Rod Oram: Doomsayers have got it wrong
THE ALARM and despondency from some pundits about the government's bank deposit guarantee scheme is one of the weirder New Zealand responses to the global credit crisis.
Other countries are rejoicing at the stability similar schemes are bringing to their banking systems. But here the most extreme views hold that the guarantees will trigger a series of events that could lead to the collapse of the entire financial sector, including the stockmarket. That in turn will do massive damage to the wider economy, they argue.
Their central argument is two-fold. First, the guarantees will heavily distort the market. Depositors will no longer need to exercise discretion about where they put their funds because most institutions will have a government guarantee. This in turn will give the less responsible institutions a free rein to do reckless things at taxpayers' expense.
Second, the difficulties banks are having accessing international credit markets will soon cause them to severely cut back on the credit they advance to companies and households, thereby dragging the country into a serious recession.
Both arguments are wildly over-blown. They also ignore the real challenge for banks and their borrowers; that is it is nothing less than adjustment to a radically different world financial order, in particular the end of abundant, cheap credit.
The first argument is wrong because it misses the real significance of the guarantees. They are nothing less than a massive regulatory shift that starts to bring New Zealand banking back into the global mainstream. The same shift, and over-reaction, is under way with parent banks in Australia, too.
For almost two decades, the two countries have taken a free-market approach to financial supervision. We have believed that information is more important than regulation. As long as depositors and investors have detailed, timely disclosure of institutions' financial health, they will make sensible choices about where to put their money.
There is, of course, still a level of scrutiny by the Reserve Bank but its reporting requirements are much lighter than those of heavily prescriptive regulatory regimes overseas.
And the system has served us well, at least with the banks. They have remained conservative, well-capitalised and good judges of risk. Theirs is a very traditional banking model where most loans remain on their balance sheets, keeping them in close touch with their customers.
Still, the banks deserve criticism. They scooped up easy, low-cost credit overseas over the past decade and aggressively lent it to households here, fuelling the debt-driven consumer and housing boom. In doing so, the banks made a mockery of monetary policy. They showed how ineffectual the Reserve Bank's official cash rate is in guiding the economy.
The banks are being too complacent now, at least in public. They say their bad debt levels will rise only modestly from very low levels.
Actually, there is a good chance that a deepening recession will cause more households and companies to buckle under the burden of their debt and the banks will take much bigger hits.
Our regulatory system did not work, however, with finance companies. Many collapsed because they were reckless by being so heavily dependent on debentures as their source of funding and were careless in their lending. More disclosure might have helped reduce some of the bad practices.
But the real problem lay with the public which was hopelessly optimistic about financial de-regulation to believe they would make sensible, detailed judgements about the strength of one finance company over another. Instead, they simply chased high yields.
But by arguing these bad behaviours will continue under a guarantee scheme, the doomsayers are ignoring the new reality. The scheme begins to reimpose a level of regulation and scrutiny found in mainstream banking regimes. It offers carrots and wields sticks to get poorly rated deposit-takers to improve their performance.
Understandably, it will take financial markets a while to adjust to this return to tight regulation and government guarantees.
Inevitably, such a big switch done rapidly to keep pace with the global crisis response of regulators overseas has led to some temporary wrinkles and uncertainties. But the steady stream of refinements and adjustments by Treasury and the Reserve Bank are bringing clarity and practicality to the guarantee scheme.
The second argument for impending financial disaster is equally misjudged. Yes, it's true the four Australian-owned banks that constitute 90% of our banking system are heavily dependent on overseas funding. Because we are such poor savers, they raised 40% of their funding as of February this year from overseas sources for a total of $116.5 billion. That was almost a four-fold increase from $33.5b, or 29.6% of their funding, in December 1998.
And, incautiously, they borrow short - on average terms of less than a year - but lend long for the likes of mortgages. That wasn't a problem when the world was awash with credit as it was over the past decade. But it has been a problem since global credit markets began collapsing in August last year.
Over the first year of the crisis, credit markets locked up on a handful of occasions but were quickly reopened up by injections of funds from central banks. But the catastrophic failure in early September in the United States of Lehman Brothers, AIG, Fannie Mae, Freddie Mac and a number of large banks, shut down global credit markets to virtually all borrowers, even those such as our banks with plenty of capital, high credit ratings and low loan losses.
Fortunately, over the past two weeks, inter-bank lending has gradually resumed in the main markets overseas and their interest rates have started to ease from punishingly high levels.
The New Zealand banks and their Australian parents are being very circumspect about how the markets are treating them. But it is likely they are still finding it hard to borrow, even at high rates. One of their problems is they compete with borrowers whose government have guaranteed their wholesale deposits which is a great comfort to their lenders.
Clearly, there's a very good case for New Zealand banks to enjoy similar help from our government. Treasury and the Reserve Bank are working on such wholesale guarantees. But it's difficult work that shouldn't be rushed. The central challenge is to ring fence the guarantees so they benefit only the New Zealand banks and not their Australian parents and shareholders.
While it's necessary to get such a guarantee in place because there is no knowing if, when or how suddenly global credit markets could fall apart again, there should be no sense of panic.
The Reserve Bank already has stop-gap measures to relieve funding pressures.
Moreover, the government and markets should not agonise over devising the perfect guarantee. Any mechanism will be temporary. The global crisis is forcing a fundamental redesign on financial regulation and market structures. We, along with the rest of the world, will have migrated to fundamentally different systems within a few years. They will deal with the new realities and anomalies the crisis is throwing at us.
New Zealand will respond successfully to these seismic shifts if our debate and decision-making is quick, pragmatic and insightful.
The lack of these essential qualities in some quarters in recent weeks has hindered, not helped, the process.
We'd better correct that failure soon because the global economic crisis will throw many more big challenges at us over the next few years.
Sunday Star Times