Financialisation: The OECD is barking up the wrong tree
The report finds that increases in credit – particularly to households – were associated with lower rates of growth. Financial deregulation, reliance on bank as opposed to market lending, and ‘too big to fail’ implicit guarantees are highlighted as the main channels through which this alleged adverse impact on growth takes place.
The OECD’s research also links finance with higher income inequality, again primarily driven by three factors: the high pay of bankers, an unequal distribution of bank lending, and an unequal distribution of stock market wealth.
The usual caveats apply. Correlation does not imply causation. The data could be distorted by statistical noise, and the trends identified could be driven by third factors. Furthermore, it is unclear why inequality in itself should be a matter of concern, so long as living standards at the bottom also increase (and these are usually unrelated to inequality, unless inequality is politically driven like in some African countries).
However, here I would like to assume the OECD’s findings are true and robust, and focus instead on the policy prescriptions. The blog post calls for “tools to keep credit growth in check,” such as “caps on debt-service-to-income ratios […] strong capital requirements on […] lenders” and measures to end too big to fail, including “structural separation [i.e. breaking up the banks]” and capital surcharges. Additionally, the authors advocate measures to end the tax preference given to debt over equity, although without making specific policy proposals.
In sum, the OECD believes that the source of the problem is too little intervention, and that the answer to the problem is more intervention, on the part of government authorities. But is this really the case?
Governments routinely promote household indebtedness in the form of tax-deductible mortgages, subsidised credit and the encouragement of lending to low-income (subprime) groups. Indeed, in some countries such as the UK tight constraints on housing supply force all households to go deeper into debt than they otherwise would in order to achieve home ownership.
‘Too big to fail’ is largely a creation of government interventions, including statutory guarantees on deposits and banking rules which make entry difficult, thus hindering competition and entrenching the big players. The cost of this implicit guarantee is raised further by rules on regulatory capital and credit ratings which encourage herding and lead to risk correlations.
The financial inequalities identified in the report are also partly related to onerous government rules. Credit to low-income borrowers is made more expensive by bank regulation, and lending in general is suffering as margins are squeezed by low (or negative) interest rates. Some forms of consumer credit which are particularly favoured by the less well-off, such as payday loans, are severely restricted, while those forms of lending which cater to the better-off, such as mortgages, are encouraged.
Finally, stock-market participation is highly unequal in large part because low-income households are not able to save much after taxes and living expenses. Moreover, participation in equity markets is further limited by a reliance on public PAYGO systems rather than fully funded private pension plans.
The bottom line is that governments are at least partly culprits for the problems highlighted by the OECD. Yet, they make no attempt to suggest ways in which reducing state intervention might improve matters. Here are some ideas:
- End credit subsidies such as mortgage deposit top-ups and government guarantees. Lower the cost of housing by facilitating land development and liberalising rental markets.
- Abolish rules that force lenders to market to particular underserved groups. These regulations are well-intentioned but often lead to overindebted households, especially vulnerable ones.
- Consider reforms to deposit guarantee schemes. They create moral hazard and their purpose could be better served by liquidity insurance, as proposed by Andrew Lilico.
- Liberalise consumer credit and acknowledge payday loans for what they are: a convenient way for low-income borrowers to obtain urgent financing with dignity, respect and safety.
- Facilitate participation in private pension plans so more people can save for old age and take advantage of stock market growth and compound interest.
- Give nascent fintech firms a regulatory moratorium, as they develop new and cheaper ways to cater to ordinary people looking for reasonably safe ways to obtain yield on their savings.
The financial services industry is one of the most heavily regulated in the world, and the burden keeps growing. Despite, or perhaps because of, these onerous rules financial institutions are still exposed to great risks, while many income groups remain underserved and others go too deep into debt. Let’s recognise that financial deregulation can make us all safer and better off.
Diego Zuluaga is the IEA’s Financial Services Research Fellow and Head of Resarch at EPICENTER.