How Much Money Will Callaghan Innovation Waste?

Callaghan Innovation released its Statement of Intent through to 2016 the other day.

Have a read of it on their site and be amazed by the managing consulting buzzword utilisation.

It is interesting to note that when their monitoring agency, the Ministry of Business, Innovation and Employment, released a report saying that hardly anyone thinks the government has much to contribute on innovation, that I became aware of how much money is being put into Callaghan Innovation.

We should be very concerned because they consider themselves a key plank of the NZ Inc strategy. No good will come of this attempt at centrally planning innovation and R&D for New Zealand.

What You Ought To Know About Financial Stability And House Prices

The Reserve Bank of New Zealand has a financial stability mandate. If you go over to their recently redesigned website you’ll find a plethora of information about their oversight of banks, insurers and non-bank deposit takers (that’s finance companies and the like).

But what you ought to know about financial stability is that there is only so much that the Reserve Bank can do. Just because there is regulation and frameworks that have a goal of financial stability, does not mean that there actually is financial stability.

I believe that many people have no idea about what financial stability is, and how policies to achieve that sort of objective interact with their banking relationships and insurance relationships. Reading the latest Financial Stability Report would go right over the heads of many people that sort of information is produced to protect.

The other day I shared with you my thoughts on Basel III and how that has an impact on capital allocation in the economy. The higher capital and liquidity requirements mean there is a bias towards secured mortgage lending over business lending for example.

But here in New Zealand, the Reserve Bank is making judgments that I consider to be outside its purview. Here is a selection of quotes from that report’s introduction that concern me:

  1. New Zealand’s elevated exchange rate is also continuing to hinder a rebalancing of domestic activity towards the tradables sector, which would assist in reducing external vulnerabilities.

  2. Despite the higher capital buffers, rising house prices are creating risks for the New Zealand financial system, by increasing both the probability and potential impact on bank balance sheets of a significant house price adjustment. The greater willingness of banks to approve high loan-to-value ratio (LVR) mortgages has further increased the potential adverse impact of a fall in house prices.

  3. This [limits on high LVR lending] will strengthen the capacity of the banking system to weather a housing downturn, and should also lead the banks to review the riskiness of the loans they are currently writing.

  4. The Reserve Bank’s aim would be to apply the restrictions at times when high-LVR lending was judged to be posing a significant risk to financial system stability.

These are just some quotes that jumped out at me and set off alarm bells in my head. You should be concerned that the Reserve Bank thinks it can identify when price increases are in response to supply side contraints as opposed to “naughty” types of demand like speculation and residential property investment 😉

Why should you be concerned? Because there is no evidence that any central bank in the world has ever successfully identified the peak of a market cycle and adjusted its policy in such a way that a “crisis” was averted.

We need to think about what sort of buyer ends up in a high loan-to-value mortgage. Then we need to think about the reasons why house prices are so high relative to incomes. Then we need to read the NZ Initiative’s report on how all of the little rules and regulations around housing have halved the average number of houses built in this country to half of what needs to be built just to cover population growth.

We also need to think about changes in the rate of family formation and how that affects the number of houses and apartments that must be built. Deferred marriage and children means way more apartments are currently needed than are currently available. It also means that many couples are less able to save for a house because supply side restrictions jack up their rent and their income growth is not what they thought it would be when they left university or trades training.

All of these things matter when it comes to the price of houses – yet although I’m sure RBNZ officials are aware of them, they do not seem to realise how premature action on property lending could cut off the desperately needed supply side response before it even begins.

When BNZ Chief Economist Tony Alexander wrote a big wishlist of policy that could fix housing, I could not help but think about the most obvious reason there has been a slow supply side response to higher demand for housing in Auckland – his bank and other big banks pulled the plug on umpteen numbers of property developers and small time investors because of the GFC and the need to reduce risk.

The Reserve Bank does not want to acknowledge the role that the financial system plays in allocating capital. Mum & dad investors (the notional investor, as finance company judgments called them) are unlikely to invest in property developments. The only way for houses to be built in an industry that depends on credit is when the banks lend to builders and developers. That is not happening nearly as much as it should.

There are a lot of skilled people in construction sitting on the sidelines because the people that employ them can’t obtain funding even though there are clear supply side issues. It is a capital allocation failure that pursuit of financial stability at all costs will only make worse.

In fact, the concept of the “counter cyclical buffer” that would require banks to reduce lending and raise more capital if the RBNZ judges the economy to be in a “boom” does not come with any discussion of price rises as a price signal for more supply attached.

That should terrify you. There are hundreds of thousands more people in Auckland than anyone predicted over the past few decades. There is obviously a massive increase in demand from domestic migration to Auckland before taking overseas migration into account – Auckland is where most of the jobs are.

I am skeptical of the idea that more rules and regulations around financial stability will do anything to actually attain financial stability. Financial stability is a nebulous policy objective that runs the risk of thwarting any recovery in the economy. The near absence of funding for supply side responses to increased demand for housing is a function of risk reduction at the banks.

The collapse of many finance companies didn’t help things either. No matter what you think about them, and property developers, riddle me this – if finance companies had not provided billions of funding to developers that the banks didn’t want to touch, how much higher would house prices be now?

In the case of Auckland apartments, if all of those oft-disparaged “shoebox” apartments hadn’t been funded, can you imagine how much worse the housing situation in Auckland would be?

If you think the Reserve Bank is possessed of some special knowledge that enables it to call a “bubble” in the pursuit of financial stability, I have some finance company bonds with negligible risk premium to sell to you.

Why Budget 2013 Doesn’t Matter

In a short time, Bill English will stand up in Parliament and deliver his Budget Speech.

For the temporary government (that’s the guys some of us elect every 3 years), the Budget is the highlight of the year.

It is a chance for them to show that they’re doing something to fix all of the problems in the economy.

For the permanent government, the Budget is the lowlight of the year.

It is when elected officials get to upset the slow, glacial growth of the permanent government in Wellington.

The incentives faced by a bureaucrat are diammetrically opposed to those of a politician.

The goal is to increase your department’s funding, prestige, size or regulatory powers.

This is why Budget 2013 doesn’t matter – because it will not change a single thing in government.

It won’t fix our schools that turn out illiterate and innumerate dropouts year after year without consequence.

And it won’t deliver any substantive policy initiatives that will fix supply side problems in the economy.

The pipe dream of the retirement age increasing from 65 is just that – a pipe dream.

I’ll be watching, but skeptical that anything will change. The central planning fallacy lives on for the inhabitants of Gosplan-on-Bowen.

Gosplan And Soviet Aotearoa

The Soviet Union collapsed because of central planning. The agency responsible for the 5 Year Plans was called Gosplan. It would use statistics to decide what would be produced, where it would be produced and by whom it would be produced. Gosplan was staffed by the best and brightest the Soviet education system could provide. But in the end, they were not capable of reproducing the decision making ability of the entire Soviet population by way of committee.

“From the start,” write the Soviet economists Nikolai Shmelev and Vladimir Popov, “the administrative system was distinguished by economic romanticism, profound economic illiteracy, and incredible exaggeration of the real effect that the ‘administrative factor’ had on economic processes and on the motivations of the public.” Source.

Anyone who has ever participated in a team or group knows that committees don’t work. A committee will talk for the sake of talking, decide for the sake of deciding and never actually achieve what it sets out to accomplish. It is an exercise in futility to centrally plan everything. Almost all successful projects involve a key champion of a project who ensures that everyone else is onboard – an ubermensch taking responsibility.

New Zealand has its own form of central planning committee that repeatedly makes poor decisions and presides over the accomplishment of nothing. It’s called Cabinet, and the Chairman is John Key. They are not “neoliberal”, nor are they capitalist. They are unreconstructed central planning fetishists. The most convincing evidence of this is in how the National government have approached the rebuilding of Christchurch.

In lieu of letting the residents of Christchurch “get on with it”, they have passed new laws and created new agencies to “lead the rebuilding”. They are using statistics and models and environmentally conscious architects to impose a top-down vision of how Christchurch should be. The feelings and hopes of Christchurch residents and property owners who will actually pay for all of this be damned. The Cabinet has delegated management of the rebuild to CERA and an assortment of officials and bureaucrats.

This is actually a minor example of how National are rolling back the reforms of the 1980’s and modelling their governance on Gosplan. A better example of the central planning conceit can be found in the “Ministry of Business, Employment and Innovation”. Different departments are being rolled up into one, to be led by a “Super Minister” in the form of Steven Joyce. This irrational action shows that clear thinking is not a feature of Gosplan-On-Bowen.

This is because larger organisations are harder to run. Because bad news never flows uphill, more problems will be swept under the carpet. The “Super Minister” will be so busy that regulatory oversight problems – like mining inspectors and Pike River Coal mine – will multiply. It is more likely that a “Super Ministry” will have scandals that hurt workers and citizens of New Zealand than a smaller ministry focused on a core function with a direct line of accountability from the call centre to the Cabinet Gosplan committee room.

I fail to see how doubling down on errors in two key areas – Building & Housing; Labour; – will lead to any improvement in performance. What sort of person actually thinks that more work for less pay and less head count will ever work out? Just look at how changing military roles to civilian roles has worked out for the NZDF as evidence of why “new thinking” doesn’t work in the real world.

It is disturbing that other partisans think that their team could do any better or fail to suffer from the arrogance that a central planner can replace the price system with decisions by committee. Every single problem New Zealand has today can be directly traced back to a branch of Gosplan making a decision in concert with other Gosplan-like conspirators. In Soviet Aotearoa, top down dictates on everything under the sun will be the final knife in the corpse of a New Zealand that once held so much promise.

Abandoning Economic Models

I’m currently reading Nassim Taleb’s latest book “Antifragility: Things That Gain From Disorder“. He doesn’t pull any punches with his dislike for economists. He thinks they’re charlatans who suffer from physics envy and calls their platonified knowledge the symbol of “Soviet-Harvard” intellectualism.

Let’s go back to square one.

Forecasting is impossible.

Taleb argues that we can however recognise things that are fragile (big banks, dictatorships etc.) and make some prediction that they’ll collapse eventually to some external shock.

On the other hand, many economists live in a magical unicorn fairy world – Taleb calls them “fragilistas” or “interventionistas”.

They think the problem with their predictions is that they don’t have enough data.

Ignoring Occam’s Razor, these charlatans are everywhere in our economy and in our institutions.

Would it really be so hard for economists to admit that they are full of it?

The most honest thing economists can do is explain likely consequences of different policies with a huge caveat – there could be stuff we didn’t think about that might make this entire document null and void.

All of this forecasting business is ridiculous.

The idea that a central bank or Treasury economist can be all knowing is hilariously close to Soviet “5 Year Plans”.

We all know how those worked out. And we all know that “Top Predictions For 2013!” never bear out.

Just look at Treasury and the Reserve Bank’s forecasting since the Global Financial Crisis.

They really need to stop embarrassing themselves and just give up.

Focus on reducing fragility in the system – that means elimination of big banks and deficit spending.

Please share your thoughts below. Why do economists keep forecasting when they are always wrong? Do they have substantial ego investments in their predictions so large they ignore sunk costs?

Do We Need Big Banks?

Humans can’t handle more than 150 relationships. It’s a throwback to our caveman past – when tribes exceeded 150 people, bonds of trust started to weaken and no one really knew what was up.

Big banks in New Zealand have thousands of employees and hundreds of thousands of customers. Big banks in the US have tens of thousands of employees and millions of customers. No one really knows what is going on because there are so many people involved in the banking sector.

Back in the olden days, before I was born, you used to have a relationship with a bank manager. When you went to apply for a loan, he knew your banking history, probably your parents and your grandparents too. If you were applying for a farm loan he’d have a decent knowledge of your farming ability.

This meant that the distance between savers and borrowers was small. Relationship banking meant knowing your customers, knowing the local community and knowing that if someone had good character they were likely to pay the bank back eventually.

Back in the olden days, there was also a lower incidence of bad behaviour. Defrauding banks still happened, but it was a lot harder than it is today. Because communities were smaller, the social shame effect could be used to lower the likelihood of default.

This is all in stark contrast to how the banking sector functions today. Credit approval is granted based on points and complicated models that evaluate a potential borrowers prospects.

Putting aside the role that fancy models played in the collapse of Long Term Capital Management, the NASDAQ technology collapse, the housing boom and rise of sub-prime, the derivatives on sovereign debt and even domestic housing developments, the big banks today have enormous distance between the savers and the borrowers.

In any system, when you centralise decision making, you lose knowledge at the coal face that matters. In his essay The Use of Knowledge In Society, F A Hayek argued that the reason central planning failed was because a committee couldn’t make price decisions for every single actor in an economy.

Central planning in the banking system is represented by centralised credit approval systems. They use fancy models that use crap models like “Value at Risk” because the regulators, who know very little about the real world, have mandated that those models are the true representation of the risk a bank is exposed to.

Dispersed knowledge applies just as much as the private sector as it does in the public sector. Dozens of local bank managers making subjective decisions is likely to be more stable than a centralised credit approval system.

The conceit, of course, is that a model is a simplification of reality. It is made up of assumptions, can disregard potentially relevant factors as “not useful” and applied to situations it really shouldn’t be.

Big banks in New Zealand today are walking blind through a minefield. Their loan default models are based on past default rates. Their “worst case scenario” stress testing models forget that the “worst case scenario” is always worse than the last worst case scenario before that!

We don’t really need big banks because the arguments they use to justify their existence, like they provide payment networks and the like, are redundant in the 21st century. They are a utility, the flash offices I see in Wellington belonging to big banks offends me deeply.

They should be as boring as water companies. Not some sexy, profitable, lavish executive pay with no clawbacks for imposing systemic risks on everyone else nirvana. The big banks have to go if we want any return to a realistic distance between savers and borrowers.