The credit crisis, which dominated financial markets again this week, looks as if it will have four distinct stages:
* Financial and banking distress.
* Economic recession.
* A witch hunt.
* Major regulatory reform of the finance and banking sector.

The good news is that we seem to be seeing the beginning of the end as far as the financial and banking crisis is concerned.

Financial markets are now focusing on whether the next three stages will be as dramatic as the first.

The catalysts for the financial and banking crisis, namely too much lending and the plethora of high-risk securitised debt and derivative products, has been well documented.

However, many New Zealanders cannot understand why the Wall St-originated crisis is impacting on us when our banks seem to have been conservatively managed.

The problem is that we also plunged our claws into the great big honey pot of money created by Wall St and have to refinance or repay these borrowings.

The first two columns in the accompanying table show that total bank overseas borrowing increased from $31.6 billion in June 1998 to $126.8 billion in August 2008 or from 22.6 per cent to 35.5 per cent of total bank liabilities.

In other words nearly 44 per cent of the increase in bank funding over the past decade has been sourced from overseas.

The last three columns show total household or individual bank borrowings and deposits and the net deficit between the two. Household borrowings have risen from $55.2 billion to $160.2 billion over the past decade and the net household deficit with the banks has increased from $15.0 billion to $78.3 billion.

Based on these figures bank borrowings for the 25-65 age group, the group with most of the debt, has risen from $26,000 to $75,000 an individual over the past decade. Most of these extra borrowings, which have fuelled the housing bubble, have occurred in the past five years.

One of the problems is that most of the banks’ overseas debt is short term.

At the end of August a staggering $90.1 billion of the $126.8 billion of overseas borrowings was either at call or was due to be repaid in 90 days or less. Thus our banks have to refinance up to $90.1 billion of overseas debt before the end of next month. This is at a time when the huge honey pot of global funding has disappeared with many of the once friendly bears now wanting their money back.

This refinancing problem, which many banks around the world are facing, is the major reason why the Reserve Bank of New Zealand is offering to lend more and more money to our banks.

The good news is that the US$700 billion bailout, the introduction of measures to assist European banks and co-ordinated reductions in interest rates should help stabilise the global financial system over the next few weeks.

But the system has had a major heart attack and it will take some time before it is fully recovered. It will be a long, long time before banks can fully energise their lending activities.

Individuals and companies are deprived of finance, the fuel of the economic system, when bank lending slows or contracts.

In this situation they hoard cash, reduce spending, curtail investment, cut costs and lay off workers.

Economic statistics clearly demonstrate that these trends are developing and financial markets are beginning to focus on the inevitability of a worldwide economic recession.

A downturn will have a particularly severe impact on companies and individuals that are short of capital and highly leveraged.

The economic slowdown will be mild if the financial system recovers quickly but will be more prolonged if full credit availability takes longer to restore.

The first half of 2009 looks as if it will be particularly difficult but the New Zealand Treasury is forecasting a pick-up from mid-year, while the International Monetary Fund predicts: “Following sluggish growth through the remainder of 2008 and early 2009, the anticipated [global] recovery later in 2009 will be exceptionally gradual by past standards.”

New Zealand should be able to avoid a major slump because the Reserve Bank has more scope to cut interest rates. We should recover more quickly because our economy went into recession earlier than other countries following the collapse of the finance company sector.

The next stage in the crisis will be a witch hunt if the experiences of Wall St in the 1930s are anything to go by.

In the 1920s Wall St and its leading figures were at the apex of American society. New York’s financial district was one of the country’s top tourist attractions with visitors hoping to get a glimpse of JP Morgan, the head of the House of Morgan, and some of the other revered financiers.

But all that changed after the 1929 crash and early 1930s banking crisis. Charles R. Geisst wrote in his book Wall Street, A History: “Bankers quickly moved from the pinnacle of public esteem to the bottom. Wall Street legends became symbols of avarice and greed, despised in all quarters. Those who once drew crowds of tourists on their way to work would soon lose their jobs after public inquiry into their affairs revealed corruption and a total lack of interest in public accountability”.

The 1933 Senate inquiry into the banking and currency crisis focused on the remuneration and income tax avoidance of J. P. Morgan and other Wall Street financiers. A female midget from Ringling Brothers Circus was dumped on the lap of J. P. Morgan during these hearings, a humiliating experience that would not have been contemplated when Morgan and Wall Street ruled America in the 1920s.
We saw the first signs of the upcoming witch hunt when Richard Fuld, the former head of Lehman Brothers, faced a two-hour grilling before a House of Representatives committee on Monday. Committee members focused heavily on Fuld’s US$480 million remuneration over the past few years.

In the early 1930s there was intense debate over the regulation of Wall St with J. P. Morgan insisting that self-regulation was the most effective form of oversight for the banking and financial sector.

There was a particularly passionate debate over the regulation of short selling, which was widespread during the 1920s.

But Wall St’s reputation had sunk so low it had no hope of winning this debate. When Franklin D. Roosevelt was elected President in 1932, mainly because he unexpectedly won the Democratic Party nomination thanks to the favourite being strongly endorsed by Wall St, a major regulatory reform programme began.

The first was the Securities Act of 1933, which required promoters and underwriters to disclose full information in offer documents. The next was the Banking Act of 1933, more commonly known as the Glass-Steagall Act, which established the bank deposit insurance scheme, gave the Federal Reserve more power and separated commercial and investment banks. (Investment banks also played a major role in the boom and bust of the 1920s and 1930s.).

Finally the Securities Exchange Act of 1934 created the Securities and Exchange Commission, which immediately banned naked short-selling although investment banks have found ways around these regulations over the past 20 to 30 years.

The debate around Stage 4 of the current crisis, the reform of the finance and banking sector, will be heated and acrimonious. But this time there will be little or no support among the public and politicians for Wall St’s self-regulation stance.

The finance and banking sector needs more oversight but too much regulation will hinder the recovery of the banking sector, curtail lending and impede economic growth.
NZ Banks – Borrowing offshore and on lending to individuals

($ billion)



Borrowings % of total liabilities Borrowings Deposits Net Deficit

August 2008






June 2008






June 2007






June 2006






June 2005






June 2004






June 2003












June 1998