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Ken Henry’s three million dollar man
November 1, 2009 | 5 Comments | Sam Wylie
Ken Henry gave a speech to UNSW alumni last Thursday, 28 October, in which he recounted two conversations which brought home to him the severity of the crisis that followed the collapse of Lehman Brothers. The AFR article on Friday contained the following quote. “Should I go down to the bank on Monday morning and take all my savings out?” said Ken Henry’s mother. The article also recounted that a highly educated and respected businessman known to Henry withdrew $3 million in cash from a bank and carried it away in a briefcase. The article goes on to explain how these simple events caused Henry to grasp the severity of the crisis and advise Kevin Rudd that the Federal Government must take extreme action to stave off the impending crisis; including, a guarantee of bank lending and a massive stimulus program.
These are simple homilies intended only to jazz up Henry’s speech and not much should be made of them. However, Henry’s reaction to the comments by his mother and the businessman are illuminating in one respect. Ken Henry seems to have missed the point of the comments – we should have had deposit insurance all along. If Australia had explicit deposit insurance in September 2008 and the public was well aware of it, such as they are in the US, then no one would question the safety of bank deposits or rush to the bank to withdraw briefcases full of cash.
We still don’t know whether the Federal Government is going to withdraw deposit insurance after the GFC passes. It should be made permanent. As I have explained before (here), deposit insurance is a natural and optimal part of the design of a modern banking system. To recap, banks fulfil a critical role in monetary policy by turning liquidity (deposits) into credit (loans). But that role puts them in critical danger of a run on deposits. So, banks are given access to central bank liquidity (the discount window) and deposit insurance to solve their liquidity problem. In return the Government insists on heavy monitoring of banks and a minimum level of capital adequacy.
Unfortunately, a lot of people don’t really get it about deposit insurance yet, and I suspect, from the comments in his October 28 speech that Ken Henry is among them. Australia’s attitude to deposit insurance comes out of the the Wallis Inquiry. That inquiry simply got it wrong in regard to deposit insurance. Nevermind, the inquiry got a lot of other things right. So, let’s just lock-in deposit insurance like all the other countries in the OECD do, and then think about more difficult financial system architecture problems.
I noticed the other day that some banks are offering long maturity term deposits at very attractive rates. Bankwest is offering 7% for 5 year term deposits and touts the fact that that deposits are guaranteed by the Federal Government up to $1 million. These long term deposits should not receive deposit insurance. They are not liquidity. A 5 year term deposit is credit provided to the bank, not liquidity. In fact a five year term deposit nearly counts as Tier II capital under the Basel II agreement.
The Government should restrict deposit insurance to deposits with a term of less than one year.
By the way, the three million dollar man has probably created some aggravation for himself in the future (if the story is bonafide). It is not that easy to withdraw $3 million from a bank as an individual. It would fit snuggly into a standard briefcase — 300 bundles of 100 x $100 bills. But the bank would need to record the purpose of the withdrawal and it would need at least one day’s notice. The bank would have to report the withdrawal to the AFP who would likely advise Australian Customs and Interpol. If he is a frequent international traveller then might rue his panic attack over bank soundness.
Comments
5 Responses to “Ken Henry’s three million dollar man”
[...] Well who can blame the guy? When my mum got worried and told me to do things I jumped to it too. Update: Sam Wylie comments here. [...]
Deposit insurance a no-brainer?
Listen to this week’s podcast on Econtalk.
http://www.econtalk.org/archives/2009/10/calomiris_on_th.html
I quote: ‘Deposit insurance has been the single most important contributor to risk in the financial system. ‘
Rather than being a no-brainer, I think it requires deep thinking.
I’m still a fan of John Quiggins idea to have a two tier financial system. Have a number of highly regulated banks in which the deposits are insured, and have the less regualted investment banks where there is no insurance. This gives people the option to stick a large chunk of their money into a 100% safe bank.
Stuart, that is the case now. Commercial banks around the world receive deposit insurance because they are an integral part of monetary policy, and investment banks don’t.
In September 2008 Morgan Stanley and Goldman Sachs applied for commercial banking licences precisely because they wanted to be treated as commercial banks and therefore get access to the central bank discount window and deposit insurance.
I agree that there should be a pale of protection around commerical banks and other critical intermediaries, and all others should be beyond the pale — unprotected and allowed to fail. Until the late 1990s that is essentially the system that prevailed in the US . Cheers Sam
Regardless of whether or not its a good idea, I’m not sure that having it would have made a big difference if something did go wrong.
If you hear that a ‘well known’ businessperson has taken out $3m in cash because he’s worried that a bank might fail, and that the mother of treasury secretary has taken (or even thought of taking) her savings out of the bank for the same reason, will the average person:
a) Take some money out the bank ‘just in case’;
b) Take all of your money out the bank; or
c) Not worry, and rely on a government-run program that has never been used before to manage an orderly handout of money to 20-25% of Australians to make sure that they can meet their bills.
If I have a mortgage and overall owe the bank money, what happens? What if I have a line-of-credit and so don’t actually have any deposits at all? Even if there are good answers to these questions, do I believe them enough to not take a little bit out, ‘just in case’?