Lose control of your car in the wet, and you suddenly become the model driver — no speeding, no tailgating, and no running red lights. Your risk of an accident remains the same, but your harrowing, adrenalin-charged memory ensures you no longer tolerate even the tiniest risk. In a few days or weeks your old habits gradually return. Perhaps you drive even worse now, foolishly believing a lucky escape has lowered your chances of another mishap.

Reactions to the GFC have been similar. Amidst the economic gyrations of late 2008 and 2009, regulators and commentators evinced a steely ‘never-again’ mentality. But almost three years on, little has changed and lessons are not being learnt.

Take the housing market. The American government’s effective subsidisation of mortgages, through its feckless mortgage backers Fannie Mae and Freddie Mac, ultimately poisoned swathes of the world financial system. Government inevitably ends up buying or guaranteeing the mortgages the private sector does not want to have.

Yet as recently as April the Australian government indicated it would buy another $4 billion of residential mortgages. This mortgage-subsidy programme began with $8 billion in late 2008 to “reinvigorate” the Australian mortgage market. It was supposedly “a temporary initiative that responds to highly unusual conditions” — as temporary as the decade-old first home buyers’ grant it seems.

It is neither right nor prudent to use taxpayers’ money to facilitate housing loans to people who could not otherwise get a loan. If people cannot yet borrow from private lenders they should wait until they have a bigger deposit.

The financial crisis was also a reminder that large banks, unlike other large companies, enjoy a government guarantee against failure. This means they can borrow more cheaply, and have an incentive to engage in risky activities. Large profits accrue solely to the employees and shareholders. Large losses, on the other hand, are met by taxpayers and the resulting credit crunch reverberates throughout the entire economy.

To deal with the implications of big banks, global financial regulators have this month finalised a new set of capital standards, known as Basel III. Far from wholesale reform, however, the new standards are largely tweaks of the existing arrangements. And their full implementation is a leisurely eight years away.

The 8% minimum capital ratio, which stipulates how much money banks must keep aside as a buffer in case of bad times, won’t be changing — although what counts as capital will be better defined. It will, however, be augmented by an additional “countercyclical capital buffer”, which national bank regulators will adjust according to the “state of the credit cycle”.

In reality, a nebulous unobservable concept like “the credit cycle” will be of little help in working out how much extra banks should keep aside. And regulators will face a political backlash if they decide to increase the capital ratio: ‘working families’ would be ‘punished’ with fewer loans or higher interest rates. It would have been better to permanently increase the capital ratio at the outset.

The elephant in the trading room — that many banks are too big to fail — looks set to drift off the agenda. Yet it is the most fundamental problem with the existing financial system. And it is not only a foreign affliction. It is patently obvious that Australia’s four major banks are too big to fail, which means Australian taxpayers subsidise them, including their more risky proprietary-trading and speculative activities.

Publicly guaranteed private companies should not be part of a free market. As both Mervyn King, governor of the Bank of England, and Alan Greenspan, former chairman of the Federal Reserve Board in the United States, have suggested, if banks are too big to fail, then they are too big.

Ideally, the government’s promise not to rescue banks would be credible. Unfortunately, in a democracy, it never will be. The free-market solution is therefore to offset the benefits to private banks from their guarantee and try to curtail the perverse incentives created by it.

It is therefore ironic that Adam Bandt, a Greens MP, is calling for a “too big to fail” levy on Australia’s major banks. How any such a levy were designed would be crucial. But given Australia’s major banks do not even pay a fee for the government’s $1 million deposit guarantee, some scope exists for some type of compensation for taxpayers.

The most likely outcome, however, is that little will change. For Australians the GFC was a foreign spectacle more than a genuine economic crisis. That is unfortunate, because the problems created by explicit and implicit subsidies are no less real simply because they do not manifest themselves at a particular time.

Peter Fray

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