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Opinion: What the Credit Crunch means for New Zealanders
September 18th, 2008
The latest shocking installment of the Credit Crunch will affect New Zealanders, but not in the way many might immediately assume.
I reckon it will reduce our household wealth by cutting house prices and will squeeze our disposable incomes by stopping our debt servicing costs from falling much. It will probably also extend our recession into 2009, but is unlikely to morph into a 1930s style depression.
That was the short version for speed readers without any of the ‘why’.
Here’s the explanation with a bit more detail.
The instant reaction to the collapse of Lehman Bros and the bailouts of Bear Stearns, Fannie Mae, Freddie Mac and now AIG is being played out in the world’s stock markets as I write. The ensuing falls on stock markets will affect a few New Zealanders a little bit, but only a little. Unfortunately the stock market reaction is where the media coverage is focused. This is a mistake.
The real impact will take time to trickle through to the things that really matter for most of us: the value of our houses, the interest costs we pay on our housing debt and the interest we receive from our bank deposits.
This is a quick sermon I deliver often, but it’s worth repeating. World and New Zealand stock markets now don’t matter much to most of us. House prices and interest rates do.
New Zealand’s households had a combined net worth of NZ$634 billion at the end of 2007, according to RBNZ figures. Our houses were worth NZ$617 billion or 97% of our net wealth. We had NZ$170 billion worth of debt, which includes about NZ$160 billion of mortgage debt and the rest in credit cards and personal loans. We also had about NZ$80 billion deposited in banks and about NZ$10 billion in finance companies and mortgage trusts. Interest rate changes therefore affect around NZ$260 billion worth of debt and savings. They also indirectly affect house prices and therefore the size of that NZ$617 billion of household wealth.
Those same Reserve Bank figures show New Zealand households had NZ$15 billion invested directly in our stock markets and about NZ$9 billion invested directly overseas. Our managed funds, insurers and superannuation funds had about NZ$37 billion invested directly in assets of some sort, with less than a half invested in stocks, I’d guess. So all up, stock markets affect about NZ$42.5 billion of our household wealth.
It has dawned on me slowly that the mainstream media, which I used to be a part of, pays far too much attention to the stock markets and not nearly enough attention to house prices and interest rates.
There’s just no contest. Interest rates and house prices affect NZ$877 billion worth of our assets and debt. Stock markets affect NZ$42.5 billion worth of our wealth. This fact of life is a major part of the reason I’m working with interest.co.nz and why we think covering interest rates and house prices online is the future for financial news and information publishers in New Zealand.
Changes to house prices and interest rates happen more slowly and are below the radar of easily reported public markets, therefore are more difficult to report. But they matter much more.
So how will the Credit Crunch affect house prices and interest rates?
It’s worth taking a step back at this point to chart the trajectory of the Credit Crunch and how it has already affected both house prices and interest rates in New Zealand
The credit crunch started in mid-2007 when Bear Stearns (yes they started it) reported rising defaults on some of its securitised sub-prime mortgage bonds. House prices were already falling in the United States and it then dawned on financial markets that too much debt had been pumped into the US housing market too quickly and without nearly enough care.
US and European banks started writing down the value of these sub-prime bonds aggressively as house prices fell further and default rates started accelerating. By late 2007 many of these banks were raising fresh capital to bolster their balance sheets and ensure they met capital ratios. They did this by selling shares and bonds to regular investors. By early 2008 several had to go back to investors for a second round of capital raising. By then only the Middle Eastern and Asian sovereign wealth funds were willing to invest.
Then in March Bear Stearns almost collapsed. Only US Federal Reserve intervention to guarantee the value of assets bought by JP Morgan stopped a full collapse.
During this period from mid 2007 to March 2008 there was a significant lift in the cost of servicing the foreign debt owed by our banks because foreign lenders were more nervous about lending cheaply to anyone not in their own markets. By most measures that increased the funding costs for that NZ$135 billion of debt by around 150 to 200 basis points.
During that period banks passed on about 85 basis points to mortgage borrowers in New Zealand by increasing the average 2 year fixed mortgage rate to around 9.65% from around 8.8%.
Since March those international funding costs have eased a bit and the Reserve Bank of New Zealand has cut the Official Cash Rate (OCR) by 75 basis points to 7.5%. Over that time the average 2 year fixed rate mortgage has dropped back to 8.8% again. But we’re still back where we started in mid 2007 when the OCR was 8.25%.
The net effect then is that our fixed mortgage rates would have been about 70-80 basis points lower without the Credit Crunch. For someone with a NZ$200,000 mortgage that’s about NZ$30 a week.
So what happens from here?
The collapse of Lehman Bros, the forced sale of Merrill Lynch and the rescue (nationalisation) of AIG have shocked markets and foreign lenders all over again. The margin Australasian banks (ANZ, CBA, NAB and Westpac) pay above the safest kind of government debt has blown out again from around 150 basis points to around 200 basis points.
That means it’s likely they’ll have to pay an extra 50 basis points to foreign lenders whenever they choose to refinance their foreign debt. About NZ$60 billion of the foreign debt held by our banks has to be refinanced every 90 days.
How long could this go on for? Most observers say the world’s banks have written off about US$500 billion and they need to write off about US$1.2 trillion. That says we’re about half way through it, although some say the second US$500 billion of writeoffs (and the necessary capital raisings to go with them) could happen faster. It could happen through a series of collapses that wipes out the equity held by investors.
However fast it happens, the end result is likely to be more expensive foreign debt. That will be passed on in our fixed mortgages, either by increasing rates or by not passing on cuts in the OCR. I reckon there’s another 70-80 basis points of ‘higher’ (meaning not lower) interest costs to be built into fixed mortgage rates.
Combined with the earlier increase, that means about NZ$50-60 a week or 150 basis points of extra interest costs for someone with a NZ$200,000 mortgage. Given the Reserve Bank is likely to cut the OCR by another 50 basis points on October 23, that is likely to mean most of that rate cut will not be passed on to fixed rate borrowers.
These higher interest rates for longer will all intensify the downward pressure on house prices, but it may be a less obvious factor that reduces household wealth. Banks have already started rationing credit by lifting credit standards.
Kiwibank’s 8.49% rate for its special 2 year fixed rate mortgage only applies to borrowers with 20% equity, as does The National Bank’s 8.3% rate for its special 30 month fixed rate mortgage. Much more of the rationing is done behind the scenes.
The proof is in the new lending figures disclosed by the banks every month to the Reserve Bank. Net new mortgage lending collapsed to NZ$229 million in July from NZ$1.24 billion in the same month a year ago.
The implosion of the property finance company sector has further withdrawn credit from the property development and property investing markets. The worsening of the global Credit Crunch will extend this deleveraging of cheap and easy debt from the housing market.
We’ve predicted a 30% fall in the average house price between November 2007 and the end of 2009. We’re still on track for that.
But aside from asset prices and interest rates, what might happen to the real economy?
Some people are comparing this event to what happened before the Great Depression.
Even Alan Greenspan has said it is possibly the worst financial crisis in the last 100 years, suggesting it may even be bigger than the crash of October 1929. Greenspan should know. He was growing up during the Depression and spent much of his whole career learning the lessons of what caused the Depression and how to avoid one in the future. The defining moments of his period as Federal Reserve Chairman were his response to financial crises: the 1987 market crash, the 1998 Long Term Capital Management crisis (LTCM), the fallout from the bursting of the dot com bubble and the aftermath to the 9/11 attacks.
Many believe his reactions to these crises sowed the seeds for the reckless lending that created the massive leveraging within the US financial system and the housing markets globally. He organised the bailout of LTCM and kept interest rates obscenely low (1% for much of 2003) to protect markets.
Regardless, Greenspan cannot be ignored.
So why wouldn’t a financial crisis turn into an economic crisis like it did from 1930 to 1938?
It’s different this time…it really is. For all their faults, our financial institutions are much more sophisticated and diverse than they were in 1930. We have flexible exchange rates and monetary policies that will naturally stabilise the global economies. We have at least two other engines of economic growth that did not exist in the 1930, including China, India and Brazil. The US authorities seem absolutely determined to bail their way out of the financial crisis, reliquefying and inflating its way out of trouble. That didn’t happen from 1930 to 1933.
Global trading systems and rules are much more robust and widespread than in the 1930s. It’s very unlikely we’ll see a roll back of free trade in the way that trade was restricted in the Depression.
Our economy, along with the global economy, will go into an extended slowdown that could see many enter shallow recessions. New Zealand’s own economy will probably now remain in recession through the rest of 2008 as the forces of deleveraging on the housing market and slowing global growth keep a lid on any bounceback.
Tags: AIG, Alan Greenspan, Bear Stearns, Credit Crunch, Lehman Bros, Merrill Lynch, Mortgage rates, OCR, US Federal Reserve., US Treasury
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September 18th, 2008 at 2:50 am
Joseph E. Stiglitz in an interview just today has said that he thinks it’ll b worse than the 1930’s Depression. I don’t think he’s neccessarily a positive source, he was after all, on the world bank but that is what many other’s have said also; basically most of the world these days as opposed to the 30’s are completely dependent on the inter-connected financial superstructure distribution system and needless to say, people have absolutely no control over the distribution systems in their economies anymore.
Secondly, all financial upheavals in the past have been by design and this is no different. The real question is, what are the goals of the head fraud financial masters?
Bluntly, in the past it has always had the characteristics of populaton reduction(this is the georgian guidestones crowd after all) through the breakdown of the economic system, big wars(sometimes world ones) and a shift in history as a new regime/geo-political ethos fills a vacuum.
One thing i fell confident about, it will be used to merge countries currencies as a magical solution in the future, they might even go for the big one, one global currency, as things on the surface magically improve when any mergers happen, or so the clueless/stressed-out populations will be told.
It is also very likely that the carbon tax/credit bubbles are designed to be a further implementation/burden on populations when the chaos clears.
The Social Credit analysis provided by C H Douglas, the scottish engineer who oversaw the Brit. war economy in WW1, shows that when the inevitable consequences of filling the gap with privately created debt wth compounding interest gets to a certain extreme phase, to keep the population on the tread mill starts to destroy even the treadmill itself and thus the populations need to de-coupled from whatever meager benefits they were deriving and essentially re-calibrated as mentioned above in both historical examples and not too hard contemporary guesses.
Being an engineer, Douglas not only identified the money system and thus monetary reform for the protection of the individual from this machine, but also specifically the National Dividend as the perfect tool to stop such fluctuations building up steam n happening in the future.
September 18th, 2008 at 8:16 am
Thanks, Bernard, for an excellent account of the current situation. However, I am a little less sanguine than you about the robustness of our financial system. The credit led boom in the housing market is only the most obvious of the credit led booms we have seen in the last 20 years. A lot of production in the real economy is also fueled by credit and as this crisis starts to feed into the real economy (we have just heard that the startups in the housing sector in the US are at their lowest point in 17 years and I suspect the figures will continue to go down) then there will be further layoffs and the so-called prime mortgage market might start looking quite sick as well i.e. less prime and more and more sub-prime. And the businesses that have used credit to fuel their expansion will also start to default.
I think Greenspan and Stiglitz (I haven’t seen the source for the comment above but I can believe it) are right. This is not just going to be recession running through next year.
I have no idea what can be done about it collectively and I have little idea about how one can protect oneself and ones family from it. I do think the US needs to regulate (a clear difference between Obama and McCain here) but it should be robust and thorough. I am also concerned that those who made millions out of this in the last twenty years are going to sit in their mansions whilst the people who have to pay for the bail outs now through their taxes may well end up in dole queues and sitting outside those mansions with begging bowls. Even in relation to companies like Merrill Lynch, it is never the fat cats at the top who pay, but the much less well paid ordinary brokers who end up losing their jobs.
September 18th, 2008 at 8:29 am
Mainstream media (newspapers) recieve to much revenue from agents to report what is/could happen next……
the vested interests are running full page adverts in weekend herald to make it all look ok….
it isnt its bad, its game over for property for a long time…
September 18th, 2008 at 9:11 am
Does anyone find it interesting that the story on the Chinese baby formula poisoning broke AFTER the Olymipics ended – even though it’s been reported that for six weeks Fonterra has been aware of the problem? Isn’t also strange that a single apple mite found in NZ flower exports to the US saw an immediate ban on all flower imports to the US, but not an economy in the world has placed any kind of import ban on Chinese manufactured food products?
Could these be signs of just how indebted the rest of the world is to China – and how reliant the West is on China’s economic growth (no matter how corrupt that growth is) ’saving’ the rest of our economies?
September 18th, 2008 at 9:19 am
The reality is no one has any real idea where this is going to end up but as we’re looking at a global phenomena I expect cooperation amongst central banks should drag us out of this.
The issue in 1930 is liquidity disappeared. As long as consumers keep consuming we’ll be fine. Which is why the Fed et al keep pumping money into the system.
As for the property market, aside from the richest/debt free, we’ll ALL be out on the streets with nothing, should the worst occur. A point that is lost on most of the doomsdayers on this site.
September 18th, 2008 at 9:47 am
An excellent article Bernard. You will be pleased to hear that Gareth Morgan has also now predicted a 30% fall in house prices, so you are now in very good company. Very little is wriiten about the fact that this problem has arisen because people, encouraged by the greedy real estate community, started to believe that there homes were now investments and not places to live. So they started to treat and trade them as commodities and like all financial instruments their values became over inflated.
September 18th, 2008 at 10:01 am
Kate, being the perceptive observer you are, you’ve probably also noticed that the biggest holder of Fannie and Freddie debt is the Chinese government (US$376 billion) and that the state-owned Chinese banks are among the biggest customers of AIG for credit protection on mortgage backed bonds.
September 18th, 2008 at 10:10 am
I’m reading Soros’ latest book… He talks about a “super bubble”….. Ever more sophisticated ways of credit creation.
AND that this is based on a “misconception”.
That is…. an excessive reliance on the market mechanism…. President Reagan called it the “majic of the market place”…. Prime Minister Thatcher called it ” laissez-faire”.
We may have called it “Rogernomics”
This has its roots in the idea of “perfect competition”.
In the early 1980s’ I accepted all this as fundamental truth…. BUT now with the benefit of history… The way we apply it seems to be as dysfunctional as, for example, marxism.
SO…. Times are a changing…. and the “laissez-faire” model will be gone …. and replaced with something else..
“globalization”… “free trade”… “privatization”… “deregulation”… are all off-spring of
“laissez-faire”.. ( or should I say , the Wests version of Adam Smiths ideas’ ).
SO…. how will things change..???? ( I’m not smart enuf to know)…. ( I might need to wait for Soros’ next book…)…
But I do think that just as there was a fundamental shift in the late 1970s’..early 1980s’… there will be another one now..and
“free trade”…”privatization”… “globalization”… “deregulation” may no longer be the
” Fashion”.
September 18th, 2008 at 10:16 am
Kate
Add to that oil bounced up $6.15 last night, As expected at the end of the Olympics. The US has critically low Gasoline stocks (and are quite low on crude), The EIA reports every Wednesday to the previous friday, since the gulf of mexico is a port as well as a producer, and has been hit twice this is getting dire
I also hear the AIG may have the largest exposure to Gustav damage, boy do things happen all at once
Neven
September 18th, 2008 at 10:17 am
Houses are worth $617B and the mortgages against these houses is $160B – I suprised that ratio is so low – 26%. What happened to all these house holds that are mortgaged up to 90 – 100% and that are going to be under pressure to sell because of high interest rates and negative equity?
September 18th, 2008 at 10:17 am
What about a little closer to Home.
Western Bay Finance now out of receivership.
But thay still owe investors $0.18. Where does the trustee stand on this. Bernard being the journalist perhaps you might like to ask on behalf of the investors.
September 18th, 2008 at 10:25 am
Now that Greenspan is retired he speaks with “straight tongue”.
Last yr he said in different speeches..
THAT…. the deflationary forces of Globalization and the emergence of China are now Behind us…. ( I agree)
He said that he ccould forsee the fed rate in double figures at some point
http://www.reuters.com:80/article/businessNews/idUSN1728325720070917
Generals are always fighting the “last War”….
For us , that might be using Japans Experience in the 1990s’ as an analogue of what will happen to the west now..
That could be a mistake…
Once this deflationary tornado passes… it will be interesting which will be the ongoing issue…. Inflation or deflation…. ???….
Last yr I was thinking Stagflation… but I have no idea right now….
September 18th, 2008 at 10:34 am
Bernard I saw you on Close up the other night and just about choked my my dinner ( a lovely spread of chilli con carne ) But I have to say I was impressed with what you said. Very diplomatic of you!
I think your take on what is reported in the news ( like the share market etc ) is almost completely out of date. The rare New Zealander that does invest in Shares usually does so threw a retirement fund that they dont control individual stocks or is some one who would pick up a paper or read on-line information about. The other 4 million people in NZ are much more interested in Interest rates and House prices.
Would be great to see some coverage of all this on the news ( I guess it might not make great TV due to not enough changes happening on a daily basis… )
September 18th, 2008 at 10:40 am
Using the value to debt ratio stated someone with a $200K mortgage will have a house worth $770K. With that much equity in their home they would qualify for Kiwibanks rate of 8.5%.
September 18th, 2008 at 10:49 am
“It has dawned on me slowly that the mainstream media, which I used to be a part of, pays far too much attention to the stock markets and not nearly enough attention to house prices and interest rates”
Brendan,
Its great that you are focusing on the issues of house prices and interest rates as well as providing a steady stream of news in this area. The mainstream media provides little in the way of detailed discussion in these areas which demonstrates our national level of financial literacy something we need to change.
I’m looking forward to your next realisation which will hopefully be a focus on money itself: its creation, its construction and its place as the foundation of our hydra like financial system.
Understanding compound interest, fractional reserve banking and how the money supply increases would be a good start.
September 18th, 2008 at 12:47 pm
It’s amusing to watch the institutions buy buy buy one minute and dump dump dump the next minute. All the while looking at their charts and thinking you can make some dosh playing this game.
September 18th, 2008 at 12:54 pm
For Andy Rogers; Gareth Morgan was saying over 9 months ago, in the press articles that he writes ,that house prices were due for a 30% odd correction. I’m not trying to pour cold water on your view of Bernard, but not only has Gareth been ahead of the pack in the housing view, but he appears to have had his Kiwisaver products in as much cash as possible for many, many months now.
Also; Why 30% Bernard? Fibonacci says 23.8% or 38.2%. He fits with the Dow high from 14,164 to make the first move to 10,793. Then, worryingly 8,753.
September 18th, 2008 at 1:06 pm
Janet
I agree with a lot of what Gareth says. Just to be clear though, he is forecasting a 30% drop in real house prices, which means actual prices could fall 15-20% and inflation of 3-5% or so over the next couple of years would do the rest of the work.
I’m forecasting a 30% drop in nominal prices, which could add up to a 40% drop in real prices, depending on what happens with inflation.
I’m basing this on my view of interest rates (remaining high) and affordability (which is way out of kilter). Prices need to drop 30% from their peaks to return affordability to its 2004/2005 levels, when things were remotely affordable for most.
I’m also assuming no massive change in immigration. A new government might change that.
I’m afraid I have no idea about Fibonacci forecasting. I’m not much of a chartist.
cheers
Bernard
September 18th, 2008 at 1:53 pm
I agree that housing prices will fall 30%, however this may occur slowly and over a 3 to 5 year period. That said, the important question is when these financial institutions default as we have seen already (and some to follow) how many duopolies or monopolies will the Western economies have? If we have two giant banks, i.t.,utilities, oil etc etc, the economies have no competition which is crucial for the system to survive.
The increasing concentration of wealth, i would argue has created recessions and even depressions. With this said, interest rates have a minor role as far as I am concerned, the falling interest rate has not prevented the UsA avoiding the crisis it got it self into. I suspect the USA will experience what Japan has gone through during the 90’s and today, a low growth low interest rate for the next decade. I cannot predict a future either. The real worry is that a war will be used to boost the USA economy financed on debt, once again. Will the rest of the world lend the money this time?? Something to ponder.
September 18th, 2008 at 9:06 pm
You are probably the only one who predicts higher interest rates, even few months ago before RBNZ started cutting them down, as I can recall, you sugested rates should/would increase
September 18th, 2008 at 9:38 pm
Yep, Dosser – I had noted that! China is the USA’s second largest creditor behind Japan. Academia are dubbing this the ‘post-American’ era. Can you believe when Bush took over the US had a $127 billion budget surplus – projected (a couple of days ago, that is!) to be a record deficit of $482 billion in the year starting Oct 1.
I can see a Marshall Plan on the horizon but it ain’t gonna be devised by the US/Euro & Co. central banks.
September 23rd, 2008 at 1:38 pm
What we have seen is the expansionary flow-on effects of cheap energy (historically cheap oil), where oil purchases denominated in US dollars has had to ultimately find a home back in the USA. Excess investment in ‘financial products’ based on ponzi schemes involving a hugely over-leveraged currency must ultimately be shown to be an unsustainable confidence trick.
The obscured issue for the global economy – the real issue – is that oil is of a ‘diminishing’ or ‘wasting’ nature. About 4 barrels of oil a day are used for every new barrel found.
In addition, the major producers in the Gulf and in Mexico (but not Canada and Russia) have expanding populations and expanding oil use. As a result, while oil and ‘oil equivalent’ may uptick a little in 2009, the underlaying trend in oil EXPORTS is for steady year on year reductions. Mexico, the third largest supplier of USA oil imports, is the first to show this.
I did an opinion piece in 2005 (minor amendments in 2007) suggesting that depression is certain by 2025, at least in USA; however, I didn’t take diminishing exports (as different from total production figures) into account.
The piece is here:
http://www.naturalhub.com/slweb/fading_of_the_oil_economy_depression_timing.htm
Cheers,
Lorenzo