KEY POINTS:
The latest instalment of the credit crunch will affect New Zealanders, but not in the way many might assume.
I reckon it will push house prices lower and keep interest rates higher for longer. It will probably also extend our recession into next year, but it seems unlikely
to transform into a 1930s-style depression.
The instant reaction to the collapse of Lehman Bros - and the bail-outs of Bear Stearns, Fannie Mae, Freddie Mac and now AIG - was played out on global stock markets, but this won't affect many Kiwis much at all.
World and New Zealand stock markets now don't matter much to most of us but house prices and interest rates do.
New Zealand's households had a combined net worth of $634 billion at the end of last year, according to Reserve Bank figures. Our houses were worth $617b, or 97 per cent of our net wealth. We had $170b worth of debt, which includes about $160b of mortgage debt and the rest in credit cards and personal loans.
We also had about $80b deposited in banks and about $10b in finance companies and mortgage trusts.
Interest rate changes therefore affect debt and savings worth about $260b. They also indirectly affect house prices and therefore the size of that $617b of household wealth.
Those same Reserve Bank figures show New Zealand households had $15b invested directly in our stock markets and about $9b invested directly overseas. Our managed funds, insurers and superannuation funds had about $37b invested directly in assets of some sort, with less than half invested in stocks, I'd guess. So all up, stock markets affect about $42.5b of our household wealth.
We all give too much attention to the stock markets and not nearly enough attention to the price of houses and interest rates.
There's no contest. Interest rates and house prices affect $877b worth of our assets and debt. Stock markets affect $42.5b worth of our wealth.
The credit crunch has already lifted fixed mortgage rates and driven down house prices. From mid last year to March this year, banks passed on about 85 basis points of higher foreign borrowing costs to mortgage borrowers by increasing the average two-year fixed mortgage rate to about 9.65 per cent from about 8.8 per cent.
Since March, those international funding costs have eased a bit and the Reserve Bank has cut the official cash rate by 75 basis points to 7.5 per cent. During that time, the average two-year fixed-rate mortgage has dropped back to 8.8 per cent again. But we're still back where we started mid last year when the OCR was 8.25 per cent.
The net effect is our fixed mortgage rates would have been about 70-80 basis points lower without the credit crunch. For someone with a $200,000 mortgage that's about $30 a week.
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 interest rate or margin that our banks have to pay to foreign lenders above the benchmark of safe government debt rose by around 50 basis points to around 200 basis points last week. That means it's likely they'll have to pay an extra 50 basis points to foreign lenders when they can refinance foreign debts. About $60b 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$500b ($756b) and they need to write off about US$1.2 trillion. That means we're about half way through it.
New Zealand faces more expensive foreign debt. That will be passed on in our fixed mortgages - by increasing rates or by not passing on cuts in the OCR. I reckon there's another 70-80 basis points of "higher" interest costs to be built into fixed mortgage rates. Combined with the earlier increase, that means about $50-$60 a week, or 150 basis points of extra interest costs on a $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 won't be passed on to fixed-rate borrowers.
The high interest rates will intensify the downward pressure on house prices, but bank rationing of loans may have a bigger impact.
Kiwibank's 8.49 per cent rate for its special two-year fixed-rate mortgage only applies to borrowers with 20 per cent equity, as does the National Bank's 8.3 per cent rate for its special 30-month fixed-rate mortgage. Much more of the rationing is done behind the scenes. The proof is in lending figures disclosed by the banks every month to the Reserve Bank.
Net new mortgage lending collapsed to $229 million in July from $1.24b in the same month a year ago.
The property finance company sector's implosion has also withdrawn credit from the property development and property investing markets. The worsening global credit crunch will extend this deleveraging of cheap and easy debt from the housing market.
I've predicted a 30 per cent fall in the average house price between last November and the end of next year. We're still on track for that.
* Bernard Hickey is the managing editor of www.interest.co.nz, a website for investors and borrowers wanting free and independent news and information about interest rates, banks, finance companies and the economy.
