Monday, July 28, 2008

Financial Instability Intensifies

In quick succession, the Bank of New Zealand’s parent company, National Australia Bank (NAB), and the ANZ Banking Group announced writedowns of bad debt flowing from the US sub-prime (read “junk”) mortgage meltdown in recent days.

On Friday, NAB, said it would be making a A$830 million (NZ$1.07 billion) provision for indirect losses incurred in the US housing market. This was followed by the ANZ Banking Group’s statement on Monday that it would be writing down a further A$1.2 billion, bringing its annual debt charge off to around A$2.2 billion.

New Zealand’s top five trading (or commercial) banks are controlled by large Australian retail banks such as NAB and ANZ Banking Group, which operates the ANZ and National brands in New Zealand. The major Australian banks have claimed in the past that they had little exposure to the US sub-prime market.

It can only be hoped that the financial news from across the Tasman has shaken the smug conceit of a panel of New Zealand economists who in a Radio New Zealand National interview on July 19 concluded that the New Zealand banking system faced little exposure to the US sub-prime market.

New Zealand does not have a deposit insurance system for bank accounts.

Time for Cool Heads at No.2 The Terrace, Wellington,
Home of the Reserve Bank of NZ
Photo: Kaihsu Tai, Wiki Commons

The day before news of the NAB debt write down, the Reserve Bank of New Zealand cut its Official Cash Rate (OCR), its lending rate by a quarter point, to 8.0 percent. It was the first cut in five years.

A half-point cut, and some months ago, might have been more in order given the increasing gravity of the financial instability and weakening macroeconomic conditions, but a policy stance single-mindedly set in recent decades on inflation control holds monetary policy hostage to outdated eighteenth century ideas.

Admittedly, the Reserve Bank’s hand is constrained by not only a legislated primary monetary target of price stability, but also the need to keep monetary conditions tight to offset the effects of a widening current account deficit. High interest rates have encouraged international capital to flow in to fund the trade deficit, but that in itself has exacerbated the high exchange rate, reducing the international competitiveness of New Zealand exporters.

In early May, in a precautionary move, the Reserve Bank expanded its lender of last resort facility to trading banks by permitting home mortgage securities to be posted as collateral in return for Reserve Bank loans.

Meanwhile, in the United States, troubled banks drew a daily record US$17.7 billion from the Federal Reserve’s discount window facility on July 23, the highest sum since shortly after 9/11 2001 when $45 billion was borrowed on Sept. 12. Average daily discount window borrowing is running at 16 billion in late July, indicative of the deep financial difficulties in the US banking system.

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