Sloshing in the Age

I have an opinion piece in The Age today on financial sloshing.

Put a premium on time to study the bank guarantee instead

Joshua Gans, The Age, 24th October, 2008.

WHILE the Government’s guarantee on bank deposits may have calmed the nerves of the 85% of deposit holders with low deposits, its target was the 15% whose deposit holdings could bring down a financial institution.

From discussion in the media and before Parliament, it seems that those individuals are still jittery and have been engaged in a buzz of activity.

Two weeks ago, we were worried that they would pour their money out of our financial institutions. Today, we are apparently worried that they are pouring too much in.

Reserve Bank governor Glenn Stevens called it “irrational”. But, in my mind, the point of the actions taken by the Government was to shield us from that irrationality rather than to magically make people more rational.

Let me use an analogy to try to explain all this. Suppose that you had a bucket of water. Then you took a large object — let me call it “Fear” — and put it in the bucket. What happens? Put it slowly in and the water inside slowly displaces. Drop it in quickly and there is a big displacement and you might lose lots of water out of the bucket.

Suppose that Fear is in the bucket and you remove it. Do it slowly and the water level falls back calmly. Do it quickly and it sloshes about for a while. It is much the same effect as dropping Fear in but less chance that lots of water will leak out of the bucket.

Two weeks ago, Fear dropped in the bucket on liquidity for our financial institutions. But very quickly, the unlimited deposit took it right back out again. When Fear went in, water moved to the side quickly. When Fear went out, it moved back to the centre just as quickly and maybe more so.

That pretty much explains the wide swings or sloshing that we have seen. It is what happens when we drop in and remove large doses of Fear from the financial system.

That sloshing is occurring all over the place. Foreign institutions not governed by our guarantee are feeling it. The residential-backed mortgage securities market that had Fear completely empty its bucket earlier this year is feeling it again as wholesale investors choose deposits over non-guaranteed securities. Hopefully, the Government putting money directly into that channel will settle things down. But the point is that we shouldn’t be surprised the fundamental shifts in government policy create lots of sloshing.

Like all such things, we need only be concerned if the sloshing does not settle down or gets worse. That is why discussions of putting premiums on some deposit accounts are a worry. Put a premium on accounts with more than $1 million and you will get more accounts at $999,999. It will do little when there is so much irrational sloshing going on. Worse still, limit the cap as some are still arguing for and you will get even more accounts.

For my part, I favour some explicit premium on the insurance the Government is willing to provide depositors.

I just would not put it in place now and would wait to study carefully how that should work. For instance, an option would be to allow depositors the choice of taking out that insurance on individual accounts and charging them a premium based on the balance. It would be voluntary and so there would not be a tax; and, in the event that irrational Fear dunked its ugly hand, the flight would be in banks between insured and uninsured accounts rather than outside the bucket.

That said, the time to engage in market design — that is, setting the rules of the game — is not now, when we are in a crisis. We are talking of a completely new financial and regulatory system in Australia. That is a welcome move. But the precise parameters of how that should operate is something we can leave until later. For the moment, some certainty in the short-term government direction would do much to calm the waters.

Joshua Gans is an economics professor at Melbourne Business School. He maintains a blog on these issues at

2 thoughts on “Sloshing in the Age”

  1. Fantastic article. I’m not sure if you dumb down your writing but I always seem to understand your arguements.

    What I would be very interested in is what you actually would propose in regards to a new regulatory system – we can’t be in crisis management mode forever – where is the balance between government controlled socialism and free market capitalism. And more importantly how can a goverment convince the public this is a good idea – both here and overseas – and get elected on that platform.


  2. Nice piece. The deposit guarantee has significantly tilted the marketplace for interest-seeking deposits (perhaps significantly enough to seriously dmage the prospects of non-bank financial service firms). In effect, we can now get 7-8% returns (gross not net) risk free in the various term-deposit and high-interest online accounts from the banks. This is an enormous subsidy to this portion of the market, not offered to a bunch of competitors. Any scope for the ACCC to step in here (especially as this is also allowing the banks to gobble up the “good portion” of the securitised business loans being release from the mortgage funds thus reducing competion down the track)?

    More realistically, why couldn’t/shouldn’t the Gov’t pull the guarantee back to only cover low/zero-interest deposits? That might at least change the mindset of the wholesale investors (and financial planners) who are currently pursuing the no-brainer “sit it in a bank” approach.


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