Kiwiblog

The Government continues to dither on whether to extend the depsit guarantee scheme to include wholesale borrowing. The NZ Herald Editorial notes:

Yet local banks must renew loans as they fall due if they are to have money to advance to businesses that need it to pay wages and bills. With the global financial system nervous and near frozen, it may be hard to raise the money when it is needed, particularly if other countries are underwriting their banks’ borrowings.

The simple reality is we are too small to not give the guarantee, when other countries have done so.

Many will have applauded the National Party leader’s offer to work with the Finance Minister in developing a response to the crisis. Not as many will have appreciated Michael Cullen’s refusal to do more than keep John Key and his finance spokesman, Bill English, briefed on progress.

Indeed.

But Dr Cullen’s position has to be recognised. To bring National into the decision-making would be almost an admission that it will be the next Government and neither major party in our system could be expected to make that concession before an election.

Or it could just be a realisation we are days out from a general election, and that regardless of the outcome, a bipartisan approach is prudent during this period.

National insiders claimed the bank governor, Alan Bollard, had wanted to brief the Opposition on the original decision in advance, but Mr Key did not make an issue of the Government’s refusal to do so. He shows a refreshing lack of interest in the petty side of politics and does not make too much of the advantage he could claim for his intimate knowledge of the finance industry.

A refreshing lack of interest in the petty side of politics. A strength some mistake for a weakness.

The Hive is very worried about the flaws in the Government’s deposit scheme:

Why, if our hand was forced by the Aussies did we not adopt the same policy as the Aussies?

In particular – why did we not match Australia’s guarantee for bank lending in the international wholesale market?

Those countries that are running large current account deficits – NZ, Australia, US etc are in competition for an increasingly scarce amount of funds on the international wholesale markets. Most of the money on offer is from Asia. Now if you were an Asian investor with $100 million to invest who would you invest it with? An Australian bank which has this loan guaranteed by the Australian Government, or a New Zealand bank that has no guarantee from the New Zealand or any other government? The answer is obvious. The money will be loaned to Australia. Why would you take a risk on New Zealand when there is no risk in lending to Australia.

I imagine we could still get some credit, but have to pay more for it.

… we are a nett borrower economy. We are not at present (maybe Key’s 40% plan for the NZSF will help right this) able to generate the funds we need to keep our economy working from domestic savings. So we are dependent on a funding stream that looks as though it is about to dry up. Before too long the banks are going to have to literally stop lending. And this will mean chaos across the economy. New activity will stop and existing loans will be affected also. Don’t expect your fixed term loan to be rolled over when it expires, even on your house.

Does Cullen know what to do? He’s done okay when faced with the best economic weather since WWII, but does he have the answers now? The fact he has reversed his stance of increased borrowing for infrastructure suggests an element of making it up on the hoof.

The Press editorial lambasts Helen Clark for her partisan politics over the deposit guarantee scheme:

More worrying was the way the Prime Minister, Helen Clark, chose to play politics with the announcement of the scheme. She failed to brief the National Party, or anyone else, beforehand and made the announcement at the launch of Labour’s election campaign. This was unforgivable. It makes the scheme look like merely another device to make Clark appear decisive and on top of the situation. In fact, that kind of chicanery does the opposite. It makes her look shifty and manipulative. The present crisis is too serious a matter for anyone to be using it to engage in political posturing.

She did it of course, because certain lemmings were predictable enough to write articles declaring her decisive for doing so.

There are nonetheless concerns attached to the package. For one thing, it shows all the signs of having been cobbled together in considerable haste. There are huge problems associated with such schemes at the best of times, but this one has more than most. The breadth of it down to deposit taking finance companies and the fact that the smaller, perhaps shakier entities do not have to pay, risk distorting markets badly. These, and other problems, will have to be ironed out.

Someof these details are not minor. The more one gets into it, the more it does appear to have been done on the back of an envelope. The supllementary details yesterday by the Reserve Bank and Treasury helped.

The NZ Herald reports Alan Bollard discussing some of the flaws in the Government’s hastily announced deposit guarantee scheme.

I am going to touch on that in a later post. First I want to reflect on whether Governor Bollard and Secretary Whitehead have acted properly during this period of Government. A reader (a former senior official in Government) makes the case in e-mail to me that Bollard and Whitehead should have insisted that the Government consult with the Opposition on the scheme, before announcing it. The reader says that “in his day” the Governor and Secretary would have threatened to resign rather than damage the independence of the public service and the Reserve Bank.

This scheme provides a guarantee of $150 billion for deposts – the largest contingent liability in history. It is being done without parliamentary sanction and by a Government in the period just before an election. Traditionally in this period major decisions are not made unilaterally, let alone one of this magnitude.

Did Bollard and Whitehead advocate for bipartisan consultation, and if so why did they not insist on it? Would consulting with the two people who might be Prime Minister and Finance Minister in less than a month have detracted from economic stability and constitutional integrity or enhanced it?

Think of what a disaster it would have been if the Government announced the scheme and the Opposition then did not back it? The result would have been worse than never announcing the scheme in the first place.

I say this with great hesitation and respect for the Governor and Secretary. But their actions have undermined confidence in a neutral public service. To not insist on consultation with the Opposition for a $150 billion guarantee, just four weeks before an election, was misguided at best, and reckless at worst.

Bernard Hickey has found some very disturbing problems with the deposit insurance scheme the Government has announced:

We now have a scheme that Rod Petricevic could (in theory) use to launch new government-guaranteed finance company to repurchase loans from the receivers for Bridgecorp. It could also be used by Doug Somers-Edgar to fire up the Money Managers empire again. Allan Hawkins could start raising money for his Budget Loans finance company and promise that it was backed by the government.

Not good. The problem with rushed solutions where the driving factor is being able to announce it in time for your political campaign launch, instead of have we got the policy right.

Every finance company wannabe will be licking their licks. They’ll be working on schemes and dreams about new developments or buying bankrupt holes in the ground as we speak. Just imgaine. They will be able to offer deposits at 10% with a government guarantee. If they’re quick enough they’ll be able to do their business before the two years runs out and leave an even bigger smoking hole in the ground for the government (ie the taxpayer) to clean up.

One hopes this would not happen, but often solutions cause worse problems than the one they were tring to solve.

The second big truck sized gap in the scheme explicitly rules out bank deposits in other banks as being covered by the scheme.

This effectively means inter-bank lending is not covered. Why is this important? Currently more than a third of New Zealand bank lending is funded from international wholesale markets, which means our banks have borrowed from other banks overseas.

The scheme announced in Australia yesterday does provide a government guarantee for these inter-bank loans.  There is now a big risk that foreign banks will see they can be guaranteed if they pull their money out of New Zealand banks and put them into Australian banks.

Hopefully others will look beyond the press release and look at the details of how it might work.

The decision by the Government, backed by National, to guarantee bank deposits is sensible in the current climate, and really just brings us into the international mainstream.

It will also cover finance companies, but not the ones that have already collapsed:

It applies to finance companies that take deposits but is not retrospective, so it will be of no comfort to the thousands of investors who have lost money in collapses.

There is a valid argument that a government guarantee encourages more risky behaviour, but I think there has been so much of that behaviour regardless, that is less of an issue.

Helen Clark said a mini-Budget would be produced in December if Labour won the November 8 election.

Amazing – the biggest secret agenda of them all. We will announce our response to the financial crisis – after the election!

It is easy to conclude tax cuts will be cancelled (they will call it a delay) at a minimum.

Danyl at Dim-Post has a list:

CEO –Chief Embezzlement Officer.

CFO– Corporate Fraud Officer.

BULL MARKET — A random market movement causing an investor to mistake himself for a financial genius.

BEAR MARKET — A 6 to 18 month period when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.

VALUE INVESTING — The art of buying low and selling lower.

P/E RATIO — The percentage of investors wetting their pants as the market keeps crashing.

BROKER — What my broker has made me.

STANDARD & POOR – Your life in a nutshell.

STOCK ANALYST — Idiot who just downgraded your stock.

STOCK SPLIT — When your ex-wife and her lawyer split your assets equally between themselves.

FINANCIAL PLANNER — A guy whose phone has been disconnected.

MARKET CORRECTION — The day after you buy stocks.

CASH FLOW — The movement your money makes as it disappears down the toilet.

YAHOO — What you yell after selling it to some poor sucker for $240 per share.

WINDOWS — What you jump out of when you’re the sucker who bought Yahoo @ $240 per share.

INSTITUTIONAL INVESTOR — Past year investor who’s now locked up in a nuthouse.

PROFIT — An archaic word no longer in use.

Heh.

NZBC has a good Q&A on the global financial crisis:

The questions are:

1. Does this crisis represent a failure of free markets, of untrammelled deregulation, and the consequence of unrelenting greed?
2. But surely it is greed that motivates Wall St, and is behind all these troubles?
3. Did nobody see this coming?
4. But don’t these central banking bailouts show that capitalist banking doesn’t work?
5. If it doesn’t get done?
6. OK, but isn’t the bailout just going to renew all the moral hazard issues associated with the so-called “Greenspan put”?
7. So should we feel smug that the New Zealand banking system seems very safe by comparison?
8. This is all terribly serious, is there nothing to laugh at here?
9. What does this mean for investors?

Go read the article for the answers. It is very very good.

Danyl writes:

I can unhestitatingly guarantee that Four Weeks, Three Months and Two days is the best film about getting an abortion in Ceausescu’s Romania you’ll see all year.

Possibly not such a great first date movie.

Heh indeed. That reminds me of a story from a friend. A guy took her to a film festival film on a date. The film basically was about how both the female and male leads were raped, and how it affected their relationship. Eventually the male lead blew his brains out. I think it may have been the worst possible date movie ever!

Aaron B blogs:

Americans have taken to emailing Nigerians warning them that if they get offers to put money into an American bank – don’t do it, because it’s a scam.

Heh.

Homepaddock praises Wotif for finding places to stay. I agree – it is a great site and I use it all the time.

No Minister has a list of false statements made by Joe Biden in the Vice-Presidential debate. I’m waiting to see what Fact Check makes of the claims from both sides.

George W Bush has signed the $700 billion bailout bill into law within an hour of the House of Representatives passing it 263 to 171. I guess he didn’t want to risk them changing their minds!

26 Republicans and 32 Deomcrats who voted no last time, voted yes this time.

Steven Horwitz from St Lawence University does an open letter to his friends on the left re the financial crisis:

In the last week or two, I have heard frequently from you that the current financial mess has been caused by the failures of free markets and deregulation. I have heard from you that the lust after profits, any profits, that is central to free markets is at the core of our problems. And I have heard from you that only significant government intervention into financial markets can cure these problems, perhaps once and for all. I ask of you for the next few minutes to, in the words of Oliver Cromwell, consider that you may be mistaken. Consider that both the diagnosis and the cure might be equally mistaken.

And then he addresses the issue of greed:

One of the biggest confusions in the current mess is the claim that it is the result of greed. The problem with that explanation is that greed is always a feature of human interaction. It always has been. Why, all of a sudden, has greed produced so much harm? And why only in one sector of the economy? After all, isn’t there plenty of greed elsewhere? Firms are indeed profit seekers. And they will seek after profit where the institutional incentives are such that profit is available. In a free market, firms profit by providing the goods that consumers want at prices they are willing to pay. (My friends, don’t stop reading there even if you disagree – now you know how I feel when you claim this mess is a failure of free markets – at least finish this paragraph.) However, regulations and policies and even the rhetoric of powerful political actors can change the incentives to profit. Regulations can make it harder for firms to minimize their risk by requiring that they make loans to marginal borrowers. Government institutions can encourage banks to take on extra risk by offering an implicit government guarantee if those risks fail. Policies can direct self-interest into activities that only serve corporate profits, not the public.

And then he looks at the facts:

For starters, Fannie Mae and Freddie Mac are “government sponsored enterprises”. Though technically privately owned, they have particular privileges granted by the government, they are overseen by Congress, and, most importantly, they have operated with a clear promise that if they failed, they would be bailed out. Hardly a “free market.” All the players in the mortgage market knew this from early on. In the early 1990s, Congress eased Fannie and Freddie’s lending requirements (to 1/4^th the capital required by regular commercial banks) so as to increase their ability to lend to poor areas.

Now think about this as the Government here passes a law requiring affordable housing in certain areas. The best of motives often lead to the worst of results.

At the same time, home prices were rising making those who had taken on large mortgages with small down payments feel as though they could handle them and inspiring a whole variety of new mortagage instruments. What’s interesting is that the rise in prices affected most strongly cities with stricter land-use regulations, which also explains the fact that not every city was affected to the same degree by the rising home values. These regulations prevented certain kinds of land from being used for homes, pushing the rising demand for housing (fueled by the considerations above) into a slowly responding supply of land. The result was rapidly rising prices. In those areas with less stringent land-use regulations, the housing price boom’s effect was much smaller. Again, it was regulation, not free markets, that drove the search for profits and was a key contributor to the rising home prices that fueled the lending spree.

Sounds a lot like NZ again doesn’t it – strict land use policies pushign up house prices.

The final chapter of the story is that in 2004 and 2005, following the accounting scandals at Freddie, both Freddie and Fannie paid penance to Congress by agreeing to expand their lending to low-income customers. Both agreed to acquire greater amounts of subprime and Alt-A loans, sending the green light to banks to originate them. From 2004 to 2006, the percentage of loans in those riskier categories grew from 8% to 20% of all US mortgage originations. And the quality of these loans were dropping too: downpayments were getting progressively smaller and more and more loans carried low starter interest rates that would adjust upward later on. The banks were taking on riskier borrowers, but knew they had a guaranteed buyer for those loans in Fannie and Freddie, back, of course, by us taxpayers. Yes, banks were “greedy” for new customers and riskier loans, but they were responding to incentives created by well-intentioned but misguided government interventions. It is these interventions that are ultimately responsible for the risky loans gone bad that are at the center of the current crisis, not the “free market.“

I suggest people read the full thing. EVen better NBR should run it as a full page story!

The US House of Representatives has voted down the US$700 billion bailout plan, and share markets have fallen further. Democrats voted around 3:2 in favour while Republicans voted around 2:1 against. The elections in a few weeks loom large – one of the problems of having such a short two year term.

Ironically Brian Fallow must have written his column in advance, saying:

American lawmakers may have pulled the United States and the rest of us back from the brink of economic calamity, but the path down from the clifftop remains long, tortuous and slippery.

Actually the lawmakers have pushed the world a bit closer to economic calamity.