Brian Fallow: Tough grind in new world order

Alan Bollard says the banks have been over-reliant on short-term international funding. Photo / Mark Mitchell

The global financial crisis has changed the world. The hard part is to figure out how much it has changed and whether it has changed enough.

Alan Bollard's book Crisis, published this week, concludes with his reflections on the lessons of the crisis for him and for the rest of us.

When it comes to doing monetary policy the challenge, he says, is that banks' funding costs have risen and their interest margins have widened, businesses and households are more cautious and mortgages are of shorter duration.

"It is a new world and none of us can be quite sure what concepts like 'normal' and 'neutral' now mean, nor how long it will be before interest rates are back at these levels. But we will surely find our way to some sort of equilibrium in the years ahead."

The plural "years" may be significant.

On the international horizon, the Reserve Bank Governor does not see a slip back into recession.

"We don't think a double dip is going to happen. It's not anywhere in our base forecasts. Is it conceivable? Yes. Much more likely, though, is a very soggy recovery, something of a grind," he told the Herald.

His account of the origins of the crisis includes the big global current account imbalances which had built up over the previous decade and the surge in prices for commodities in general and oil in particular. Those imbalances have not been "fixed" and we have not seen our last oil shock.

"As we went through this we looked out to the future and said the new world is going to be different. At a certain stage, we said, it is going to be rebalanced and we will see asset prices back realigned and those international balance of payments deficits even out," he said.

"That has happened, but only a bit."

Flexible prices, in particular exchange rates, interest rates and the terms of trade, are supposed to deal with such problems.

"But international distortions in these prices have persisted, and look like persisting into the future."

New Zealand needs the big economic powers to run sensible monetary and exchange rate policies. "Without that we will be buffeted by whatever global winds blow our way," he said.

"There are lessons for the United States from the long period of loose monetary policy following the East Asian crisis, and lessons for East Asia about over-reliance on indebted Western consumers as the main drivers of their growth."

The global crisis damaged the old northern countries much more than emerging markets and commodity producers and this is changing the economic balance of power.

To be "crisis-resilient" an economy has to be as balanced as possible.

"With its large savings and current account imbalances, New Zealand can hardly claim this."

We need to understand how we built up such a large current account deficit, which reached 9 per cent of gross domestic product at the height of the boom.

"The challenge is to understand ... why our household sector was so profligate while the business sector was more abstemious."

Business seemed to have learned from the 1991/92 recession when there was a lot of bad debt to be worked through. "This time it looks a heap better than that, though we don't want to suggest it's all over."

Both businesses and banks had learned a lot about managing their balance sheets and managing risk.

However, he added: "In self-interest, banks may encourage New Zealanders to take on more debt than is good for them individually or deliver more external liability than is good for the country."

One of the lessons the Reserve Bank drew from the crisis was that the banks had been over-reliant on short-term international funding.

It has responded by imposing a core funding ratio on them which effectively lowers and caps how much of their funding they can derive from that source.

New Zealand was comparatively lucky during the crisis, Bollard says.

"We had no bank collapses, no big government bailouts, no nasty scars. But we have no cause to be smug: it was not by our cleverness that we survived."

The "no big government bailouts" bit might ring a little hollow in light of the South Canterbury Finance debacle.

Taxpayers are bound to get grumpy when $1.6 billion is being paid out to depositors in that failed finance company under the deposit guarantee scheme. A degree of retrospective nit-picking is inevitable.

Deputy Treasury Secretary Gabriel Makhlouf said on Monday that in total taxpayers are on the hook for about $1.9 billion to honour guarantees under the scheme, but the Treasury estimates the Crown will get back about $1.1 billion from receiverships.

Prime Minister John Key expressed confidence the same day that the $900 million set aside in the Crown accounts to cover liabilities under the scheme would be enough. In any case half of that was offset by the fee income the Government received under both the deposit and wholesale guarantee schemes.

In a thinly veiled dig at the previous Government, Key said it was "dumb" not to have charged a fee for every dollar covered by the deposit scheme from day one.

That is Bollard's view, too, but his book makes it clear that then Finance Minister Michael Cullen was worried that smaller institutions including the building societies and credit unions might struggle to meet such a cost.

At the height of the crisis, under the pressure of international events, and with concerns about the stability of the financial system mounting, surely it was better to err on the side of inclusiveness, rather than get too fastidious about distortions and moral hazard.

Whatever the final cost to taxpayers is, perhaps it is best to think of it as the excess on an insurance claim. Which is better, to bear the first $150 of a loss or to go uninsured and trust to luck?