Opinion: Why NZ should be obsessed with the broken US banks too

By Bernard Hickey It's occurred to me re-reading my Top 10 at 10s from recent days that I seem almost obsessed with the nitty gritty of the US banking system debacle and what Barack Obama and Timothy Geithner are doing about it. I come across as almost painfully bearish about this. Some might ask why are you so focused on it? I'm obsessed because it is the source of everything. The global credit boom started there. It bust there. It will recover from there. My fundamental view is that the global economic system will not start recovering properly until the insolvent US banking system is fixed through the nationalisation of the biggest ones and creation of bad banks which effectively wipe out the shareholders and bond holders in these banks. This nationalisation debate is political dynamite, but must be had. So far, Obama and Geithner are failing to come to grips with this. Many Obama supporters, including Paul Krugman and Nouriel Roubini, share the same view about the current (fudged) solution to the US banking crisis being inadequate. Geithner wants to create Public Private Investment Partnerships (PPIP) that buy toxic debt off the banks. It will succeed only in The key number for anyone watching the global economy right now is US$4 trillion. That is the size of the losses the banks, insurers and fund managers will have to declare, according to the IMF and others. So far, they have only declared less than US$2 trillion. On top of the de-leveraging from this, the Northern Hemisphere banks will have to reduce their leverage levels anyway from the 20 plus pre-bust to around 15 times equity now. The amount of debt that will have to pulled back in, written off and devalued in some way is mind boggling. It will handicap the global economy for a decade, unless there is an explosion of debt writeoffs, inflation and devaluations. These 'medicines' could be just as bad as the disease. Fundamentally, the only real solutions are debt writeoffs and restructuring, less consumption, more saving and slow growth for years. Luckily for us, New Zealand is far less exposed to this banking crisis than almost anyone. I give thanks every day that our bankers were so boring, so conservative and so lacking in greed that they avoided investing heavily in US housing and other toxic debt. Hallelullah for boring bankers and for former Australian Prime Minister Paul Keating, who refused to drop the 'four pillars' policy banning the big four banks from buying each other and banning foreign banks from buying them. I'm sure one or all of them would have been dragged into this mess if they had been bought by a Citigroup or a Royal Bank of Scotland or an HSBC. The meaning of all this for New Zealanders and our economy is that we shouldn't expect a global rebound to drag our economy out of recession for at least the next year or two, possibly longer. Luckily for us, our forecast economic contraction is relatively small, with GDP down maybe 1-2% in 2009. This is light compared with others. The IMF sees US GDP down 2.8% in 2009; Japan down 6.2%; Germany down 5.6% and UK down 4.1%. Our banking system is still growing lending and our exports (in NZ dollar terms) are still relatively robust because the automatic stabiliser of our currency has worked by falling fast. It also helps we sell mostly food rather than manufactured consumer goods, although Tourism is being hit hard. All this will mean our recession will long (probably well into 2010) but relatively shallow, at least compared to other economies. Unemployment could rise over 8%, but my gut feel is it will stay under 8%. Employers have long memories (last 5 years or so) of labour shortages and will hoard wherever they can. However, we won't avoid the fallout from all this global de-leveraging and economic contraction. Export returns will be lacklustre at best and very weak at worst. Our banks also owe about NZ$100 billion overseas, although much of that is to Australian parents and institutions. This deleveraging means that overseas funding will be more expensive than pre-bust, meaning the banks will be reluctant to cut their fixed rate mortgages much at all, even if the Official Cash Rate is cut. All this means I don't see a turnaround in the global economy and therefore the end of our recession until the US banking system is fixed. We'll know that it is fixed when the banks start growing lending again and have cleared toxic debt from their balance sheets. That's why we should all be watching what US Treasury Secretary Timothy Geithner is saying, and more importantly, doing.