Opinion: We're an economic hostage to Kevin Rudd's whims

The future of New Zealand's deposit guarantee scheme is now a hostage to decisions by Australian Prime Minister Kevin Rudd and has been for 2 weeks. There are moments in New Zealand's history when we realise the limits of our power as an independent sovereign nation. These moments of clarity usually involve us realising we are dependent to some greater power and the best we can do is duck and weave our way to the least painful solution. In October 1994 Australian Aviation Minister Laurie Brereton sent a now infamous fax cancelling a single aviation market with New Zealand without warning or explanation. This poisoned relations between the two governments for years. In February 1986 French President Francois Mitterand issued a press release banning NZ$8.5 million worth of New Zealand lambs brain exports to France to force New Zealand to hand back convicted Rainbow Warrior bombers Dominique Prieur and Alain Mafart. Eventually the sanctions were escalated and New Zealand agreed to extradite the bombers to Hao atoll. Sunday before last (Oct 12) New Zealand Prime Minister Helen Clark received a morning phone call from Australian Prime Minister Kevin Rudd with another one of these 'moments of clarity'. Rudd said he planned to announce a blanket guarantee of Australian bank, building society and credit union deposits, including both retail and wholesale deposits. Australia would also give a guarantee for Australian bank borrowing on international markets. The scale of Rudd's pledge was enormous and has generated similarly large controversy and fallout across the Tasman. Many believe he over-reacted to schemes announced in Europe in previous days and Australia is now paying the price for a grand gesture of a policy made on the run. This put New Zealand in an awful position. Without a similar guarantee here there was a risk New Zealand depositors would rush to the exits on Monday morning to put their money in guaranteed Australian bank accounts. Helen Clark had no choice. By Sunday afternoon she had announced a government guarantee of retail deposits in New Zealand banks, building societies, credit unions. She announced it as the centrepiece of her re-election campaign launch, but this was not a long-considered, carefully worded policy. It was policy-making by phone call, email and text message. It was policy making under pressure from a much bigger neighbour who genuinely feared a global financial meltdown. The Reserve Bank had been working on a deposit guarantee or insurance scheme for a week before that Sunday morning phone call, but it was not nearly fully formed and few were prepared for the breadth or the unintended consequences of Rudd's policy bombshell. The first announcement from Treasury and the Reserve Bank had some very rough edges and was different from Rudd's version in two key respects that have now become a subject of political dispute -- it lacked a wholesale guarantee for very large deposits or a government guarantee for big bank bond issues internationally. The rough edges were many and varied. The first version appeared to make it easy for entrepreneurial property developer/finance company types to launch a new finance company with a government guarantee. It also appeared to open up a huge opportunity for lowly rated finance companies to offer high rates with a government guarantee that encouraged savers to take their money out of banks. The initial policy also charged big banks with more than NZ$5 billion of deposits a fee for the guarantee, but did not charge the rest. The implications were enormous for New Zealand's financial system, its savings framework and its economy. Perversely, the original deposit guarantee scheme would have encouraged savers to move money out of sound bank accounts and managed funds and into finance companies. It would have punished conservative banks and made them pay for a guarantee for sometimes poorly managed and risky finance companies. The lack of a wholesale deposit guarantee and the government guarantee on bank bond issues overseas also raised the risk of an exodus from New Zealand banks by big fund managers and the refusal of overseas lenders to roll over significant debts with our banks. As National Party Leader John Key has pointed out, a worst-case scenario could leave our banks unable to make new loans by the end of the year. By mid-way through the first week the patch-ups started appearing. Treasury and the Reserve Bank announced that BB or lower rated finance companies and building societies (sub-investment grade) would have to pay a 3% fee for any new deposits taken after October 12. New finance companies would need a BBB minus investment grade credit rating to get a guarantee. Managed funds with investments in bank accounts and government bonds were also included in the scheme to ensure Cash PIEs (Portfolio Investment Entities) were covered. This effectively ruled out new finance companies getting the guarantee and put a limit on lowly rated finance companies taking in huge amounts of new deposits. This week a fresh batch of alterations were made to limit the guarantee to accounts with no more than NZ$1 million and impose a range of fees for new deposits taken by building societies, credit unions and finance companies. But the core issues of whether New Zealand should also offer a wholesale guarantee and guarantee bank bond issues overseas remained unresolved by Friday. National's Key would like to see it resolved "with some urgency" and has suggested Helen Clark was unaware of the seriousness of the issue. Finance Minister Michael Cullen has in return accused Key of "dancing to the tune of the Australian-owned banks" and told him not to panic, arguing there was still time to resolve the issue before the end of the year. The reason for the delay is clear. All our officials are focused on developments across the Tasman. It makes no sense for New Zealand to announce any move to a wholesale guarantee until it's clear what the Australian one looks like. Rudd's Sunday policy bombshell has unleashed a financial firestorm across the Tasman. Managed funds and mortgage trusts have frozen withdrawals to stop an exodus from unguaranteed trusts and funds to guaranteed bank accounts. Foreign bank branch managers are furious that their wholesale accounts are not covered by the scheme. Large corporates are worried their commercial paper programmes, which they use to fund their day-to-day lending, will be shut down as fund managers avoid any debt that is not government guaranteed. The CEOs of Australia's biggest banks, including New Zealand's Ralph Norris who now runs Commonwealth Bank of Australia, flew to Canberra on Thursday evening for crisis talks with Rudd and his Treasurer Wayne Swan. Many industry leaders in Australia wish they could turn the clock back to before Rudd's October 12 bombshell and the unintended consequences it has unleased. There are plenty of regulators, bankers and corporate treasurers on this side of the Tasman who wish the same. Meanwhile, we all ponder again the limits of our sovereign power.