Helen and Michael get lucky again!

Up until 12 months ago the Labour-led coalition government in New Zealand had experienced a dream-run with multi-year strong economic growth from 2002 until 2007 boosting Government finances.

Unfortunately, for a number of reasons the average Joe Blow did not see his income rise in proportion to the GDP growth. However, no-one worried about that. The house value was going up and the bank would lend to you more than you wanted and some more for the investment property.

My, the world has changed in a year. The party is over and the hangover is painful and long. With the economy in recession and the global credit crunch preventing mortgage borrowing rates from falling to the normal extent, it appeared that squeezed household budgets/balance sheets would guarantee a change of Government to National next month.

Luck has just returned for Labour with guarantees of another sort coming to the rescue of Helen and Michael. New Zealand had to follow Australia into the Government guaranteeing retail bank deposits. The Australians have gone further than us with their Government guaranteeing their banks' international wholesale borrowing as well.

In theory, the banks here should lower their interest rates paid to retail depositors to somewhere near the Government bond interest rate curve (6.00% to 5.50%). If a bank deposit or bank bond is guaranteed by the Government, the pricing of risk should be at a small margin above the Government bond yield. Why should an investor get a return of 7.55% for a 90-day term from a bank when the deposit is guaranteed by the Government and Government Treasury Bills for 90-days are 6.00%? It may take some time, but bank retail deposit rates must fall considerably from current levels to reflect the underlying Government credit risk. The big 4 banks fund between 60% and 70% from retail deposits, therefore their average funding costs must reduce.

The other side of the argument is that the banks will want to pay interest rates to attract new retail deposit monies. They want to have less reliance on offshore wholesale funding sources. If the banks do not lower their retail deposit rates to just above 6.00%, it is a great deal for retail investors, as they get a bank-type return for a Government credit risk.

The Government guarantee will cause all sorts of market distortions, but Helen and Michael will not worry about that if the voting punters receive significant reductions in mortgage interest rates over coming weeks. A month out from the general election, the incumbent regime, after doing very little for the economy over nine years, just got lucky in the nick of time again.

Public being hoodwinked on real causes of the recession

We are in an election campaign period, so let the political propaganda flow and "never let the truth get in the way of a good story". A radio station called me this morning, asking for my comments on the Government's "rescue package for NZ banks". The communications spin doctors will use any fortuitous event to push their cause. Labour Government politicians are happily blaming the current economic recession on the global banking and credit crisis. They are wrong. PM Helen Clark labels the money-markets as "greedy" and they have caused all these financial and economic problems. She is wrong. Got to have someone to blame, to divert the attention from your own actions (or lack of action). The global meltdown has added to our economic challenges, but they were not the root-cause of the NZ recession.

The facts behind how we got ourselves into this recessionary mess are as follows:

• Excessively tight monetary policy settings in 2005 and 2006 caused the recession by crucifying the exporters with the resultant high NZD currency value and pushing mortgage interest rates up on an over-leveraged household sector.

• Easy credit and cavalier lending by the banks (particularly the fixed-rate mortgage war in late 2006) fuelled the already over-extended property market and led to the inevitable property bust.

• The economy was already on a path to recession in mid-2007 before the global credit crunch started.

• The RBNZ miss-read the sources of inflation and mistakenly hammered home-owners and exporters, when most of the inflation was supply-side or Government sector sourced.

Getting ourselves out of this mess will take more than a superficial blame game approach. It will require leadership, fortitude and vision.

*Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com