary reformers who argue for replacing a bank created money by government created money.

8.2. A range of information about how governments in history dealt with financial crises or when banks tend to have too much power over politicians.

These might include:-
a. When Lloyd George suddenly found he had to go to war in 1914 and within a matter of days the Treasury had created Bradbury Pounds, which were good for payment of tax and could fund the war.

b. When Abraham Lincoln, faced in 1861 with the option of borrowing from banks at usurious interest rates, decided to create Greenbacks without interest to fight the civil war.

c. When President John F Kennedy, five months before he was shot, issued $4,292,893,825 of cash money; free of debt and free of interest. It was a sufficient amount to allow the nation to operate without the private Federal Reserve. On June 4, 1963, Kennedy signed Executive Order 11110, which authorized the US Treasury to issue a new form of silver certificate.

8.3. A range of information about how governments dealt with financial crises eg. From 1999 there was a surge of complementary currencies in Argentina becauses the country was deep in recession and had high inflation. Wikipedia says “While the provinces had always issued complementary currency in the form of bonds and drafts to manage shortages of cash, the scale of such borrowing reached unprecedented levels during this period. This led to their being called “quasi-currencies”. The strongest of them was Buenos Aires’s Patacón. The national government issued its own quasi-currency—the LECOP.” They brought back their own peso.

What happened in 1923 in Germany at the peak of their hyperinflation crisis and how the Rentenmark solved the problem within days. When Germany had no gold to back the currency after the first world war, and inflation had grown till there was massive hyperinflation, poverty and social chaos, they issued a new land backed currency and imposed a twice yearly payment for the use of that land. The nation quickly went from a state of chaos and misery to stability. Descriptions of what happened included the term “the miracle of the Rentenmark”. So this successful system effectively combined a land backed currency with what amounted to a regular land fee. One author said “The Rentenmark experiment marks one of the most extraordinary monetary experiments of all time, yet most historians of the episode seem to have misunderstood the mechanism and its role to the stabilization.” My own account of what happened and how its success could be explained is here. Although they issued the money as mortgages, for the first year of its existence it seemed as though the mortgage payment was a full land rental.

I am of the opinion that it is important to look at bank stability in conjunction with fiscal policy. It is unrealistic, for instance to expect monetary policy to deal to the escalation of Auckland house prices while the tax system favours land owners and there is no charge on the holding of land. Restrictions on LVR can never therefore work by itself, nor can more house building.

8.4. A range of information about how countries in depression or financial crises allow the issuing of local currencies e.g. Greece’s TEM. The Austrian town called Wørgl in 1932 issued work certificates, good for paying local taxes and designed with a circulation incentive. They paid their workers in it. When unemployment dropped dramatically it became known as the miracle of Wørgl and people came from all over Europe to see it.

8.5. The need for Parliament to legislate to support and not stand in the way of new well designed currencies at any level. Complementary currencies have been springing up all over the world. New Zealand’s timebanks now number 27 for instance. Numerous books have been written on the topic, including authors like Bernard Lietaer, Stephen Belgin, Thomas Greco, Margrit Kennedy, and myself. The list of 180 books and DVDs sold by the LIving Economies Educational Trust is comprehensive. An international skype chat group on the topic has been going for seven years and has reached 200 participants and a google search on complementary currencies turns up over 1 million results nowadays. They can be local or national, private or public and have a variety of designs and purposes. An education currency can make the budget go further, a health currency can make the health budget go further. A currency for small businesses can stimulate job growth. A currency can also solve problems as when rubbish piled in narrow streets in Curitiba, Brazil. Tokens were given to those who produced sorted rubbish and were accepted on buses. In Lyttelton during the earthquakes the timebank was there to help before the Civil Defence, Red Cross and other agencies got organised. Other purposes for complementary currencies are helping deal with aged care, encourage customer loyalty e.g. airmiles and flybuys, buiding community, mitigating unemployment and other social problems and encouraging volunteering. On November 3rd 2012 in Christchurch the Volunteer Army Foundation, led by Sam Johnson, Jason Pemberton and Raf Manji , organised a one day Concert, featuring 24 bands, for volunteers only. The only way to get a ticket was to do at least 4 hours of volunteering. Nearly 50,000 hours of time was donated with hundreds of community projects completed. Volunteer hours are now becoming an important part of a student’s transcript, alongside traditional academic information.

As long as complementary currencies are not producing inflation, they should be welcomed by the Reserve Bank of New Zealand. During a period of high unemployment the Internal Affairs Department encouraged green dollar exchanges which flourished in the early 90s.

8.6. The need for universities to reintroduce courses on economic history.

Why we need a parliamentary enquiry into the best methods of making banks stable

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Submission of Deirdre Kent in support of petition 2011_78 to Parliament

This submission is substantial. It outlines why banks are unstable, includes charts on banks assets compared with their exposure to derivatives and on housing bubbles. In a hyperconnected world New Zealand’s four Australian owned banks are not going to be immune to shocks. Now instead of taxpayer bailouts, it seems depositors will bailout the banks. The Reserve Bank has in place a system called Open Bank Resolution. We would rather the banks were stable in the first place.

Derivatives for Dummies

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This I found on the web. Sorry I can’t acknowedge the writer. Others seem to have put it on their websites too. I asked a meeting of 35 people in New Plymouth the other day how many people know what a derivative is and only one person put up her hand. It is worrying that the shadow economy of at least $700 trillion is at least ten times as big as the real economy yet so few understand the shadow economy.

A financial reporter in Australia said in 2009 all banks are exposed to toxic derivatives. If 1% of these contracts default because third parties get into trouble, the whole shareholder wealth would be wiped out and the banks could be broke.

So here is the derivatives for dummies piece. Nice and easy.

Derivatives for Dummies

An Easily Understandable Explanation of Derivative Markets

Heidi is the proprietor of a bar in Detroit . She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around about Heidi’s “drink now pay later” marketing strategy and, as a result, increasing numbers of customers flood into Heidi’s bar. Soon she has the largest sales volume for any bar in Detroit .

By providing her customers’ freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for whiskey and beer, the most consumed beverages. Consequently, Heidi’s gross sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi’s borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral.

At the bank’s corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALCOBONDS and PUKEBONDS. These securities are then bundled and traded on international security markets. Naive investors don’t really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation’s leading brokerage houses.

One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi’s bar. He so informs Heidi.

Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since, Heidi cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.

Overnight, DRINKBONDS, ALCOBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset value destroys the banks’ liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.

The suppliers of Heidi’s bar had granted her generous payment extensions and had invested their firms’ pension funds in the various BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her whiskey supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations. Her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.

Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion dollar no-strings attached cash infusion from the Government.

The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-alcoholics.

IMF economist Michael Kumhof says the key function of banks is to create money

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imfToday I made the mistake of going to a website where there was a sentence which made me mad. It said that in New Zealand, banks like finance companies can only lend out deposits made with them. Well I rarely get mad these days but I don’t like untruths being perpetrated. So I thought the best way to recover would go and transcribe the first seven minutes of a talk Michael Kumhof, economist from the IMF made to a seminar in January 2013.  It is on youtube here and here is my transcript, give or take the odd aside I left out.

“Virtually all money is bank deposits.

The key function of banks is money creation not intermediation. The entire economics literature that you see out there today is that it is intermediation, taking the money from granny, storing it up and then when someone comes and needs it I can lend it out to them. That is complete nonsense. Intermediation of course exists, but it is incidental and secondary and it comes after the actual money creation. Banks do not have to attract deposits before they create money. I’m a former bank manager. I worked for Barclays for five years. I’ve created those book entries. That is how it works. And if a leading light economist like Paul Krugman tries to tell you otherwise, he does not know what he is talking about.

When you approve a loan, as a bank manager you enter on the asset side of your balance sheet the loan, which is your claim against this guy and at the exact same time you create a new deposit on the liability side. You have created new money because this gives this guy purchasing power to go out and buy something with it. Banks have created money at that point. No intermediation, because the asset and liability are in the same name at that moment. What happens afterwards is that that guy can spend it somewhere else later but it is still in the banking system. I care about the aggregate banking system. Looking at the microeconomy and transferring the logic to the macroeconomy is really wrong. Someone will accept that payment.

money

What that means is that it becomes very, very easy for banks to start or lead a lending boom even though policy makers might not, because if they feel that the time is right, they simply expand the money supply. There is no third party involved, just the bank and the customer and I make the loan. The only thing that is required is that someone else will accept that deposit, say as payment for a machine, and he knows that is acceptable because it is legal fiat.

There is an important corollary to this story. A lot of loans are not for investment purposes, in physical capital. Loans that are for investment purposes are a small fraction. The story that is often told in development economics is that first you need to have savings, then once you have the savings, you can have investment. So a country needs to have sufficient savings in order to have enough investment. Nonsense too – at least for the part of investment that is financed through banks because when a bank makes a new loan it creates new purchasing power for the investment to go ahead. The investment goes ahead. Then the investor takes his new bank deposit and gives it to someone else In the end someone is going to leave that new deposit in the bank. That is saving.  The saving is created along with the investment. It’s not that saving has to come before investment. Saving comes after investment, not before. This is important for development economics.

The deposit multiplier that is taught in economics textbooks is a fairytale. I could use less polite terms. The story goes that central bank creates narrow money and there is a multiplier because banks can lend out a fraction. It is actually exactly the opposite. Broad monetary aggregates lead the cycle and narrow monetary aggregates lag the cycle.”

How safe is your bank?

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When you have your money in a bank, the money is legally no longer yours. It belongs to the bank and you become an “unsecured creditor”. This is the legal situation and it has been confirmed by the Reserve Bank in an email (27 March from Sonia Speedy) to Sue Hamill of Positive Money. When the bank has your money it can do what it likes with it, including take risks you don’t know about. So putting your money in a bank is a “customer beware” activity it seems.

If you have your money in Bank of New Zealand, Westpac, ASB or ANZ, then you run the risk that you don’t know too much about what your bank is up to. The latest thing is covered bonds, which is just one of these risks. They are packaging their ‘high quality residential mortgages’ up and selling them off as ‘Covered Bonds’ to investment funds. Then if the bank gets into trouble, the investment funds are ‘secured creditors’ and are ahead of you in line when the liquidator takes over. This means that Kiwi households will be forced to help bail out banks while overseas lenders have their money protected.

If you think Kiwibank is an exception, then think again. They started selling off their mortgages as covered bonds in April 2013.

But authorisation from Government doesn’t seem to matter to banks. When I rang Parliament on 9 May 2013, I found the Bill on covered bonds was still at committee stage, having passed its Second Reading on 22 February.

Then there is the small matter of Interest Rate Swaps (IRS) which all these banks (and the Co-operative Bank too, not sure about TSB) engage in. If you can imagine taking out a variable-rate mortgage and then paying a bank to make your loan payments fixed, you’ve got the basic idea of an interest-rate swap. They comprise 80% of our derivatives market and are widely used by local authorities to hedge against the risk of interest rate changes.

In April 2013 the US futures regulator was reported to be investigating allegations of manipulation of this popular derivatives benchmark and had issued subpoenas to market participants including the interdealer brokerage ICAP and several global banks. It seems the rates are set by 20 exhorbitantly paid brokers at a desk in Jersey City, New Jersey. A year earlier they had discovered that the LIBOR rates were being manipulated and this investigation has now been widened. LIBOR sets the actual interest rate that banks charge each other. Since mortgages, student loans, financial derivatives, and other financial products often rely on Libor as a reference rate, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide.

At the time LIBOR was though to be the biggest financial scam ever. Two big banks have been fined for this including the Swiss bank UBS which was fined a record $1.5billion in Dec, 2012.

Interest rates swaps are a gigantic market. Would you believe this figure, or even be able to imagine how big it is? It is $379 trillion in June 2012 (Bank of International Settlements website accessed May 1, 2103). The size of the global economy is $70 trillion, so it is more than five times this. The risk manager of the Co-operative Bank told me when I visited him in early 2012 that they were involved in interest rate swaps because it was safe and it saved them money. The Financial Manager of Kapiti Coast District Council told me they had made money from interest rate swaps and had no plans to drop the practice.

So this leaves us with the possibility of putting your money with a credit union. Unfortunately all credit unions must use a bank for their overnight transfers, so that one is a dud too.

There is one other possibility. When I rang the Reserve Bank some time ago about which banks were involved with Open Bank Resolution (where the customers bail out a distressed bank and which will be in place by July 1 this year) I was told there are two small Indian banks which were too small to be involved in the scheme.

So there are the facts. The choice is now yours. I am sticking with the Co-operative Bank and TSB.

Haircut anyone? Saver bailout is coming to New Zealand

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On 1 February when I received a letter from the Minister of Finance on the matter of the Chicago Plan Revisited I learnt that New Zealand banks were working quietly behind the scenes with the Reserve Bank of New Zealand on a depositor bailout scheme probably unique in the world. ‘Open Bank Resolution’ was its bland and harmless name and it had apparently been discussed during 2011 when public submissions had been invited.  Registered banks with $1 billion or more in assets were required to work with the Reserve Bank to put their IT systems in place by 30 June, 2013. If a bank was in distress, accounts would be frozen overnight, while liquidators decided how much of a ‘haircut’ to give the accounts before releasing them the next day.

Yet we had seen nothing in the news media. Nothing. Suddenly we woke up to the fact that as depositors we were to bail out a failing bank.

At the height of the 2008 Global Financial Crisis, the New Zealand government guaranteed all bank deposits and this scheme stopped at the end of 2011. But during 2009 many South Canterbury Finance investors greatly benefitted from it. Their finance company, into which investors had poured money after the government guarantee, had gone belly up and the taxpayer coughed up to the tune of $1 billion.

This experience turned the government against guaranteeing bank deposits. They didn’t want private deposit insurance either, arguing it was a cost to investors. So the Reserve Bank of New Zealand set about inventing a new scheme (or rather revisiting one they started formulating a few years earlier), but when they finally told the public about OBR in November 2012, their one media statement sank without trace. Perhaps they naïvely believed mum and dad bank customers would read their website, on which they now have plenty of information on Open Bank Resolution. Banks, naturally, didn’t tell their customers.

On 8 February therefore the New Economics Party launched a petition.  We decided it was best to ask for a Parliamentary Enquiry into the best methods of making banks stable. We added that New Zealand could consider The Chicago Plan Revisited. We said we didn’t want either taxpayer bailout or customer bailout of a failing bank. We believe banks should be stable in the first place. Such radical monetary reform  has to be done internationally and simultaneously. Those who have collected petition signatures have found it relatively easy.

In promoting this petition we cooperated with members of the Green Party, the Awareness Party, Positive Money NZ, the Democrats for Social Credit, The Maori Party and the Mana Party.

We created a Facebook page at http://tinyurl.com/ab9qc7w and started an online petition. For five weeks it was an uphill battle to get any publicity.

imagesBut on the weekend of March 16-17 the Cyprus news broke.  Suddenly depositor bailout of banks was in the news. Over the next two weeks I was completely obsessed with the daily dramas in Cyprus and Brussels, I tweeted relentlessly to inform my twitter friends that depositor bailout was also planned for New Zealand. Our Facebook page became very useful to share news.

It is wonderful how networks work. When the newsletter editor of our local Transition Town group put our information about Open Bank Resolution in their publication, a friend rang me for more information. She then penned an excellent letter to the Dominion Post, which was published as the top letter on March 18.  The following day the Dominion Post published a comprehensive article on Open Bank Resolution, and more facts emerged. The New Zealand Herald and the Press followed, then radio and TV.

On March 19, the Greens, who had a policy opposing Open Bank Resolution sitting quietly on their books, called for the Government to drop their Cyprus style solution. Saver bailout became the focus of a series of questions in Parliament from Russell Norman, leader of the Greens, where it emerged that the Government was fully behind the scheme and didn’t want a bar of taxpayer bailout or government guarantees. The Minister standing in for the Minister of Finance that day described OBR as “a brilliant policy.” He emphasised it would be a one off haircut overnight, enabling the bank to open the next day. The depositors in the troubled bank would then have the rest of their money Government guaranteed. The Minister couldn’t be pinned down on what percentage would be confiscated.

The Greens also came out in favour of Government guarantees. The Labour Party, who often follow the lead of the Greens, said they would guarantee the first $30,000. They said if it was good enough for overseas lenders of covered bonds to be protected it was good enough for NZ households too. NZ First reiterated their long held interesting policy they would only guarantee deposits in New Zealand owned banks. In answer to my letters, I am told the TSB and the Co-operative Bank have no covered bonds or other protected assets. Kiwbank, however is getting in to both covered bonds and mortgage backed securities (RMBS). The letter said “In addition to the covered bond assets Kiwibank has transferred approximately $600m into a RMBS programme.“

The small credit union sector won’t be required to comply.

Academics have not been inactive in this matter. Geoff Bertram and David Tripe wrote an article in the November 2012 edition of Policy Quarterly journal of Victoria University’s Institute for Governance and Policy studies (http://bit.ly.10c3750) shows how secured creditors are gaining more protection for themselves should a bank collapse. Among these are holders of Covered Bonds, now legal in New Zealand and used by the four major banks. These bonds are ring fenced high quality housing loans. New Zealand’s big four banks have borrowed more than NZ$11 billion through covered bond issues, mainly to overseas institutional investors, since BNZ became the first to do so in 2010.

Even the publicly owned bank Kiwibank is now getting into them, with the selling of their first covered bonds on March 25.  Interest.co.nz reports “Kiwibank has turned to Switzerland for its first covered bond issue, borrowing 150 million Swiss francs (about NZ$188 million). Covered bonds were made legal in 2012.” Gareth Vaughan of the same website wrote an excellent article (Mar 25, 2012) on what it means for your mortgage.

Tripe and Bertram list five other types of assets which would not be available to bank liquidators. These include loans sold back to the parent bank, residential mortgage backed securities sold to third parties, repos, assets pledged as collateral for derivatives, other derivatives and intangible assets not available to liquidators.  Their calculation for a typical bank is that after allowing for secured depositors, approximately only  58% of deposits could still be available to liquidators. Such an alarming figure indicates the study needs repeating. Whatever the figure for the actual bank in distress, it means unsecured creditors bear a large share of the losses.

There is something else the Reserve Bank appears to have overlooked. Business commentator Rod Oram has pointed out that, after a bank had been liquidated and deposits government guaranteed, bank customers from other banks would transfer to the bank where their deposit was safe.

The Reserve Bank tells us there is no need for legislation to authorise Open Bank Resolution. But is it legal? Apparently when you deposit money in a bank you forfeit ownership of money and gain ownership of a claim against the bank – a claim for instant repayment of money but a claim nonetheless.

Here is a quote from a House of Lords decision Foley v Hill (1848).

The money paid into the banker’s, is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the principal and a small rate of interest, according to the custom of bankers in other places. The money placed in the custody of a banker is, to all *1006 intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal, but he is of course answerable for the amount, because he has contracted, having received that money, to repay to the [37] principal, when demanded, a sum equivalent to that paid into his hands.

Sue Hamill of Positive Money NZ asked the Reserve Bank if this decision is the common law in New Zealand who confirmed that the common law she had quoted was still standing. The email (27/3/2013) from Sonia Speedy of RBNZ said

“Our legal advice is that the case you mention is part of the common law in New Zealand. In essence it confirms that a bank/customer relationship, in respect of a deposit, is a contractual one of debtor/creditor. In that sense the bank is liable to repay the customer the sum of the deposit. The case confirms there is no fiduciary relationship between the two parties. It also confirms the customer/creditor has no right to challenge the use put by the bank to the money deposited with it.”

UnknownBecause New Zealanders are dependent on the four big Australian owned banks, ASB, ANZ, Westpac and BNZ, I thought it interesting to investigate their ownership and their directors. (The ASB is owned by Commonwealth Bank and the BNZ is owned by NAB). It seems in each case four of their major shareholders are HSBC, JP Morgan, NAB Holdings and Citigroup. Their directors come from banking, real estate, infrastructure, contractors, building, aluminium, communication, computing, investment, asset management, gambling, alcohol, aviation, food and beverages, fossil fuels, mills, clothing and mining. Their lawyer directors are in the field of tax, litigation or mergers and acquisition.  And they have their fair share of academics and former government regulators and Central Bankers.

One can’t help but get the feeling that the interconnectedness of all this is overwhelming.  If banks go down, the pension funds of the world go down and so does the economy.

But how likely is it that a bank will fail in New Zealand? Financial adviser Chris Lee has told a friend who asked, “In my opinion a major bank wipeout would rank in likelihood with global nuclear war – possible but hopefully unlikely. The chance of one lesser bank failing is more realistic.” (3 April private email)

But according to an IMF working paper[1] on the vulnerability of NZ banks (Jan 2013), the big four banks have 90% of the bank assets in New Zealand and together their assets amount to 160% of our GDP.  “The banks’ large exposure to highly indebted household and sizeable short term offshore borrowing are key vulnerabilities.” The big four account for 95% of the residential mortgage market. A rise in mortgage rates together with an increase in unemployment could lead to an increase in nonperforming loans. A large fall in commodity prices would impair the quality of agricultural loans. It says our house prices are 10-20% too high. Since that paper the Auckland house prices have risen again.

The big four are all making healthy profits. In November it was announced that the BNZ, ANZ/National, Westpac and ASB had made a combined $3.4 billion profit after tax in New Zealand, up an average of 20 percent on 2011. This is an average of $772 profit for every person in New Zealand, with a large chunk of it heading across the Tasman.

So New Zealand is an interesting case. As at the end of 2012 there were total deposits of $115.2 billion in our banks.  Will a crisis in one of our banks test out the political viability of our Open Bank Resolution proposal as did the first Cyprus/Brussels solution? Will our small depositors have their savings confiscated?

We watch of course the unfolding drama in Europe and see whether the Cyprus solution is going to be a blueprint for other countries in crisis. Those who have the stomach for it might be at this moment monitoring Slovenia. Or Greece, or Spain, or France or Lichtenstein.  Obviously each country is different.

The banks operating in New Zealand are part of a larger global system. While their capital adequacy is high at 13 percent in 2012 and the big four have proved resilient in the past, speeches and articles from our Reserve Bank indicate there is no certainty. They even point out that few foresaw the Global Financial Crisis  either and we are in new territory nowadays.

According to IMF data, there were 145 banking crises, 208 monetary crashes and 72 sovereign debt crises between 1970 and 2010. This represents a total of 425 systemic crises, an average of more than 10 countries getting into trouble every year. This was even before the Global Financial Crisis and illustrates the fragility and structural flaws of the banking system. Time for 100% backing for deposits, as the Chicago Plan Revisited explains.

We will have to watch our house prices, and dairy and meat prices. The IMF paper says, “A hard landing in China, and thus Australia, would consequently reduce demand for New Zealand exports, worsen terms of trade and could trigger a sudden decline in house prices.”

So my concerns about Open Bank Resolution are:

  1. While it is fine to argue that it is preferable to a bank closing after failure and preferable to taxpayer bailout, it frightens bank depositors and is a political lemon. The idea of confiscating the money of small bank depositors has been tested in Cyprus and found wanting.
  2.  The Reserve Bank doesn’t appear to have thought through the situation that would arise when the failed bank becomes the only one to have Government deposit guarantees. More homework boys and girls!
  3. In the case of Westpac, ASB, ANZ and BNZ, depositors will bear the main brunt of the loss, as there are many types of bank assets unavailable to liquidators. This whole field needs more discussion and clarification and bank customers should write to the CEO of their bank to find out who is ahead of them in the event of liquidation.
  4. It could become an election issue in 2014.
  5. The common law on this topic needs to be known and the law needs to be obeyed.

Deirdre Kent, author of Healthy Money Healthy Planet –Developing Sustainability through New Money Systems

 

[1] New Zealand Banks’ Vulnerabilities and Capital Adequacy by Byung Kyoon Jang and Mashiko Kataoka. IMF Working paper/13/7. January 2013

You could always change to a Credit Union

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Unknown-1Today I phoned the CEO of the NZ Association for Credit Unions, Henry Lynch. I told him that feedback we had had from our members about our petition on Open Bank Resolution had included people who said they banked with a credit union anyway so didn’t have to worry about Open Bank Resolution.

It seems there are three big credit unions in New Zealand. Baywide Credit Union based in Hawkes Bay has 15 branches. First Credit Union in Hamilton has 50,000 members and NZCU South covers the South Island. No limit on deposit size. And there are other smaller ones. They are owned by their members and you can go to their AGM etc.

They do have mortgages, but only at floating rates. They don’t have credit cards but their debit cards, where you preload your money, uses your own money and is fine for all online payments like Amazon etc. That is a relief for those wanting to change.

I also learnt by listening to a Radio Live interview with the CEO of the Co-operative Bank that people don’t have so many problems changing banks these days. The only situation in which they have problems is if they have a fixed rate mortgage and it costs them to break it.

Credit Unions in New Zealand are champing under controls which don’t exist in Canada, where almost one in three people bank with a credit union.  Last Sunday the Sunday Star-Times had an article which outlined the various laws and regulations which constrain credit unions or impose unnecessary costs on them. Obviously the New Economics Party would develop policies which address these concerns.