Questions please on our banks, interest rates...anything really

There seems to be an enormous appetite for up to date information about New Zealand's banks, other financial institutions and our economic outlook in the midst of the worst Global Credit Crisis since the Depression. People are asking which financial institution is safe? What might happen to interest rates? Will banks keep lending? What will happen to house prices? Is our economy going into recession or depression? I am now regularly being called and emailed for information. These are hot topics and we're keen to help answer those questions. I'm just a journalist so I'm not in a position (and wouldn't want to be in a position) to give financial advice. I certainly don't sell any products. All I do is report and comment on banks, finance companies, the economy, interest rates, monetary policy and global markets. Interest.co.nz makes money by selling advertising and by selling news and data to other media companies. I have no role in the advertising part of the business. My aim is to provide independent, reliable and useful news and commentary for people who are saving or borrowing from banks, finance companies and building societies. I have criticised finance companies before who also advertised on this site so I am not beholden to advertisers. I am always thinking about the 2 million or so New Zealanders who have to roll over or lend their term deposits and debentures (NZ$100 billion), or who roll over or take out fixed rate mortgages (NZ$170 billion) every 6 to 18 months. They want to know what might happen to interest rates so they choose to borrow or lend short or long. They want to know which finance company or bank is safe enough to invest in and who is offering the highest term deposit rate or lowest mortgage rate. I'm happy to answer questions about these things in the best way I can. Again, I can't provide financial advice. But hopefully I can shed some light with accurate, up to date information. I also welcome any information from other commenters on this blog. Often they know a lot more about specific subjects than I do. Also please point out if you think I'm wrong and I'll correct if I agree. Fire away using the comments facility below. I'll do my best to answer them in a timely fashon in the comments on the blog. But first to get things started, here's five of the questions I get asked regularly and my answers.

Are the big banks safe ? I agree with the Reserve Bank that our major Australian-owned banks (ANZ, ASB, BNZ, National Bank and Westpac,)  are sound and are in a much stronger position to cope with the Global Credit Crunch. They are well capitalised, hold plenty of cash, have strong credit ratings (all are AA rated) and are not materially exposed to the US Sub Prime mortgage debacle. Here's more on why our banks are different from the US and European banks. Here's why they are generally safer. But they are not immune from the catastrophic events in Europe's and America's banking systems in the last couple of weeks. The British government promised this week to spend 50 billion pounds to buy a 1/3 of its banks to ensure they had enough capital to survive. Last week the US government set up a US$700 billion fund to buy toxic bonds from banks to help them cope. This week it said it may use the fund to buy control of its major banks and may offer a temporary blanket government guarantee on all bank deposits. Banks in the Northern Hemisphere have stopped lending to each other because they fear that other banks will collapse, leaving them with debt that is worth a lot less and impossible to trade. Some European countries (Germany, Austria, Greece, Denmark and Ireland) have also announced blanket government guarantees on bank deposits. Things are very serious up North and could get much worse. New Zealand's banks have borrowed heavily on short term foreign debt markets and then lent that money to us for a mortgage-fuelled property binge over the last 5 years. These banks owe NZ$60 billion to foreign lenders that may have to be repaid over the next 40 days, various measures show. Most of that will be to their parents in Australia or to other Australian banks. That should be fine because the Australian inter-bank market is still working. A worst case scenario is that some of that NZ$60 billion owed to non-Australian foreign banks would have to be repaid immediately. The Reserve Bank of New Zealand is ready if needed to lend to the banks if they need to repay those short term debts. The Reserve Bank would lend to the banks in exchange for mortgage backed bonds. This would effectively mean a good chunk of New Zealand's home borrowers owed the Reserve Bank instead of the big four banks. But it would ensure stability. It would however require political approval, given this adds significant new liabilities to the Reserve Bank's balance sheet. It may also mean these big four banks curtail new lending significantly. This would mean getting new home loans, particularly 'riskier' 80% plus and 'low doc' loans would be much harder. Credit card limits would be cut, overdrafts may be cut and many businesses would find it harder to get new loans to invest. Some higher risk borrowers may be asked to repay some or all of their loans early. Our banks have to right to demand repayment on any mortgage at short notice, although it is unthinkable they would do this in any widespread way. The system would keep functioning.  It's also likely the Reserve Bank will cut the Official Cash Rate by 100 basis points to 6.5% on October 23 to help soften the blow for the banks of higher funding costs and give them some breathing room to pass on some rate cuts to borrowers.  It's also possible the government and the Reserve Bank could announce some form of government guarantee or deposit insurance on bank deposits if the situation worsened substantially. I support such a move. Here's more on my call for a deposit insurance scheme on Monday. The crunch point comes when the Australian banks who own our banks have to repay or roll over the A$100 billion they owe to banks in the Northern Hemisphere. The way the Reserve Bank in Australia and the Australian government deal with this is crucial. So far they have been very proactive in widening their ability to lend to banks in various ways and the government has already lent to the banks directly through its Future Fund, which is a type of Cullen fund. In the event of some sort of catastrophic event in Northern Hemisphere markets and a signficant threat to the system here in Australasia I believe either the New Zealand or Australian governments (or both) would step in to make sure the big four banks did not collapse. They would engineer a takeover by another bank, engineer a nationalisation themselves or manage a shutdown in a way that meant depositors, who are always first in line to receive funds in any collapse, would not lose money. No government or Reserve Bank would ever say this, but I believe these big 4 banks are too big to fail and it would be politically unacceptable for any one of them to collapse in a way that lost depositors' money or froze the payments system (ie EFTPOS, bill payments, salary payments). Other banks operating here, including Kiwibank and Raboplus, also have either some form of government backing or a very strong credit rating. Kiwibank is AA minus rated by Standard and Poor's and is owned by NZ Post, which is a State Owned Enterprise that guarantees deposits at Kiwibank. However, NZ Post has the right to withdraw that guarantee with 90 days notice. Raboplus is owned by the Dutch-based cooperative Rabobank, which has the highest possible credit rating of AAA and is therefore seen as safer than the New Zealand banks. Here is the latest ratings report for Rabobank. What's going to happen to interest rates? Short term interest rates for both term deposits and mortgages are likely to fall over the next couple of months because the Reserve Bank of New Zealand is widely expected to cut the Official Cash Rate (OCR) quite sharply.  The OCR is the interest rate that the Reserve Bank charges the banks to lend to them overnight. It sets the base for all interest rates and eventually it pulls down or pushes up all the interest rates that banks offer and charge to their borrowers and depositors. But it has the most effect most quickly on short term rates, particularly at the moment. That's because longer term interest rates, particularly for 1, 2, 3 and 5 year fixed rate mortgages, are based at least partially on what's happening in the international wholesale credit markets. Right now the cost of that credit to the banks has skyrocketed to around 10% for longer term debt, if they can find it.  That has significantly increased the funding costs for the big 4 Australian banks who operate here because they fund about a third of lending through these international money markets. The Reserve Bank of New Zealand is expected to cut the OCR by 100 basis points to 6.5% on or before its scheduled announcement on October 23.  Some believe the OCR may be cut to 5.5% by the end of the year. That means deposit rates for 1 to 6 months are likely to drop to around 5.5% to 6% by the end of the year. That means if you can place it on term deposit at a bank now for around 7-8% you'll be in good shape.  See our list of all the term deposit rates on offer here now from zero to 12 months. Currently the highest short term rate on offer by any of the big banks or Kiwibank is a special offer of 7.8% from ASB for a 5 month deposit.  Longer term deposit rates are also likely to fall from around 7% now to around 5 to 5.5% by the end of the year. So lock in now if you want to keep a high savings rate. See our list of all the term deposit and debenture rates on offer here now for 1 year to 5 years. Currently the highest longer term rate on offer from the big banks and Kiwibank is a special offer of 8% for 18 months from ANZ. Mortgage rates are dropping too, but not as fast because of those high overseas funding costs. Not all of the 100-200 basis points of OCR cuts will be passed on in fixed mortgage rates. Currently the big banks are offering around 8.4-8.7% for their two year fixed rate mortgages, which are usually the most popular. Kiwibank is offering 7.99%, but it has that government backing and funds almost completely from the local term deposit market. I think it's likely the 2 year fixed rates offered by the big banks will drop to around 7.5%. Kiwibank may be able to drop to 7%. Currently the lowest mortgage rate offer from any of the banks is Kiwibank's 7.99% for 2 years, although it is only open to borrowers wanting less than 80% of the value of the home. The lowest offer from the big banks is National's 8.3% special for 2 and a half years.  If we see the OCR drop to 5.5% or even lower, it's possible that variable mortgage rates could start to become competitive at around 7-7.5%. They are currently around 9.7% to 10.5%. Borrowers hoping to take advantage of lower mortgage rates should fix for shorter periods, potentially as short as 6 to 12 months. A variable mortgage may be more attractive by mid 2009. What's going to happen to the economy and unemployment? The economy has been in recession all through 2008 and I think it is likely to remain that way all through 2009. This is more pessimistic than most economists. The shock to the global economy from this global credit catasrophe is already driving down the prices of the commodities we rely on for export receipts. Dairy commodity prices have fallen more than a third in the last three months.  Disruptions to global trade from the credit crunch are already showing up. Some goods are being left on docks because letters of credit cannot be obtained. China's economy is slowing fast. The US and European economies are probably already in recession. Meanwhile, back at home, the slump in the housing market and tightening of credit from banks is slowing consumer spending and business investment. An initial rebound in business and consumer confidence in August and September has evaporated in the last week as the scale of the Global Credit Crunch becomes clear to everyone. Tax cuts have just kicked in and there will be more over the next year or two, but it won't help that much. I had thought that unemployment would not rise much given New Zealand employers are more likely to 'hoard' workers, given their experience over the last 5 years that good people were hard to find. There are also some demographic factors (emigration of our young workers and an ageing population) that made me think unemployment wouldn't rise much. I think now unemployment is likely to rise well above 6% in the next two years because of the length and likely depth of the recession, but that's still not as bad as in 1991 when unemployment nearly hit 11%. What's going to happen to house prices? We at interest.co.nz forecast back in February that median house prices were likely to fall 30% over the next couple of years from their November 2007 peaks. We think it will take until 2018 before the median house price gets back above the NZ$352,000 peak it reached in November 2007. This was a very pessimistic forecast at the time and was widely ridiculed. We are sticking with this forecast. We estimate it still takes over 70% of take-home pay for someone on a median income to afford an 80% mortgage on the median house price. This interest cost portion was vaguely affordable at around 45% of takehome pay in late 2003. We think prices will have to fall around 30% to become affordable again. We think the extent the credit crunch and the collapse going on in the property investment market will ensure that a generation of New Zealanders will come to loathe property investing in the same way that a generation of New Zealanders loathe stock market investing because of the 1987. We are seeing the 2008 property crash. Property prices will not recover for a decade. Will this recession be as bad as the depression of the 1930s? No. The world's central banks and governments appear not to be repeating the fundamental mistakes made in the early 1930s. Back then central banks withdrew money from the banking system and governments reduced spending, thinking this was the way to deal with financial market and economic stress. Politicians also legislated to restrict trade, thinking this was the best way to protect their own citizens. All of these things deepened the economic depression that lasted from 1930 until 1939 for many countries. Also, most of the world's banking systems were based on the Gold Standard, which meant every dollar, pound and franc was backed by gold held in bank vaults. This was attacked by speculators and restricted policymakers from responding to the crisis. There is no Gold Standard now. Some say that is the cause of our problems, but it does make our central banks and governments more flexible, as does the existence of floating exchange rates. Floating exchange rates and freely traded interest rate markets allow economies to automatically stabilise.  There we go. I'm sure you have many other questions. I'm happy to try to answer them.