KEY POINTS:
It's not panic stations, but New Zealand businesspeople and residential mortgage borrowers would be wise to prepare themselves for a global credit tightening.
At issue is whether the troubles in the US residential mortgage market and the related credit crunch can be contained, or whether they will result in global contagion.
As respected New York Times columnist Paul Krugman wrote yesterday: "The origins of the current crunch lie in the financial follies of the last few years, which, in retrospect, were as irrational as the dot-com mania. The housing bubble was only part of it; across the board, people began acting as if risk had disappeared."
Sounds awfully familiar doesn't it? Right now it seems as if no one really knows just how bad the underlying problems with the risky US subprime mortgage market are, or the extent of the associated credit crunch.
But the mere fact that central banks around the world have been injecting extra funds into the financial system as lenders sit on their hands indicates the underlying problems are worse than the associated confidence statements suggest.
Wall St closed out a difficult week yesterday after the Federal Reserve injected US$38 billion (NZ$50.5b) into the banking system on top of the US$24 billion it put in on Friday to replace evaporating credit. Stock markets had plunged around the world as the turmoil spread. But by close of play on Wall St, the Dow Jones had recovered most of its losses for that day.
But the emergency action by central banks in the US, Japan and Europe to pump out billions of dollars of extra liquidity in the past couple of days suggests the problems with the US subprime mortgage market are just the tip of an underlying asset valuation iceberg.
We won't know for some time yet whether the wild gyrations in global financial markets during the past week - particularly in the US - will translate into a broader economic fallout.
The Federal Reserve has pledged to do all it can to facilitate the orderly functioning of financial markets.
But when Wall St sneezes, the world usually catches a cold. And some respected US economic pundits are mentioning the dreadful R word - recession.
The problem is that when liquidity dries up, it sets off a chain reaction. Banks foreclose on mortgage holders, the banks then come under pressure as they try to pay interest to their lenders, and further pressure from institutions which have bought collateralised securities that turn out not to be worth the paper they are written on.
If the loan funds have come from offshore (as is the case with a considerable amount of New Zealand's private borrowing), currency risk also has to be factored in.
At the corporate level, the junk bonds that have funded private equity buyouts of major companies will similarly come under pressure as investors reassess risk levels.
What does this have to do with New Zealand? Well, unfortunately when the world's prime financiers go dog on credit quality, funds will dry up. That means New Zealanders are likely to have to pay more for borrowings and it will be harder to get finance for riskier ventures.
Finance Minister Michael Cullen did not see fit to issue calming statements here after New Zealand shares suffered yet another day of losses on Friday.
But Australian Treasurer Peter Costello urged investors not to panic after the ASX struck similar sticky patch and the Reserve Bank of Australia injected A$4.95 billion (NZ$5.5 billion) into its local money market by buying debt-related instruments.
The confidence that Costello has in the Australian banking sector to ride out the storm is important. Nearly 85 per cent of New Zealand's banking sector is Australian-owned.
But you can bet that the Australian banks will be taking a much sharper look at the asset quality on their own books now - including in New Zealand, which has seen a huge explosion of credit through the Aussie bank's mortgage lending war.
This tends to suggest the interest rate for residential and business borrowers will be higher in future and more attention will be paid to their ability to fund interest payments.
The upside is that it is now quite unlikely that Reserve Bank governor Alan Bollard will need to raise interest rates again next month to force a clampdown on house lending. The banks will be doing it anyway.
