You missed one point, banks will colapse and people lose their savings

Awesome analysis

A hard lesson for a hell of a lot of people to get to grips with BUT, what is going to stop it from happening again.
As you say, NZ's problem has been excessive overseas borrowing to fuel a housing feeding frenzy, essentially a non productive activity.
With the huge blow out in property prices, this 'paper' money was used to fuel a spending frenzy.
Dangerous ground, especially when that paper money starts to dissappear as the bubble deflates.
So as I ask, what's going to stop it happening again, no one appears game to tackle the ring fencing of tax benefits.

Interesting read
The crutch of the 12 points in my opinion sounds like it lies with point 7,'the ability to borrow on wholesale money markets'. The extents to which the future points 8-11 manifest themselves would seem to be directly related to this inter bank lending. If it can't be unfreezed soon then points 7-11 would be much worse although they will still happen to a lesser extent anyway. So if this is the case i would be very interested to follow this inter bank lending and if it can unfreeze itself

I have two questions, excuse my finance ignorance if these are common knowledge. Firstly why haven't we been able to borrow on the london and new york markets in the past three weeks? and how do i follow if New Zealand banks are finally able to borrow on these markets.

I understand that the LIBOR rate controls these inter bank lending. Is it because this rate is just too high at present that we can't borrow or is it just because the facility is not open to New Zealand banks at present??

Bernard replies;
Banks in New York and London are simply not lending to each because they don't trust each other and our banks are caught up in that. Luckily most of their interbank lending is done in Australian markets and they're still working.
We'll know they're working again from anecdotal evidence in Europe and the United States. I watch reports from Bloomberg, Reuters, the FT, Wall St Journal, RGEMonitor and others. I'll report it here when I see it.
On your point about LIBOR. Even though there is a rate being quoted, observers are saying this is often a number plucked from the air because no actual trading is going on. cheers/bernard

Bernard

Sounds scary, nevertheless, it would be imprudent to think your outcomes could occur in isolation. NAB is already rumoured to be raising new capital in the region of AUD 2.5 billion: http://www.bloomberg.com/apps/news?pid=20601081&sid=aPjZ1E6cM39k&refer=a...

Banks are fully capable of replacing the foreign liabilities on-balance sheet with adequate tier 1 capital.

Of more concern is the break down of the US Treasury debt funding conduits into Europe, China and Japan. In a matter of weeks the US domination of these financial recycling pathways has ended with nationalisation of banking systems beyond the US border.

Within the space of those weeks the US Treasury has raised upwards of half a trillion dollars, just to fund the current rescue activities of the Federal Reserve. I would guess there are many more half trillions to come: http://www.treasurydirect.gov/instit/annceresult/press/preanre/2008/2008...

Which country will feel the need to buy these liabilities, unless they represent the costs of vendor financing. As it stands the US slow down reduces the likelihood of that outcome.

More probable is an explicit default/devaluation by the US authorities some time next year. It happened effectively in 1973 when Nixon removed all vestiges of the Gold Standard.

So what maybe more important if we are going to enter the realms of fear mongering is to protect our USD foreign reserves and other savings based offshore and think about capitalising our banks to enable them to grow their own balance sheets at a sustainable level.

Bernard replies;
Stephen,
Very interesting points. Hadn't thought of the US money printing issue and I agree there are lots of factors that could easily upset the 12 steps. As I said, this is my speculation and I hoped it would trigger an open debate how might happen and how to prepare for it.
I'm curious about the banks replacing those foreign liabilities with tier one capital. Do they have enough? Will this force nationalisations?
cheers/bernard

Bernard,
if you want to have a 13th step ( to differentiate yourself from AA and Roubini) then...

Bollard drops the OCR by 1% on Oct 23rd

Mr & Mrs Watanabe go hmmm

By Oct 24th the currency has gone the Iceland route.

Although after looking at the following link then perhaps its not so unlikely..
http://www.ft.com/cms/s/0/49af564c-9bad-11dd-ae76-000077b07658,dwp_uuid=...

caveat - the bits and pieces I've seen about Oct 21 and Lehmans CDS don't have a part to play in driving the NZD south

For example http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/321164...
Regards,
Gibber

Recession is the time at which assests go back to the rightful owners. There were many "trend chasers" who borrowed money and invested in housing. These investors are still at a huge profit, who are chocking the dreams of many who are stil renting and unable to buy a house.

Retirees who invested in term deposits were fooled by the high inflation and the real value of their savings dropped in the last 5 years.

Many retailers, particularly building product retailers, have actually increased their margins even when our dolar was strong. Mega stores were built on borrowed money and the costs of servicing this debt was passed on to the public. I have seen many 10 dollar imports are being retailed for 50 dollars. For example, the price of HDMI cables. Retail margins are huge compared to import cost, save a few items such as TVs & whiteware. Many of these debt ridden retailers will have to leave the market.

There are many sectors of the economy which thrived on the growth driven by the debts. Time for the debt to stike back and correct the skew it caused in our economy.

Bernard
I can agree with most of your points. The one I really don't agree with is your time line. Bill Bonner wrote today, 7 years of plenty and 7 years of Famine. I don't think this is going to be short. I re-read some of my Grandfathers diaries in 1929 he wrote "the good years have gone will they ever return". They did but it was a long time and a lot of pain and it took the 2nd world war to restart the economy. We not only have to stop running deficits we have to start running surpluses. We also need capital which may stay expensive due to a shortage, for longer than we would like. It is hard to see new businesses being established under the present high cost regime. So we need to accept some significant change in how we look at businesses and how they are treated. If we stay dependent on the $US then it may get sticky fairly soon I think we need, in the very short term to reduce exposure. I think that it will take longer than we think for attitudes to change. Eventually the belief that we have right to a certain standard of living and faith in a welfare ridden govt controlled high cost system needs to be broken. The way we treat healthcare, education,welfare and infrastructure spending etc all come with the premise that we are worthy of these things, the future may be very different.

malcolm

Good call.

Who would be left to extend loans with a negative real return on capital plus no cover for counterparty credit risk ie households unable to make payments?

You must think money grows on trees or those that have capital to spare are stupid.

Scary. While it might not be the 1930s, it definitely doesn't look too flash at all... Time to upskill and put the extra hours in at work I reckon.

The forced rise of frugalism as the dominant lifestyle will be a welcome relief though- I have often been appalled at how much debt people are prepared to take on, it's staggering.

The really interesting thing will be the longer term international reaction- if the Americans are driven into grinding poverty along with the rest of the Anglosphere, will they go quietly into the night and let China take over as the dominant superpower? Or will they elect a madman who defaults on their crushing debt and starts WW3? That's the real nightmare scenario.

Bernard

I wonder if you know the answers to some of the questions i have about interbank lending and other issues about our foreign debt and how it is now financed and how it will be financed.

1. Firstly interbank lending rates are not very high. They indicate that if you wanted to borrow you could at those relatively low rates. The banks daily say they could borrow at these relatively low rates via the LIBOR questionairre. But banks dont need to borrow from other banks because they have access to cheaper CB funds. So what is the problem? Banks just dont need the interbank market because they have access to the central bank funds. Respected US banking analyst Dick Bove said it is a fallacy that banks cannot borrow. He said rates would have to be 21% before he believed that banks could not borrow.

2. Via Scandanavia the Federal reserve has done some kind of swop deal to allow Australian and new zealand banks to get access to the cheap dollar funds the federal reserve is offering at the very low rates available. What about the influence of that in our local market?

3. Do we yet know the total overseas currency exposure that we as a nation have that needs to be funded from only overseas borrowing which if it were to end we would need to pay back?

4. As i mentioned currently the interbank borrowing rates as given by the banks own information if they wanted to borrow is relatively low. NZ banks could i believe simply fund all their credit card debt profitably via that borrowing rate and only perhaps slowly have problems as they dont make profits. Remember they have made large profits i believe you have said? And you have said these banks are safe because they are well capitalised and have better ratings than other banks. Other things being equal NZ banks dont have funding difficulties relative to the other banks in the world. The issue here seems to be higher rates than we would like rather than something grim.

5. You say that the banks have borrowed on our behalf and we have used that money to pump up house prices. That seems a bit upside down to me. We here stories from banking unions that staff are under pressure to push borrowing out to customers even if they dont really want that invitation. And related to that please note 6.

6. I spoke to a franchise owner of Ross? pero mortgages earlier this week when i went to visiit the RBNZ also. Some 100% mortgages are availble for example graduates who are likely to get increasing earnings. Others can get 90% finance. The person i spoke to seemed to be fairly clued up so i took that as the situation as it was earlier this week.

7. And as i mentioned earlier to you this week, the RBNZ was very surprised that the figure of 84billion of overseas debt needing to be rolled over every 90 days and felt that could not possibly be foreign currency but rather was partly what i refer to myself as the recycling of NZ dollars from overseas which get accumulated by our surplus trading partners who are happy to lend it back to us at our high rates of interest in preference to spending the money on our export goods.

8. NZ finance compainies got burnt on car loans it seems. But Mcquarie bank also got burnt. But they have access to the ECB for some reason that i have never seen discussed in Europe. Why exactly is it part of the 12 step *plan* that the finance companies go bust? It appears that some of the risks that the finance companies took were funded by for example HBOS? or Royal bank of scotland? who must have been hungry to enjoy high NZ interest rates or whatever they were doing being here? They might also have enjoyed some kind of gain from the increasingly more valueable NZ dollar as this kind of inwards funding drove up the dollar? And by exiting and collapsing the finance companies they could lock in that gain? I dont know i am just guessing but all these things seem possible. Macquarie were bailed out by the europeans for doing what the 'terrible' NZ finance companies did. Perhaps macquarie were supporting sales of european cars?

So whats my point here? I suppose i am wondering if it is possible to get debate on what is really really happening as opposed to what various lobby groups might want us to believe is happening.

Other things being equal if people in the united states can still get more or less zero rate credit cards at the moment a bank should easily be able to borrow money from another bank. The only question is how much will it cost.

Bernard replies;
Andrew in Ngaio,
Interesting questions. The Northern Hemisphere markets are frozen. The LIBOR rates quoted are not being transacted at. I've repeatedly asked the Reserve Bank for the 'real' short term foreign debt rollover number. No response yet. It may be less than NZ$84 billion, but it is certainly more than NZ$10 billion. cheers/bernard

Yep quite a good sum up of what had been and what may come

Unfortunatly more Growth wont be happening since the resource base required is no longer there.

So if you can figure out how those resources fit into the growth economic joke its more likely to be a serious depression...

Growth economics has always been a smoke screen of nonsense if you examine it closely!

I think we need another scenario.

The Ten steps to Recovery

1. The international and local rescue plans work like magic.
2. Labour is re-elected and economic stimulus plans are implemented
3. Interest rates are slashed to 6% by Christmas and, by February, confidence returns to the banks and they start to lend again, but this time in a more regulated environment
4. Rates are cut further, to 5% by mid 2009.
5. House prices stabilise as affordability increases, buyers come back and consumer and business confidence turns up.
6. Export earnings start to rise as the dollar drops to 55 c to US
7. Companies report lower profits, but there are no big collapses.
8. Commodity prices stabilise.
9. Oil goes to $60 and stays there, helping bring inflation down to 2%.
10. The global economy is helped by only a mild slowdown in Asia and returning confidence in the US under the measured jurisdiction of the Democrats

It is a kinder, slower and more thoughtful world

"9. Oil goes to $60 and stays there, helping bring inflation down to 2%."

Theres a thought..price drop, consumption drop or little growth...India and China will eventually get hit hard too...
I dont think OPEC counties will be happy about a reduction in income...no oil will go up.

Bugger $30m lotto draw postponed till 8.30pm - maybe they are having trouble securing $30m to pay out on Monday LOL

In practical terms for most businesses in our economy recession means:
Slow consumption= less income for businesses= less profits= less production/services= redundancies and bankruptcies= more debts= less affordability= less consumption= etc.

Considering even more surprises on worldwide economic, financial and political fronts I think prediction of a 8% unemployment rate is to low- it can go up sooner and to breaking point.

Without new drastic and fantastic visions are we not at the beginning of a vicious cycle ?

A bit doomsdayish but nevertheless an interesting strawman to put out there.

A few things do ring true though.

a) consumer credit drying up substantially
b) house prices dropping a lot
c) the Kiwi$ falling ...

Bernard

The thing we need to wrap our heads around is the nature of LIBOR.

LIBOR is based on a question that is asked of a bank.

That question is: If you needed to borrow *that currency* from another bank what rate of interest would you pay for the following 15 different loan types.

1. Overnite
n.
15. One year.

The banks answer to the question 'what rate can you borrow at from another bank' is the LIBOR input they give back to the British Bankers Association which publishe this opinion poll result called LIBOR.

The banks ***dont need to borrow*** at LIBOR

The LIBOR interbank markets are **not** frozen. Instead they dont exist.

They dont exist because the banks can get ***cheaper*** risk free money from the central banks.

****but*** daily the banks are asked the simple question.

"If you had to borrow money 'what rate of interest would you be charged to borrow from another bank' "

How do you **personally** know the markets are frozen?

You do not know. Somebody has told you that. Just as they tell me that.

But the banks are indirectly telling us that they have no problems at all borrowing at the LIBOR rates if they ***wish*** to do that.

There is just no insentive to borrow at LIBOR.

Banks normally fund their existing loans at wholesale interbank LIBOR rate cheaper than the lend out.

But now they are being asked to borrow from banks at the same price they lend out to customers and there is no point in doing that. They make no profit on lending. So they dont want to lend.

Instead they get cheaper money from the central banks.

Until we look at that whole story i dont think we are looking at this topic correctly.

All that is being signalled is that central banks are finding it hard to force banks to lend.

But banks can lend at higher rates.

That is why you can still ***easily*** get a loan in the UK or finland or New Zealand or the USA. But it is not *so* easy as it was.

We are talking about a relative change here rather than a disasterous one.

Please consider that possibility based on what we actually know as opposed to what we are actually being told by banks who are receiving massive injections of public money with very little relative public equity - if any at all.

Sunday Star Times this morning Reserve Bank comments - maybe the post above is a bit too negative?

The Reserve Bank says figures suggesting High St banks must refinance more than $80 billion of funding within three months are misleading, and there is no wholesale funding problem requiring a government guarantee.

Several commentators have highlighted Statistics New Zealand data implying a funding crisis looms as banks struggle to roll over huge overseas debts in a tough global market. But Reserve Bank spokesman Mike Hannah said the figures were misleading as much of the figure was simply interest rate resets rather than money actually due for renewal.

The debts up for renewal were "a fraction of the figures being talked about".

"We are confident the banks have got funding to take them through to Christmas," he said. The Reserve Bank had taken measures to ensure banks could fund themselves through the credit crunch and "we haven't dipped into all of our tool kit yet".

Sorry- wrong link. This one
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/3218250/...
"The rate that banks charge rivals to borrow pounds for three months edged lower to 6.16pc, leaving it down more than 10 basis points on the week. It was the first time since early September that the rate ended the week lower.

"Libor rates continue to edge down, bringing the prospect of some rejuvenated inter-bank lending that little bit closer, even if it is still some way distant,'' said Daragh Maher of Credit Agricole.

The cheaper rates available to banks seeking sterling were matched by similar drops for those after dollars and euros. By yesterday, the cost of borrowing dollars for three months hit 4.42pc, almost half a percentage point cheaper than at the start of the week."

"For those promoting frugalism, I believe it has been a spectacular failure in Japan, and has only promoted deflation."

Are you implying that house price hyperinflation and an orgy of consumption funded by foreign borrowing is a better way of running an economy?

The Japanese central bank and successive governments threw everything they had at trying to stop the real estate bubble bust and the bank insolvencies, and still failed, as happened in the US in the great depression. Frugality was largely forced on them, not chosen!

The Japanese have now perfected the art of running a steady-state economy, which may well prove essential if predictions of resource shortages and climate change come true. The greenies are always going on about the impossibility of infinite growth on a finite planet, perhaps the Japanese are just a bit ahead of the rest of us.

Gibber - we will know the extent of the problem by Jan/Feb I guess. Totally out of my control and what will be will be eh!

Uk Kiwi and Malcolm,

Take care with unargued assumptions regarding Japan.

It is not a steady state economy at present. It is not really frugal ...but they do save more cash per household than probably any other country (havent space to detail reasons but briefly at 83 yen to the NZ$ a person doing a similar job earning 40KNZ is paid 70kNZ = in JP...and the increased JP cost of living does not fill that gap). Furthermore, more than half of businessess are debt free! But if no trade occurs .......

What the West needs to understand is that the Japanese business model and way of life is quite unlike any other. Their culture and thinking is that of a monoculture society whose ideals and ethics stem out of their history not out of the western churches (including sex, that arises from nature not convention or religion (E. Bruce Mitford 1913!)

If anyone is interested to gain a quick insight, I advise you to read De Monte Boye Lafayettes book, Business Ettiquette and Ethics in Business practice...the other way is to live over here, work among them and study the business and social culture,,,,,

The Japanese will do it their way....and the relationship with near neighbours is polite but under the surface harbours deep resentments from centuries of hostility...and visa versa.

Its not the friendly NZ vs Australia situation.

Are people bored? Are they hoping for a crash? The truth is the credit markets have begun to thaw. Overnight Libor (London Interbank Offered Rate) dropped 27 basis points to 1.67 percent, the lowest level since September 2004. Three month Libor shed 40 basis points this week to 4.42 percent. And no, we are not out of the woods , we are still in recession, but the financial markets are beginning to stabilise.
.
http://www.marketoracle.co.uk/Article6862.html

Bernard

The other dimension to this is that since RBNZ does not require a fractional reserve ratio to be maintained by the banks and credit creation is only constrained by capital adequacy ratios which are related to share prices and the overal amount of lending the actuall amount of overseas funding needed to sustain a binge in household credit is possibly a very small amount of money. The problem comes however when the share prices of the banks fall. They are then in an impossible position of having to raise capital to meet regulatory requirements just at the time when they can least do so.

You have said the banks are well regulated. They might be according to the various banking accords agreed over recent years but i seriously challenge the idea that the banks are well regulated when the amount of prudential oversight of banks by regulators is such that RBNZ staff have to tell me that they had that authority taken away years ago and have no ability to instruct banks to limit lending!!! ??? Bizarre but true or so they told me.

By the very nature of a regulator the regulator regulates. Our regulator is missing.

In a steam engine you had some rotating spherical heavy weights that regulated steam pressure at the power end depending on the power required to maintain the same rotation. That device is a regulator. At the other end of the system you had a boiler which was much harder to quickly control.

Our current system involves either pouring more petrol on the fire or removing fuel from the boiler to control our economic speed.. This is rediculously primitive. It is not a modern regulation method. By the time the boiler is too hot there is tremendous difficulty in cooling it down again and excess pressure cannot be easily diverted until it cools. Similarly once it has cooled down again it is hard to heat it up again. Our system has no automatic regulator like in the old days where if lending was too high then lending ratios could be required to be changed immediately to calm down lending regardless of borrower desire to take on more credit regardless of cost of credit. Obviously when house prices are rising nobody really cares about cost of credit and we have no ability at all to control the economic pressure. This is simple economics.

Currently we have this stupidly inefficient system where lending can be out of control pushing up inflation and we need continually high rates because somebody has taken away the regulator or demand valve that limits flow to only what the regulator will allow to flow. The absense of the regulator to cool demand means we have to have higher and higher rates to cool demand at a time when people are happy to pay higher rates to get capital appreciation of the assett that they are buying with credit.

Why are we stuck with such a silly system?