Wednesday, 5 September 2007

Nothing more destructive for finance sector

Brian Gaynor's value as an economic commentator is limited by his apparent ignorance of some economic fundamentals.

One such was displayed this morning. The Reserve Bank, he told radio programmes this morning, should act as a lender of last resort to troubled finance houses.

This is utterly absurd.

Gaynor's thinking is shockingly short term. Not only is it not the taxpayer's job to bail out poorly managed finance houses, not only would it all-too frequently throw good money after bad, but in the final analysis nothing would be more certain of increasing the number of risky lenders in the long term than the guarantee given on a plate to them that the backstop to their riskier activities is the power of the government to make the taxpayer their involuntary guarantor.

Having the Reserve Bank as a lender of last resort would reward the riskier lenders, and invite all lenders to take equal risks to keep their place in the market.

The proposal is absurd.

The best solution to the existence of the riskier lenders is to get them out of the market forthwith, so they're unable to consume any more of their investors' wealth. This is the "creative destruction" about which intelligent economists have spent so much time trying to educate their less informed colleagues.

I recommend some study of the topic to Mr Gaynor and his colleagues.


  1. Yes, it is a shocking idea, Peter, because it was never the intention of the legislation.

    The 'lender of last resort' part of the Reserve Bank Act was meant for a unique situation, such as financing a War (I heard David Caygill say that during the Second Reading of the Bill)...rather than 'lending' or 'bailouts' in a traditional way, such as the Bank of England did in 1975 for Finance Companies in the UK.

    (Those British Finance Companies had also lend Billions in the early 1970s to Spiv Property developers) history repeats!

  2. Opps...I just noticed a spelling error.

    The last paragraph was meant to read "...had also LENT billions.."

  3. I agree with you Peter, although alarmingly, the Federal Reserve in the US is looking at doing precisely this, and on a huge scale, indeed, it was partly this that helped smooth the turmoil the markets have been going through.

    (And I have to say, given the share portion of my portfolio was being 'crunched' pretty hard at the time, a part of me was glad at the announcement: just goes to show how easy it is to get sucked into short term thinking when real money is on the line (short term!). No excuse for Gaynor though.)

    Mark Hubbard

  4. I should have said above 'the Federal Reserve in the US is looking at doing precisely this ... 'in the sub-prime market'.

    Mark Hubbard

  5. The new regulatory framework allows for RBNZ 'intervening' in NBDT's to control risk contagion, which we have now got.

    Irresponsible people blowing off nonsense about the banking system being a pyramid/ponzi scheme are part of the problem, of course...

    Gaynor is a top man - great dry sense of humour, and highly intelligent. Being ideologically inflexible is not a virtue - not when there is 1bn of pain out there, and counting.

  6. If my memory serves me the proposal was that the Reserve Bank lend to otherwise sound finance companies who were threatened by the run on finance companies resulting from the recent collapse of so many.

    I agree with the proposal.

    Even the soundest of Bamks cannot survive a mass withdrawal of funds.

  7. Those who identify the present banking system as being fraudulent and little more than a pyramid scheme are correct, for that is exactly what it is. That identification is based on fact.

    The various "private" banks are franchise holders in a nationalised, central-bank operated money printing scheme. It is unstable. It impoverishes and it destroys wealth. It results in the devaluation of savings. It is a cause of mal-investment and the mis-allocation of resources. It is the cause of the boom bust cycle.

    The present central bank based system, including the creation of fiat money out of nothing (all unbacked), is directly responsible for the mis-allocation of resources and the eventual failure of businesses, some of which should have been successful and some of which should never have formed in the first place (but whose formation and existance was enabled by the existence of easy fiat money which in turn resulted in further mis-allocation of resources away from those activities that would otherwise have been supported).

    The creation of fiat money with no backing is inflation. It is unsustainable in the long run.

    Those who warn about the dangers of such a banking system are correct. The instabilities and necessary financial pain such a system inevitably results in is not the fault of they who identify it and publicise it. The nature of the present banking system and those who operate it are the fault.

    Expect to see much more BS fiat money introduced into the sstem to "keep it liquid". All that'll achieve is to is make things worse.



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