Working Papers

Rudd Bank Puts Taxpayers Last

I have an op-ed in today’s AFR on the so-called ‘Rudd Bank.’  Text below the fold (may differ slightly from edited AFR version).

Henry Ergas made related arguments in The Australian yesterday.

The Rudd government’s $2 billion intervention to provide loans to the commercial property sector is rationalised as a measure to save jobs, but once again puts the interests of business and financial institutions ahead of those of consumers and taxpayers. 

This latest intervention in financial intermediation follows the $8 billion the government is investing in residential mortgage-backed securities. 

This was great news for the mortgage securitisation industry, and may even have saved some non-bank lenders from going bust, but there is no evidence that home borrowers are any better off.  The benefits went straight to the bottom line of financial intermediaries.

Subsidies to first-time home buyers for the purchase newly-built housing stock are a more effective way of stimulating residential construction and the housing sector, rather than relying on the benevolence of the non-banks lenders to share their government support with their customers.

The government’s latest intervention to further socialise financial intermediation suffers similar problems.  Banks and the commercial property industry stand to benefit from the scheme, while taxpayers wear all the attendant risks.

The government talks about the jobs that might be lost in the construction sector. 

There is no question that construction industry jobs are at risk, although this has more to do with general economic conditions than a lack of capital.

The government has arguably got well ahead of events in anticipating the withdrawal of foreign lenders from the Australian marketplace. 

The construction industry is hardly unique in losing jobs because of the emerging economic downturn.  Most industries and firms could make a claim for government assistance on this basis. 

The government cannot possibly hope to save every business or job that is now at risk as a result of a global economic downturn.  Saving jobs in one sector of the economy is likely to come at expense of jobs elsewhere and only encourages others to beg for more intervention.

The government has little basis on which to favour some industries at the expense of others.  The employment intensity of a given industry is a poor basis on which to be allocating government assistance.

In propping-up those politically-favoured firms and industries deemed most in need, the government will only prolong the necessary adjustment to weaker economic conditions. 

The government is likely to be as good at financing commercial property as it is at defence equipment project management or running schools and hospitals. 

There is a risk that some projects that should be allowed to go under will instead be propped-up at taxpayers’ expense.  If the government and the banks get it wrong, taxpayers will end-up footing the bill.

While the government has talked-up the safeguards it intends to put in place to miminse the risk of loss to taxpayers, these safeguards are explicit acknowledgement that the intervention is fraught with danger.

Taxpayers are now serving as lenders of last resort on both residential mortgages and commercial property.

The combined $10 billion the government is putting into mortgage-backed securities and commercial property substitutes the public sector’s balance sheet for that of the private sector.

The federal budget is likely to go into deficit due to the operation of the automatic stabilisers in the context of an economic downturn. 

But the government is adding to this cyclical downturn in the budget balance through a wide-range of discretionary policy measures.

Regardless of the way the government accounts for its investments in mortgage-backed securities and commercial property loans, the government will soon be making a substantial net call on capital markets for the first time since the mid-1990s.

Last year, the government announced a $10 billion expansion of its debt issuance program under the guise of ‘enhancing market liquidity.’  The government claimed that the increase in debt issuance was to accommodate increased demand for government bonds.

In fact, the government is accommodating its emerging need to once again tap capital markets to fund its activities.

The government risks crowding-out private capital in already strained capital markets, putting at risk investment and jobs elsewhere in the economy.

The political imperative for the government is to be seen to be doing something in response to the global financial crisis, regardless of relative effectiveness.

As with the intervention in the market for mortgage-backed securities, the government is putting the needs of business and financial institutions ahead of consumers and taxpayers.

Through its interventions in financial intermediation, the Rudd government is constructing a corporate welfare state that will ultimately hold back rather than support the economy.

posted on 28 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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For once I agree with you.  If Rudd wants to save construction industry jobs, why prop up the commercial property sector?  We have a hell of a lot of infrastructure that needs building in this country, not more shopping centres and offices that will probably be empty for the next few years.

Kohler’s take on the Rudd Bank: Nation building, not hand-outs

The Rudd Bank announced last week, where the government is putting money into a fund to lend to commercial property firms, is possibly worth doing if it stops a healthy developer going broke because it can’t get bank refinancing – although I doubt whether that would actually happen.

But it’s not okay if it results in someone getting funding for a new shopping centre or office building we don’t need.

We have enough shops and offices already; in fact many of them will be sitting empty for a while. If the new Kevin Rudd Bank finances more commercial property he might as well stand on the lawn of Kirribilli House and throw money into Sydney Harbour.

It’s infrastructure Mr Rudd, nothing more. Not tax cuts, handouts, shops or offices, but railways, irrigation, desalination, solar energy, and better ports.

Posted by .(JavaScript must be enabled to view this email address)  on  01/28  at  11:17 AM

Good infrastructure should be funded because it is worth doing in any economic conditions, rather than as a stimulus measure. An economic downturn does not make a given infrastructure project any more or less worthwhile.

Posted by skirchner  on  01/28  at  11:36 AM

Fair enough, but given Rudd is in a mood to spend (a very different situation to mid-2008 when inflation was public enemy #1) he should be encouraged to spend on worthwhile infrastructure, and not go handing it to shopping centre developers, car manufacturers etc

Naturally you guys would be in favour of the rumoured tax cuts.  I mean, there’s no such thing as a bad tax cut, especially if it flattens the tax scales and favours high income earners :)

Posted by .(JavaScript must be enabled to view this email address)  on  01/28  at  12:25 PM

Actually, I would argue against unfunded tax cuts as a stimulus measure, since they are subject to the same Ricardian equivalence critique as unfunded government spending.

Like good quality infrastructure spending, taxes should be cut for supply-side reasons, rather than to boost demand.  Lower taxes may ease some distortions that reduce economic activity.  By contrast, increased government spending is only like to add to those distortions.  Demand management is the wrong way to look at it.

Posted by skirchner  on  01/28  at  12:36 PM

LOL!  There are a lot of hopelessly discredited views expressed here, but “Ricardian equivalence” has to be the silliest.

If consumers are ‘Ricardian’ they will save more now to compensate for the higher taxes they expect to face in the future, as the government has to pay back its debts.

To work, this needs several conditions, most commonly:

  * A perfect capital market where any household can borrow or save as much as is required at a fixed rate which is the same for all persons at a given date.
  * The path of government spending is fixed
  * Intergenerational concern. The tax rise required may not occur for centuries, and will be paid off by the great-great-grandchildren of the population around at the time the debt was incurred. Ricardian equivalence only happens when the current generation has some concern for all future generations, even if not perfect concern. Barro phrased this as “any operative intergenerational transfer”.

These assumptions are widely challenged.

Gee I wonder why?

Like I said, if you can find anyone who lists “I’m worried that the government is spending too much borrowed money” as a reason why they are cutting back on spending, I’ll send you my first born.

People are worried about losing their jobs

Posted by .(JavaScript must be enabled to view this email address)  on  01/29  at  10:12 AM

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