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  21 September 2008AGENDAPresented by RAWDON CHRISTIERAWDON Stock markets around the world have roared their approval with record gains as the United States government has pledged to spend what could be a thousand billion US dollars to try and stem losses springing from the financial meltdown we saw last week. Altogether it's been described as the biggest United States government intervention in the economy since the depression of the 1930s, but is it over, is there a danger that what so far has been a financial crisis could yet become a world wide economic crisis. Former Reserve Bank Governor and National Party Leader Don Brash and Economist and Investment Advisor Gareth Morgan join me now. Good morning Don I'll start here. The big question why – why are we seeing such huge uncertainty you know, a war hasn’t started, buildings haven’t collapsed, planes haven’t been driven into the ground, why is there such huge uncertainty here? DON BRASH – Former Governor, Reserve Bank Well I mean six months back we had five independent investment banks in the United States, now we have two with rumours surrounding at least one of the other two. We had the largest insurance company in the world threatened with collapse this week. This has been a very very scary financial turmoil and it clearly will have an effect on New Zealand. RAWDON And now the US has come up with this idea of putting a trillion dollars to basically remove all the toxic debt, put it to one side and sort of state own it, is this a wise move? DON Well, I guess what's the alternative, they simply cannot face the possibility that major banks all over the world will get into serious difficulty, so something drastic had to be done, I don’t think there's any doubt about that. I don’t know whether this will work or not, we don’t yet have any details of it how it will work, there's clearly some significant risk in telling banks that no matter how many bad debts they have the government will bail them out, there's a moral hazard risk there, but clearly no country can afford to have all its banking system fail and that seemed to be what was at risk. RAWDON Gareth let me just ask you about what you think about this idea of the government buying all the toxic debt, I mean is there an alternative or is this as good as it can get at this stage? GARETH MORGAN – Economist and Investment Advisor Well right at the moment I think that that’s all they can do, but my view on this is that you know they’ve been doing it now ever since deregulation, every time the world gets in crisis the central banks seem to be trigger happy and they come in very quickly and rescue everybody you know this is the moral hazard argument that Don's referred to, I mean it happened in 87, happened with the savings and loans, happened with long term credit, happened with the tech boom 2000-2002, now it's happening again. So I would fairly and squarely lay blame for this at the doorstep of central banks who unfortunately do not allow markets to adjust, they become so allergic to recession which I wouldn’t have thought was ever in their brief, but they have that now everybody knows that when we get into a situation where recession, not depression recession, where recession's threatening the central banks of the world will just turn on the money taps and as a result of that the amount of leverage in the world over the last 20 years has continued to increase, the whole derivatives market's a leverage based exercise for example and we're getting just the levels of instability I think that have been unprecedented. For me the parallel is after the Depression when they went to governments to save you know the economic cycle and that was keynesian economics when governments would spend when the private sector was going into a natural contraction that you have to have, I mean private sectors do expand and do contract I mean it's the sort of you know the nature of things overshooting and undershooting, but the whole keynesian economic thing was on and we can stop that by government spending when the private sector's down and contracting when the private sector's up, of course that turned into a license just for governments to spend all the time and we ended up with embedded inflation and you know a big dislocation, I think we got a wee run of exactly the same but the central banks are causing it. RAWDON Now they're saying that it's probably not gonna hurt, it's not gonna be as devastating as in the 30s so how much is it gonna hurt us here in New Zealand? GARETH Oh well I mean this is one of the most leveraged economies in the world you know with a lot of external debt, we've had a lot of external borrowing over recent years, I mean look at us now I mean it's pathetic, we've got the highest terms of trade I think we've had since the Korean wool boom and we're still borrowing like hell, I mean a record balance of payments deficit's just come out so we are highly leveraged so if they turn off our money taps then we're gonna feel it, so you’ve gotta ask yourself the question what have we don’t with all that money, where have we put it, and you know what the answer is, we've all put it into the same asset classed property which is now about 30% overvalued. RAWDON And that’s where it's gonna hurt most, that’s what's gonna come down? GARETH That’s where it'll hurt the most yes. RAWDON Don Brash let me ask you, Gareth Morgan basically said it's the fault of the central banks, well you're off to a meeting in the US of the central bankers next week, is that a fair comment? DON Well I don’t want to get into whose fault it was, I think the key question is what effect will it have on New Zealand and I think Gareth is right that New Zealand is a very highly leveraged country, a ratio of net external liabilities to the size of our economy's about 80-85% which is a very high figure by international standards and undoubtedly that means that with turbulence internationally we will pay a higher price to raise the money required to bridge that gap. RAWDON Which comes down to the Reserve Bank at the moment trying to lower interest rates to try and kick start our economy, that’s effectively gonna be nullified by this? DON Well certainly to a large extent, the Reserve Bank can affect the short term interest rate because they control that, they cannot affect the two three four year interest rate and that’s where many of our mortgages are funded. RAWDON What would you do if you were still running the Reserve Bank? DON Well I don’t know that I want to comment on that, because it's not fair to my successor, but I think gradually reducing the short term rate is a relevant and right thing to be doing. RAWDON And that’s what we'll probably see, an emergency rate cut possibly? DON I wouldn’t expect to see that, but we're affected in two ways actually, one is by the direct effect of interest rates being higher than they otherwise would be, the other is by the fact that the world economy is gonna be slower than it would have been and that'll affect our exports as well. RAWDON Gareth is there something good to come out of all this, I mean people are talking about a consolidation, a sort of rethinking of how our banks operate, is that a good thing? GARETH Well I hope that that follows and that we don’t this time next year have basically forgotten this crisis and moved on on an ever greater level of leverage and we're waiting for you know the next boom. I mean the 2000-2002 period I thought was the greatest threat that we'd had since the great depression, that’s when sharemarkets fell 35%, they’ve only fallen 25, but the problem is that the authorities will not let it work its way through and they are actually causing the problem by rescuing us all the time, and this is what central bankers have gotta face up to, and not you know hide behind walls on because they're actually causing the trouble and certainly when you get into a crisis like this, you know their options are limited I'm the first to acknowledge that, but we shouldn’t be in this crisis, they shouldn’t have allowed prudential ratios to slip to the degree that they have and therein is the problem. RAWDON As a director of the ANZ Bank what sort of conversations are being had this week, late in the week? DON Well I don’t want to disclose those conversations but what is clear is that the New Zealand based banking system is having to pay more for its offshore funding than was true 12 months ago, no question about that, and that will undoubtedly mortgage rates as I said earlier, at a higher level than would be the case. Can I just make one other comment about regulation and non regulation, Alan Greenspan made an interesting comment just last month in fact when he said that when we thought about the next financial crisis we expected that to be about the hedge funds and the private equity funds which are not regulated. In fact what has happened is the crisis is in the most regulated part of the financial sector which says something about the way regulation works. RAWDON And regulation's obviously gonna be something which is gonna be addressed at length … DON Certainly but I don’t think the answer is as obvious as people assume it is. GARETH I'm not actually saying that things should be fixed by regulation, I'm actually saying that when these markets overshoot like this you should stand back and let them self correct, it's not an argument about regulation it's an argument about not being such a busybody and trying to keep the world from recession every quarter of every year, that’s the problem. BRIAN FALLOW – NZ Herald It's not just on Wall Street though that people have been piling up debt, New Zealand households have like crazy during the housing boom of the middle of this decade and now it looks as though they're gonna spend quite a long time in sort of the cold dark shadow of that mountain of debt, and I assume that part of the adjustment is a further fall in house prices, is that right gentlemen and but also just the passage of time and the shift of behaviour towards less spending more saving, more repayment of debt. So for parts of our economy that are based on discretionary spending by consumers it's gonna be a pretty grim trudge even if we avoid sort of some apocalyptic scenario. RAWDON Gareth can you give us an answer to that? GARETH Yeah well no I agree with that Brian that’s essentially the path we've looked for. In terms of house price falls, I mean my own view is that you know as long as they don’t pump too much liquidity into this thing and we get a rerun then I would expect house prices to fall 30%, not nominal, real. Now we've already had a fall – 4-5% fall in nominal prices over a year where inflation's been about 3-4 so you’ve already had almost a third of it. I just expect that to continue over the next few years. GAVIN ELLIS – Former Editor, NZ Herald Gareth what you’ve been talking about has a commonsense feel to it but we're talking here about spilt milk, the actions have already taken effect. If you take the central banks out of it now at this point aren’t you inviting in a complete melt down and the transition from a financial crisis to a full economic crisis? GARETH Yeah well you’ve gotta get back from the cliff first that’s the first priority, my concern is then once you're back from the cliff and remember the tech boom you know we came back from the cliff and then we allowed this whole expansion in the New Zealand case it was the housing boom, and we do nothing about that because the central bank sort of feels oh well we only focus on goods and service inflation, but meantime the prudential standards for loans going into that household were just going out through the window, I mean for goodness sake these trading banks in New Zealand have been lending over 100% of the value of houses. You know when I was a young fella and you buy a house you had to have 30-40% equity, so I think where the problem is is on the prudential side. BRIAN Dr Brash could I ask you about this really ugly current account number we had on Friday, 15 billion the gap between what we spend and what we earn overseas, that has to be funded by an inflow of capital. As I understand it if for some reason because of this crisis that flow of funding is choked off or choked back we've gotta make an adjustment that means basically importing less stuff, less consumption, less investment, fewer jobs, less growth. Do you think that we could be forced into that sort of scenario? DON Oh I think your comments earlier are absolutely right, we face a prolonged period when discretionary spending will be much less in evidence than it has been in the past, we will not any longer be able to enjoy the luxury of house prices constantly going up and refilling the bank balance so to speak, so I think we do face that. The question is is that a prolonged gradual process or is it a relatively abrupt vicious process. We know from looking at the Asian crisis in 97/98 that countries can move from big current account deficits to quite large current account surpluses but that’s a very painful process if it happens quickly. GAVIN When Gareth mentioned the prudential aspect of this it does raise does it not the possibility of a return to orthodoxy if you like, the removal of these rather innovative but dangerous financial devices that have proliferated and in fact are at the core of the problem, can we see a return to a situation where you will have to have a third deposit and it will be difficult for you to get a mortgage, the sort of things that we had back in the 50s and 60s? DON I don’t think we'll go that far back frankly, and what I take it there have been some innovative things done, we haven’t seen anything like the scale of that sort of hanky panky if you like which went on in the US market, yes there are some banks that lent 95% 100% on a house but by and large that’s a very very small part of most banks' total mortgage book, and normally it's done because there are other assets or other income to support that loan. The US situation's very different and I don’t have any concern at all about the mortgage books of the New Zealand banking system. BRIAN There's some comfort isn't there in that our banks still generally hold the mortgages that they write so that they have that incentive to ensure that the person they lend to is good for the money. DON That’s right, they're not flicking those on to other parties, that’s right. RAWDON Gareth let me ask you about investment opportunities then, what should we be doing? GARETH Oh well I think as far as the individual is concerned at the moment you know obviously it's just trying to hold on to your money is the challenge of the times. Now to do that you know it's the old granny story again you’ve just simply got to diversify, because you know none of us can sit here and tell which is gonna be the next winner or the next loser and to what extent, so if it's about wealth preservation you diversify and unfortunately in the New Zealand sense diversification amongst households has been well I'll have one house in Wanaka and the other in Auckland, so it's not quite what I mean. RAWDON But the problem with preservation is that growth's going to stagnate completely is it not? GARETH Well under this and I agree with Don the main mechanism that’s going to affect New Zealand is just a tightening up of the credit supply from offshore because that’s how it'll happen here, so it will be a slow go economy here, so you know cash will be king really and I think that that side of the risk spectrum would be preferred for people. RAWDON Gareth Morgan and Dr Don Brash thank you both very much for joining us this morning, much appreciated giving us your time. |
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