Mark Lister: Into maelstrom of world's money meltdown

Dr Alan Bollard's book on the world financial crisis describes how few experts saw it coming. Photo / Mark Mitchell

It's not often that a sitting Reserve Bank governor publishes a book. That alone makes Crisis, written about the global financial crisis by Dr Alan Bollard with Sarah Gaitanos, interesting.

The story starts in August 2005 at the annual talkfest for central bankers at Jackson Hole in Kansas. It's Alan Greenspan's swansong before he retires in 2006. It sounds like much of the time was spent giving tributes to Greenspan as "the best central banker ever". Indeed, since his appointment in 1987 the world had enjoyed a remarkable period of growth and low inflation.

However, Bollard noted one presentation by two academics from Chicago University that ruffled feathers. They said recent developments had made the world a riskier place. But it all ended on a reassuring note, Greenspan closing the conference by saying that despite ongoing challenges, the housing boom would settle down, savings would improve and current account imbalances would rebalance.

Bollard recalls not all central bankers felt as comfortable as Green-span. A couple voiced concerns believing markets were too complac-ent and had a misplaced belief that central banks were now able to avoid economies falling into recession.

The five years to 2007 was a period of intense financial "innovation". A savings glut from fast-growing emerging economies was hitting the United States and keeping interest rates low. This was creating demand from investors for higher returns and from borrowers for cheaper debt. The investment banks, armed with sophisticated new models, figured out a way of meeting both demands.

Sub-prime lending took off and those who could not really afford a mortgage could now get one because another company could insure their mortgage and it would be bundled up with lots of others to "reduce risk".

These repackaged securities were then given various credit ratings from the ratings agencies and were sold off to investors around the world.

To make matters worse Greenspan, after justifiably cutting interest rates sharply in 2000, had inexplicably decided to leave them low for the next three years. As a result, people were able to borrow at very low rates, which spurred an unsustainable housing boom and encouraged commodities like oil to be treated as financial investments.

We were enjoying a period of strong growth in New Zealand also. House prices were rising by 20 per cent a year, consumption and household debt were growing at a much faster rate than incomes, and the dairy sector was booming on the back of higher milk prices, rising land prices and liberal bank lending.

Bollard describes 2004 and 2005 as tough going. He was raising the official cash rate to combat this growing property bubble but it was forcing the dollar up and producing tough times for many people who couldn't understand his logic.

A number of politicians inexcusably joined the anti-Bollard bandwagon at this time to get some cheap PR out of an emotive issue. Bollard got one death threat and recalls feeling uncomfortable walking home in the dark at times.

In 2007 this exuberance continued. Finance companies started to show signs of stress, and by late 2007 they were "falling like flies". To its credit, the Reserve Bank had been warning investors about the dangers of the finance company sector for some time.

The first spark in the global financial crisis was ignited in April 2007 when a medium-sized US financial firm filed for bankruptcy. Congress was told that the failure "does not appear to have spilled over to a significant event". Bollard admits that the importance of this was not recognised at the time.

It wasn't until August, when BNP Paribas froze two structured funds made up of sub-prime assets due to "complete evaporation of liquidity in the market", that he really became aware of what was happening. Bollard admits to Googling "sub-prime mortgages" to learn more about these toxic assets.

Things worsened through 2008 and on the afternoon of September 15, markets got a trifecta of terrible news. Lehman Brothers had failed, AIG needed a massive rescue package and Merrill Lynch had been sold.

Bollard uses the word "carnage" to describe market events in Sept-ember and October, with equity markets falling 40 per cent from their 2007 peak.

In 2009, the crisis that had been reverberating around financial markets hit the broader economy. People started losing their jobs, house prices started to fall and economically sensitive sectors like retail and building came to a virtual standstill. Dairy prices, which had been a driver of our economy in recent years, fell sharply.

This dire economic situation saw our currency fall to US48 cents (having peaked at US81c in 2008) as investors headed back to the safe haven of the US dollar.

In February, the Government held its Job Summit in Manukau. Bollard gave an introductory speech, which he admits probably wasn't as upbeat as John Key wanted. He then confesses to finding the whole experience a bit of a drain. A noisy room full of people debating doesn't suit such a self-confessed introvert.

He quietly called his assistant and asked her to get him an earlier flight back to Wellington.

In early March, equity markets hit bottom and have risen more than 90 per cent since then. Looking back, the pending G20 meeting in London may have driven this turnaround. Bollard calls the size of the packages to rescue the financial system "mind-blowing", at US$1.1 trillion.

The last part of the book talks through the measures of 2009 and 2010 and the wide discussion about possible causes of the crisis, from regulation to banks, overly loose monetary policy to rating agencies.

Debt was at the heart of this crisis. The tech bubble wasn't so bad because it wasn't financed with debt, but the property boom was fuelled by heavy and irresponsible borrowing, making it so much more dangerous. Taxpayers have had to bail out the banking sector so whatever our regulations were, they didn't work.

What is clear with any considered review of this period is that when investing, it's more important to pro-tect downside than to grab every ounce of upside. In March 2009 it could easily have gone the other way and protecting against that possibil-ity is more important than capturing every dollar of a market bounce.

Market timing is tough and a measured approach remains vital. Keep a balanced portfolio and tilt the exposures towards cash when equity markets get extended and rebalance back to equities after market falls.

An interesting anecdote came towards the end of the book from the Jackson Hole meeting. One of the world's top central bankers recount-ed wandering to the local store for a copy of the Wall Street Journal. "Do you want yesterday's or today's?" asked the storekeeper. "Today's of course," replied the central banker. "Well then," said the man, "you'd best come back tomorrow." The irony wasn't lost on the bankers. It would not be until tomorrow that we would truly understand what was happening today.

* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available under his profile on www.craigsip.com. This column is general in nature and should not be regarded as investment advice.