If you want to understand what bank regulators were doing in 2008, and what people like APRA and the Reserve Bank worry about here, try reading Matt Levine’s latest column.
Leviine’s piece is nominally about a weird court case involving AIG, the insurance behemoth which almost blew up the world financial system in 2008. But in the process of explaining the court case, Levine sets out with admirable clarity why our current banking system doesn’t allow easy, perfect regulatory solutions to banking problems like we faced six years ago. (A different banking system might do that, but so far no-one has come up with anything even faintly convincing enough to make us re-architect the entire financial world.)
Simplifying a lot, a bank is a thing that allows some people (“savers”) to put money somewhere, get paid interest on it and be confident that they’ll get it back, and that allows that money to be invested in the real economy. That is: Banks have risky claims on the real economy and hand out risk-free claims to their savers.
This is a bit of magic that works most of the time, but not all of the time. Sometimes people realize that their risk-free claims are backed by risky assets, and might be riskier than they thought, and then they panic and pull their money out of the banks and that’s a big problem for the rest of the economy. This has been an extremely well-known problem for centuries, and the solution has been extremely well-known for about 140 years. It’s for the central bank to lend the banks money until the crisis passes.
This has nothing to do with subprime, or derivatives, or too-big-to-fail banks. It’s just a feature of banks, which are where the money is, but only in a probabilistic sense. Sometimes they are not where the money is, and that’s a crisis. But if the central bank (or, sort of equivalently, the government) lends them money, then the crisis will pass, and they’ll be able to pay it back with interest.
Many people dislike this, and it is sort of unseemly, but it really is a well-known set of facts. You can reduce the risk of banking crises happening, but not to zero, because of that core mismatch between banking’s risky assets and savers’ expectations of safety. And if crises do happen, central-bank support seems to be the only effective way to solve them.
Among other things Levine points out, in his copious and typically excellent footnotes*, that what we call “bail-outs” are less about helping bankers and more about helping the people (“bank creditors”) who have lent a lot of money to banks. In Australia these days, of course, people who have lent a little bit to banks are generally covered by a government guarantee.
Read the whole thing.
* I have no idea why so few journalistic articles in online-only publications have footnotes. They seem like a terrific idea for dealing with thoughts that aren’t core to your main narrative. Levine’s footnotes are a series of tasty hors d’ouevres sprinkled through the main meal.