Monster bound and gagged but may yet get out

Revelation of the week: the New Zealand Treasury has a fail-safe way of predicting the timing for the next financial crisis.

All it has to do is reschedule endlessly postponed talks between itself, the Australian Treasury, and the Reserve Banks of New Zealand and Australia.

The inaugural meeting, in 2008, coincided with the collapse of the Northern Rock bank in Britain. The meeting was cancelled.

The next attempt coincided with the collapse of Lehman Brothers, a moment in time that Reserve Bank governor Alan Bollard described this week as "a horrible week when we saw the end of the standalone banking industry in the US as we knew it".

Once again, the trans-Tasman meeting of minds was cancelled.

Third time is a charm, or so you would hope, and the meeting was eventually rescheduled for last week, coinciding perfectly with the collapse of South Canterbury Finance and the Christchurch earthquake. Guess what? No meeting.

"The Reserve Bank wants to know when the fourth attempt will be," said Dr Bollard, at the launch this week of Crisis, a personal reflection on his wild ride through the global financial crisis. The book's launch also coincides with Dr Bollard's return from the annual gathering of the world's central bankers at Jackson Hole, Wyoming, hosted by the United States Federal Reserve.

Indeed, the rhythm of Crisis is driven by these annual summits, at which Dr Bollard would come face to face with what Treasury Secretary John Whitehead is calling "the largest economic event in our lives, hopefully".

Reserve Bank staff say that Dr Bollard came back from these trips in 2008 and 2009 so pessimistic that they sometimes had a hard time taking him seriously. But that is partly the nature of crises.

Dr Bollard's chronicle is a timely reminder of how bad things got, but also of the loneliness of leadership during crises, especially the duty to make knife- edge decisions of such magnitude that those most affected barely understand the stakes.

As a result, Dr Bollard found himself frustrated by New Zealand captains of industry who argued their parochial corner while failing to see the bigger picture.

"They reverted quickly to defending the interests of their own particular industries, but the situation called for a broader response than just what was convenient for bankers, farmers or manufacturers," he writes. He was equally taken aback when Reserve Bank staff reacted poorly to a wage freeze at the height of the crisis.

A similarly dissonant moment was the angry reaction of trustee companies when the Reserve Bank concluded they had been both "under-resourced and under- committed" in their duties to oversee finance companies.

It is easy to forget, too, that New Zealand and Australian banks spent weeks so scared to seek money from overseas lenders that they stopped asking, for fear of a rejection sparking a run. For a while, the normal machinery of the financial markets seized up.

"Normally in the month of October we issue around 150,000 $100 notes. In October 2008, we issued about seven times that amount," Dr Bollard writes.

It was in this white-hot environment that the retail deposit guarantee scheme was hatched. In his best Sir Humphrey-ese, Dr Bollard makes it clear there were huge disagreements with then finance minister Michael Cullen over its terms, and especially whether finance companies should be allowed to join the scheme for free - a fact that enraged the already jittery local operations of the big Australian banks.

"This changed the economics considerably: such a plan would be very costly and would leave the way open for entrepreneurial finance companies to undertake risky investments at the taxpayer's expense," Dr Bollard warned. "We had to find legal ways of making sure none of these failures worked its way into the guarantee scheme, thus recovering profitability at the taxpayer's expense."

Dr Cullen eventually agreed to charge finance firms for new business they took on. Even so, South Canterbury Finance aggressively built its book after the guarantee scheme came in.

The Reserve Bank board was unimpressed. Meeting in SCF's home town of Timaru in late 2008, they told Dr Bollard the guarantee scheme was "risky, mispriced and distorting".

"I had to agree but argued that, more importantly, it had stopped an incipient bank run."

As he noted this week, so many larger economies, in potentially worse shape, were introducing such guarantees that New Zealand risked wealth destruction simply by failing to follow suit.

The dust has settled on the global financial crisis, but just how far the threat has receded remains to be seen. "Like all good storybooks, the question remains: how will it end?" said Dr Bollard this week. "The monster is bound and gagged and locked in a basement somewhere, but one day, it might just get out again."

Pattrick Smellie is a co-founder and editor of BusinessDesk.

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