Oct 19, 2008

Day Of Reckoning Is Nigh

Remember Fran O'Sullivan yesterday? The banks are about to stop lending because the Government won't guarantee their international borrowings (in contrast to pretty much every other Government of its type).
Now read Bernard Hickey who adds some important context - just in case you don't see the relevance to your situation:
Some facts about our level of indebtedness are needed to convince New Zealanders how serious the situation is. Firstly, Kiwi households are much more indebted than those in the US blamed for the sub-prime debt that triggered the credit crunch.
Our household debt to disposable income ratio has risen to 163 per cent from 110 per cent in the past five years. This is well above the 13 per cent seen in the US.
Our household debt servicing cost to disposable income ratio has risen from 9 to 14.4 per cent 10 years ago. Our debt servicing burden rose above the US' for the first time this year.
New Zealanders borrowed more than $50b extra from foreign banks and investors in the past 30 months through our banks.
The credit crunch has frozen global credit markets, making it difficult for our banks to easily and cheaply roll over that debt every few months. That heavy borrowing was reflected in our high current account deficit and borrowing needed to service that deficit.
For the past five years much of that borrowing was used to pay for imports and to invest mostly in each others houses, pushing up property prices.
But there's been an ominous change in the past year. We have stopped borrowing so much to invest in housing or pay for imports. We are now borrowing to pay the interest on the previous borrowing.
New Zealand's interest payments and dividend payments to the rest of the world accelerated to a record $4.44b in the June quarter. About $2.2b of that was interest payments. Our foreign borrowings rose a further $1.6b in the June quarter.
This means we borrowed more simply to pay the interest on previous debt. This is like using a credit card to pay the interest costs on the mortgage but on a national scale.
The man credited with the discoveries that unleashed the atomic bomb, Albert Einstein, said: "The most powerful force in the universe is compound interest." He was right. Compound interest on unpaid debt will destroy everything in its path.
New Zealand has an atomic bomb of debt which is about to blow up the Kiwi economy for a decade or two. If we are lucky the Reserve Bank and our major banks will manage a controlled explosion that leaves plenty of walking wounded but is not fatal to everyone.
The worst case scenario is an almost complete cessation of new lending. The best case is a sharp reduction in new lending growth spread out over two to three years.
This is where the changes of behaviour have to come in. New Zealanders generally, our politicians specifically and our banking system in particular have to acknowledge a change of behaviour is needed.
Put simply, we need to stop borrowing more overseas as a percentage of GDP and actually reduce it. We must do that because if we don't our creditors will do it for us in a more violent way.
That means not borrowing any more overseas for a decade or so. In real terms that means New Zealanders need to stop spending and borrowing about $1.5b a month or $375 per person.
To put that into context, about $1.7b worth of residential property was sold in September. Total retail sales were $5.3b last month. Reducing spending on this scale will need massive changes in behaviour.