Tuesday, October 28, 2008

The way out of the mess some say the government created

(I am not one of them)

More managed funds are suspending redemptions every few hours. One of the latest, Colonial First State is actually owned by a bank.

If I was advising the government, I'd tell it to do nothing other than help people put out by the suspensions.

The market-linked funds had a business model that was always going to go south when times got tough. Guaranteeing money in the bank is what matters.

This morning in the Age Tim Colebatch takes a different view:

"Australia cannot afford mistakes in economic policy. Kevin Rudd made one with his hasty, sweeping pledge to guarantee all bank deposits for three years. That mistake was understandable in the circumstances, but the Government's failure since to admit it and fix it is inexcusable.

Let's be clear about what happened. Rudd's aim was to avert a potential threat to the banks; instead, he overdid it, and created a real crisis for the non-banks. The reason 14 of the 20 biggest mortgage funds have now frozen their deposits is because the Prime Minister - with the Treasurer away in Washington, and without even talking to the heads of the Reserve Bank and the Australian Prudential Regulation Authority - dramatically tilted the playing field against them.

The Government had to concede its mistake and back down. Instead, on Friday it dug itself deeper into trouble by reaffirming that any bank account holding up to $1 million would be guaranteed free of charge. The threshold is so high as to be meaningless. Rudd is either getting bad advice, or not listening.

There is only one way out, which Kevin Rudd in opposition did very well: eat humble pie, admit error, fix it, and move on."

In The Australian Michael Stutchbury wants the government to:

"Impose a fee on all guaranteed deposits, not just those above $1 million. And make the guarantee optional for authorised banks, building societies and credit unions."

And on Radio National this morning David Murray, the Chairman of the Future Fund and the former head of the Commonwealth Bank said that he wanted the government to effectively end the bank guarantee after three years by charging (a lot) for it from then on. He also suggested that the government buy in to troubled funds.

I think none of these ideas would help much...

Ending or dramatically curtailing the governemnt guarantee of deposits as Tim Colebatch wants would send a confused message. Everyone knows that bank deposits are effectively guaranteed by the government. Saying that they are not guaranteed when people know that they are would do little to change behaviour, other than adding (somewhat) to fear and uncertainty.

Imposing a fee on all deposits in return for a guarantee as Michael Stutchbury wants would depress economic activity at a time when we need to support it. And the government might say that small depositors who don't pay the fee will be denied protection, but they are entitled to believe they will get protection anyway. Legend has it that the economy-class passengers on the Titanic were told in advance they would not have access to life rafts, but when the ship sank they got that access anyway.

Davidd Murray's main idea pushes the same problems out three years, and does nothing to help now. His other idea - buying into market linked funds - scares me.

It seems to me that none of these ideas will stop the rout on market-linked funds... unless the government buys into them big time as Murray suggests and effectively guarantees them.

Meanwhile, the details of the government's guarantee appear to be evolving by the hour.

Deutsche Bank's David Plank emailed his clients yesterday about details the Australian Treasury had put up on its website.

This morning he has emailed:

"In a short note published yesterday afternoon we commented on the 'Design and Operational Parameters' statement published on the Treasury's website at some point on Sunday. This statement clarified some aspects of the scheme.

However, this statement has now disappeared from the Treasury's website. Instead the website says the statement has 'been archived or updated and is no longer available.'

- At this stage we have been unable to find out why the statement has been removed. When we do so we will comment on whether any of the design features are going to be changed."

Strange days indeed.