Not sure when I started to compile this but Ill save it here !
Neoliberalism was an economic
philosophy that emerged among European liberal scholars in the 1930s
attempting to chart a so-called ‘Third’ or ‘Middle Way’
between the conflicting philosophies of classical
liberalism and collectivist central planning.
The impetus for this development arose from a desire to avoid
repeating the economic failures of the early 1930s which conventional
wisdom of the time tended to blame on unfettered capitalism, and a
simultaneous concern with avoiding the inhumanity of National
Socialism. In the decades that followed, neoliberal theory tended
to be at variance with the more laissez-faire
doctrine of classical liberalism and promoted instead a market
economy under the guidance and rules of a strong state, a model which
came to be known as the social
market economy. In the
sixties, usage of the term "neoliberal" heavily
declined. When the term was reintroduced in the 1980s in connection
with Pinochet’s
regime the usage of the term Neoliberalism had shifted. It had
not only become a term with negative connotations employed
principally by critics of market reform, but it also had shifted in
meaning from a moderate form of liberalism to a more radical and
economically libertarian set of ideas. Scholars now tended to
associate it with the theories of Friedrich
Hayek and Milton
Friedman.[2]
Once the new meaning of neoliberalism was established as a common
usage among Spanish-speaking scholars, it diffused directly into the
English-language study of political economy.[3]
The term
neoliberal is now used mainly by those who are critical of
legislative market reforms such as free trade, deregulation,
privatization, and reducing government control of the economy.[4]
New
Right is used in several countries as a descriptive term for various
policies or groups that are right-wing. It has also been used to
describe the emergence of Eastern European parties after the collapse
of the Soviet
Union and systems using Soviet-style communism
In
New Zealand,
as in Australia, it was the Labour
Party that initially adopted "New Right" economic
policies, while also pursuing social liberal stances such as
decriminalisation of male homosexuality, pay equity for women and
adopting a nuclear-free policy. This meant temporary realignment
within New Zealand politics, as "New Right" middle-class
voters voted Labour at the New
Zealand general election, 1987 in approval of its economic
policies. At first, Labour corporatised many former government
departments and state assets, then emulated the Conservative Thatcher
administration and privatised them altogether during Labour's second
term of office. However, recession and privatisation together led to
increasing strains within the Labour Party, which led to schism, and
the exit of Jim
Anderton and his NewLabour
Party, which later formed part of the Alliance
Party with the Greens and other opponents of New Right economics.
However,
dissent and schism were not to be limited to the Labour Party and
Alliance
Party alone. During the Labour Party's second term in office,
National selected Ruth
Richardson as Opposition finance spokesperson, and when National
won the 1990
general election, Richardson became Minister of Finance, while
Jenny Shipley
became Minister of Social Welfare. Richardson introduced
deunionisation legislation, known as the Employment Contracts Act, in
1991, while Shipley presided over social welfare benefit cuts,
designed to reduce "welfare
dependency" – both core New Right policy initiatives.
In
the early nineties, maverick National
MP Winston
Peters also came to oppose New Right economic policies, and led
his elderly voting bloc out of the National Party. As a result, his
New Zealand
First anti-monetarist party has become a coalition partner to
both National (1996–1998) and Labour (2005–2008) led coalition
governments. Due to the introduction of the MMP
electoral system, a New Right "Association of Consumers and
Taxpayers" party, known as ACT
New Zealand was formed by ex-Labour New Right-aligned Cabinet
Ministers like Richard
Prebble and others, and maintaining existing New Right policy
initiatives such as the Employment Contracts Act, while also
introducing US-style "welfare
reform." ACT New Zealand aspired to become National's
centre-right coalition partner, but has been hampered by lack of
party unity and populist leadership that often lacked strategic
direction.
As
for Labour and National themselves, their fortunes have been mixed.
Labour was out of office for most of the nineties, only regaining
power when Helen
Clark led it to victory and a Labour/Alliance coalition and
centre-left government (1999–2002). However, the Alliance
disintegrated in 2002.
National
was defeated in 1999 due to the absence of a suitable, stable
coalition partner given New Zealand First's partial disintegration
after Winston Peters abandoned the prior National-led coalition. When
Bill English
took over National, it was thought that he might lead the Opposition
away from its prior hardline New Right economic and social policies,
but his indecisiveness and lack of firm policy direction led to ACT
New Zealand gaining the New Right middle-class voting basis in
2002. When Don Brash
took over, New Right middle-class voters returned to National's fold,
causing National's revival in fortunes at the New
Zealand general election, 2005. However, at the same time, ACT
New Zealand strongly criticised it for deviating from its former
New Right economic policy perspectives, and at the same election,
National did little to enable ACT's survival. Don Brash resigned as
National party leader, being replaced by John
Key, who is seen as a more moderate National MP.
As
for the centre-left, Helen Clark and her Labour-led coalition have
been criticised from ex-Alliance members and non-government
organisations for their alleged lack of attention to centre-left
social policies, while trade union membership has recovered due to
Labour's repeal of the Employment Contracts Act 1991 and labour
market deregulation and the deunionisation that had accompanied
it in the nineties. It is plausible that Clark and her Cabinet are
influenced by Tony
Blair and his British Labour Government, which pursues a similar
balancing act between social and fiscal responsibility while in
government.
Douglas and the Development of
Economic Policy, 1969–1983
Douglas became a Labour
member of parliament at the 1969
general election. He showed his interest in economic policy in
his maiden speech, in which he argued against foreign investment in
the domestic economy.[2]
His case for external protection of the domestic economy and
government involvement in investment was characteristic of the Labour
Party of the time. From 1972 to 1975, Douglas was a junior minister
in the Third
Labour Government, where he won a reputation for his capacity for
innovation.[3]
This government followed a broadly Keynesian
approach to economic management.
As a minister, Douglas was
innovative in context of the public
sector. As Broadcasting Minister he devised an administrative
structure in which two publicly owned television channels competed
against each other.[4]
He was among the government’s leading advocates of compulsory
saving for retirement, which he saw not only as a supplement to
public provision for retirement but as a source of funding for public
investment in economic development.[5]
The superannuation scheme he helped design became law in 1974, but
was disestablished by Robert
Muldoon almost as soon as the National
Party won the 1975
election.[6]
Douglas maintained his
interest in economic issues in opposition. He framed his chief
concern as the deep-seated problems in the structure of the economy
that had contributed to deteriorating economic performance and a
standard of living that was slipping in comparison to that of other
developed countries. In 1980, he described New Zealand as a country
living on borrowed money, unable in spite of the record efforts of
its exporters to pay its own way in the world.[7]
The economic policy of
successive governments had left the domestic economy sheltered and
unresponsive to consumers. Inflation, which was more than ten per
cent a year throughout the seventies, was high by the standards of
the country’s major trading partners. There was a persistent fiscal
deficit. The public sector was inefficient. A large part of the
economy was controlled by regulation, some arbitrary or inconsistent.
The political consensus of the post-war years produced stability at
the cost of innovation.[8]
Both major political parties maintained the high levels of protection
introduced by the First
Labour Government from 1936 onwards, and since 1945 both parties
had aimed at maintaining a structural shortage of labour.
Beneficiaries of the regulated economy flourished in both public and
private sectors.[9]
Douglas argued that only
radical action would improve the economic outlook. In 1980, he
published an "Alternative Budget" that attacked what
Douglas called the Muldoon government’s “tinkering” with the
economy. He wrote that twenty years of pandering to entrenched
interests had dampened productive investment. The Labour leadership
saw his proposals and their unauthorised publication as unfavourable
comment on Labour policy. The Labour leader Bill
Rowling publicly rebuked Douglas.[10]
Douglas then published his thinking in the form of a book.[11]
Alongside far-reaching proposals for reform of taxation and
government spending, it advocated a twenty per cent devaluation of
the dollar to increase the competitiveness of exports. Although
radical, it took an eclectic approach and did not hint at the
abandonment of Labour’s Keynesian
policy framework.[12]
Douglas became increasingly
frustrated by what he saw as the Labour Party’s reluctance to deal
with fundamental issues of economic policy. He claimed in 1981 that
Labour had an image as a party that would promise the public anything
to be elected. He argued that the party should agree on its economic
policy before it agreed on anything else, and allow economic reality
to play a part in its decision-making. Unable to convince Rowling of
the merit of his case, a disillusioned Douglas decided to stand down
from parliament at the 1981
election.[13]
One of those who persuaded him to stay was Labour’s deputy leader
David Lange
who offered to make Douglas Minister
of Finance if Lange was prime minister after the 1984
election.[14]
After Labour’s narrow loss
in the 1981 election, Douglas found a growing audience in the
parliamentary party for his view that Labour’s established approach
to economic policy was deficient. His colleague Mike
Moore claimed that there was a public perception that Labour
policy sought “to reward the lazy and defend bludgers”.[15]
Douglas’s case for a radical approach was strengthened by the
belief among many of his parliamentary colleagues that the economy’s
deep-seated problems could only be solved by extensive restructuring.
It was understood that some restructuring must follow the Closer
Economic Relations agreement with Australia, which took effect in
1981 and reduced barriers to trade between Australia and New
Zealand.[16]
At the same time, many economists were arguing for the greater use of
competition as a tool of policy, and expressing concern about
excessive or inappropriate regulation of the economy.[17]
In 1983, Lange succeeded Rowling as Labour leader. He gave Douglas
responsibility for economic policy and made it clear that economic
policy would determine other policy.[18]
Although Douglas was
innovative in his approach, and his open disregard for Rowling had
earned him a reputation as a maverick, he remained within the
mainstream of economic thinking in the parliamentary Labour
Party.[19]
He argued in 1982 that the government should actively support small
business, and intervene to stop the aggregation of assets by big
business. In his view, the government should use the tax system to
encourage productive investment and discourage speculative
investment. Until the end of 1983, Douglas saw exchange rate, tax and
protection policies as means of actively shaping the business
environment. In August 1982 he supported a contributory
superannuation scheme as a means of funding industrial development
and in February 1983 he wrote a paper called “Picking Winners for
Investment” which proposed the establishment of local consultative
groups to guide regional development. In a paper dated May 1983
Douglas argued that an unregulated market led to unhealthy
concentrations of market power.[20]
A New Direction, 1983-1984
At the end of 1983 there was a
marked change in Douglas’s thinking. He prepared a caucus paper
called the “Economic Policy Package” which called for a
market-led restructuring of the economy. The key proposal was a 20
per cent devaluation of the dollar, to be followed by the removal of
subsidies to industry, border protection and export incentives. The
paper doubted the value of “picking winners” and saw only a
limited place for government funding of economic development.[21]
His colleague Stan
Rodger described the paper as a “quite unacceptable leap to the
right”. It immediately polarised opinion in the Labour Party.[22]
Douglas characterised the
policy package as restrained and responsible, and an appropriate
response to the country’s economic difficulties.[23]
He acknowledged the contribution to the package of Doug Andrew, a
Treasury officer on secondment to the parliamentary opposition, among
others.[24]
W H Oliver noted the close alignment of the package and Economic
Management,[25]
Treasury’s 1984 briefing to the incoming government.[26]
His assessment was that Douglas was predisposed towards the Treasury
view because its implementation required decisive action and because
greater reliance on the market solved what Douglas saw as the problem
of interest-group participation in policy-making.[27]
Division
in Labour over economic policy crystallised when a competing proposal
was submitted to the Labour Party's Policy Council. Its proponents
included Rowling and others who had resisted his replacement as
leader. It argued for a Keynesian
use of monetary and fiscal policy. It was sceptical about the ability
of the private sector to promote economic development. Economic
restructuring was to be led by the government, which would act within
a consultative framework. In this way, the social costs of
restructuring would be avoided.[28]
There was stalemate in the
Policy Council. As the 1984
election drew closer, Labour’s deputy leader Geoffrey
Palmer drafted a compromise that contained elements of both
proposals. The Palmer paper was broadly worded. It made no mention of
devaluation. It anticipated some form of understanding between
government and unions about wage restraint. It allowed for extensive
consultation about economic policy and stated that necessary
structural change would be gradual and agreed.[29]
When Muldoon unexpectedly called an early general election, the
Labour Party adopted Palmer’s paper as its economic policy. Lange
said that Labour went into the election with an unfinished argument
doing duty as its economic policy.[30]
Minister of Finance, 1984-1988
The key element of Douglas’s
economic thinking was implemented after Labour won the 1984
election but before it was formally sworn into office. This was
the 20 per cent devaluation of the New Zealand dollar. The
announcement of the snap
election immediately provoked selling of the dollar by dealers
who anticipated that a change of government would lead to a
substantial devaluation. The result was a currency
crisis that became a matter of public knowledge two days after
the general election. Muldoon refused to accept official advice that
devaluation was the only way to stop the currency crisis and provoked
a brief constitutional crisis when he initially declined to implement
the incoming government’s instruction that he devalue. Both crises
were soon settled when Muldoon accepted that he had no choice but to
devalue.[31]
Although devaluation was a contentious issue in the Labour Party and
was not part of Labour’s election policy, the decisiveness with
which the incoming government acted won it popular acclaim and
enhanced Douglas’s standing in the new cabinet.[32]
The reformers argued that the
speed with which the reforms were made was due to the fact that New
Zealand had not adjusted to Britain’s abandonment of the empire,
and had to move quickly to ‘catch up’ with the rest of the
world.[33]
Douglas claimed in his 1993 book Unfinished
Business that speed was a key strategy for achieving radical
economic change: "Define your objectives clearly, and move
towards them in quantum leaps, otherwise the interest groups will
have time to mobilise and drag you down".[34]
Political commentator Bruce
Jesson argued that Douglas acted fast to achieve a complete
economic revolution within one parliamentary term, in case he did not
get a second chance.[35]
The reforms can be summarised as the dismantling of the Australasian
orthodoxy of state development that had existed for the previous 90
years, and its replacement by the Anglo-American neo-classical model
based on the monetarist policies of Milton
Friedman and the Chicago
School.[33]
The financial market was deregulated and controls on foreign exchange
removed. Subsidies to many industries, notably agriculture, were
removed or significantly reduced, as was tariff protection. The
marginal tax
rate was halved over a number of years from 66% to 33%; this was
paid for by the introduction of a tax on goods and services (GST)
initially at 10%, later 12.5% (and eventually in 2011, 15%), and a
surtax on
superannuation, which had been made universal from age 60 by the
previous government.[36]
New Zealand became part of a
global
economy. With no restrictions on overseas money coming into the
country the focus in the economy shifted from the productive sector
to finance.[37]
Finance capital outstripped industrial capital[33]
and redundancies occurred in manufacturing industry; approximately
76,000 manufacturing jobs were lost between 1987 and 1992.[34]
During wage bargaining in 1986 and 1987, employers started to bargain
harder. Lock-outs
were not uncommon; the most spectacular occurred at a pulp and paper
mill owned by Fletcher
Challenge and led to changes to work practices and a no-strike
commitment from the union. Later settlements drew further concessions
from unions, including below-inflation wage increases, a cut in real
wages.[38]
There was a structural change in the economy from industry to
services, which, along with the arrival of trans-Tasman retail chains
and an increasingly cosmopolitan hospitality industry, led to a new
‘café culture’ enjoyed by more affluent New Zealanders. Some
argue that for the rest of the population, Rogernomics failed to
deliver the higher standard of living promised by its advocates.[33]
Over 15 years, New Zealand's
economy and social capital faced serious problems: the youth suicide
rate grew sharply into one of the highest in the developed world;[39]
the proliferation of food banks increased dramatically;[40]
marked increases in violent and other crime were observed;[41]
the number of New Zealanders estimated to be living in poverty grew
by at least 35% between 1989 and 1992;[42]
and health care was especially hard-hit, leading to a significant
deterioration in health standards among working and middle-class
people.[43]
In addition, many of the promised economic benefits of the experiment
never materialised.[44]
Between 1985 and 1992, New Zealand's economy grew by 4.7% during the
same period in which the average OECD
nation grew by 28.2%.[45]
From 1984 to 1993 inflation averaged 9% per year, New Zealand's
credit rating dropped twice, and foreign debt quadrupled.[46]
Between 1986 and 1993, the unemployment rate rose from 3.6% to
11%.[47]
After
Rogernomics, the New
Zealand Labour Party was paralysed by infighting for most of the
next six years, as former Trade Minister Mike
Moore became Leader of the Opposition (1990–1993), followed by
Helen Clark,
whose first term as Leader of the Opposition was undermined by
Moore's populist personal faction. However, Clark survived and
steadily gained ground during the third and final term of the Jim
Bolger and Jenny
Shipley administrations. Much like Tony
Blair in the United Kingdom, Clark decided on a compromise
solution, combining advocacy of the open
economy and free
trade with greater emphasis on fighting the New
Right consequences of social
exclusion.
The
policies of Ruth
Richardson, sometimes called "Ruthanasia",
are often seen as a continuation of Rogernomics. Richardson was
Finance Minister in the National
Party government from 1990 to 1993.
In
New Zealand advocates of radical economic policies are often branded
as "rogergnomes" by their opponents, linking their views to
Douglas's and the supposed baleful influence of international
bankers, characterised as the Gnomes
of Zürich.
Philosophy:
New Right ideas were developed in the early eighties and took a
distinctive view of elements of society such as family,
education, crime and deviance. In the United Kingdom, the term New
Right more specifically refers to a strand of Conservatism that the
likes of Margaret Thatcher and Ronald Reagan influenced. Thatcher's
style of New Right ideology, known as Thatcherism,
was heavily influenced by the work of Friedrich
Hayek (in particular the book The
Road to Serfdom). They were ideologically committed to
neo-liberalism
as well as being socially
conservative. Key policies included deregulation of business, a
dismantling of the welfare state, privatization of nationalized
industries and restructuring of the national workforce in order to
increase industrial and economic flexibility in an increasingly
global market. Similar policies were continued by the subsequent
Conservative
government under John
Major and the mark of the New Right is evident in the New
Labour government, first under Tony
Blair, then Gordon
Brown.
The World Bank Group (WBG) is
a family of five international
organizations that make leveraged loans to poor countries. It is
the largest and most famous development bank in the world and is an
observer at the United
Nations Development Group.[2]
The bank is based in Washington,
D.C. and provided around $30 billion in loans and assistance to
"developing" and transition countries in 2012.[3]
The bank's mission is to reduce poverty.[4]
The
World Bank's (the IBRD and IDA's) activities are focused on
developing
countries, in fields such as human development (e.g. education,
health), agriculture and rural development (e.g. irrigation, rural
services), environmental protection (e.g. pollution reduction,
establishing and enforcing regulations), infrastructure (e.g. roads,
urban regeneration, electricity), large industrial construction
projects, and governance
(e.g. anti-corruption, legal institutions development). The IBRD and
IDA provide loans at preferential rates to member countries, as well
as grants to the poorest countries. Loans or grants for specific
projects are often linked to wider policy changes in the sector or
the country's economy as a whole. For example, a loan to improve
coastal environmental management may be linked to development of new
environmental institutions at national and local levels and the
implementation of new regulations to limit pollution, or not, such as
in the World Bank financed constructions of paper mills along the Rio
Uruguay in 2006.[5]
The
World Bank has received various criticisms over the years and was
tarnished by a scandal with the bank's then President Paul
Wolfowitz and his aid, Shaha Riza in 2007.[6
The World Bank has long been
criticized by a range of non-governmental organizations and
academics, notably including its former Chief Economist Joseph
Stiglitz, who is equally critical of the International
Monetary Fund, the US
Treasury Department, and US and other developed country trade
negotiators.[20]
Critics argue that the so-called free
market reform policies – which the Bank advocates in many cases
– in practice are often harmful to economic
development if implemented badly, too quickly ("shock
therapy"), in the wrong sequence, or in very weak,
uncompetitive economies.[20]
World Bank loan agreements can also force procurements of goods and
services at uncompetitive, non free-market, prices.[21]:5
In
Masters of Illusion: The World Bank and the Poverty of Nations
(1996), Catherine Caufield argues that the assumptions and structure
of the World Bank operation ultimately harm developing nations rather
than promoting them. In terms of assumption, Caufield first
criticizes the highly homogenized and Western recipes of
"development" held by the Bank. To the World Bank,
different nations and regions are indistinguishable, and ready to
receive the "uniform remedy of development". The danger of
this assumption is that to attain even small portions of success,
Western approaches to life are adopted and traditional economic
structures and values are abandoned. A second assumption is that poor
countries cannot modernize without money and advice from abroad.
A
number of intellectuals in developing countries have argued that the
World Bank is deeply implicated in contemporary modes of donor and
NGO driven imperialism and that its intellectual contribution
functions, primarily, to seek to blame the poor for their
condition.[22]
Defenders
of the World Bank contend that no country is forced to borrow its
money. The Bank provides both loans and grants. Even the loans are
concessional since they are given to countries that have no access to
international capital
markets. Furthermore, the loans, both to poor and middle-income
countries, are at below market-value interest
rates. The World Bank argues that it can help development more
through loans than grants, because money repaid on the loans can then
be lent for other projects.
Criticism
was also expressed towards the IFC and MIGA and their way of
evaluating the social and environmental impact of their projects.
Critics state that even though IFC and MIGA have more of these
standards than the World Bank they mostly rely on private-sector
clients to monitor their implementation and miss an independent
monitoring institution in this context. This is why an extensive
review of the institutions' implementation strategy of social and
environmental standards is demanded.[23]
Traditionally,
the Bank President has always been a U.S. citizen nominated by the
President of the United States, the largest shareholder in the bank.
The nominee is subject to confirmation by the Board of Governors, to
serve for a five-year, renewable term
The
International Monetary Fund (IMF) (French : Fonds monétaire
international) is an international
organization that was initiated in 1944 at the Bretton
Woods Conference and formally created in 1945 by 29 member
countries. The IMF's stated goal was to assist in the reconstruction
of the world's international
payment system post–World
War II. Countries contribute money to a pool through a quota
system from which countries with payment imbalances can borrow funds
temporarily. Through this activity and others such as surveillance of
its members' economies and the demand for self-correcting policies,
the IMF works to improve the economies of its member countries.[1]
The IMF describes itself as
“an organization of 188 countries, working to foster global
monetary cooperation, secure financial stability, facilitate
international trade, promote high employment and sustainable economic
growth, and reduce poverty around the world.”[2]
The organization's stated objectives are to promote international
economic cooperation, international
trade, employment, and exchange rate stability, including by
making financial resources available to member countries to meet
balance of
payments needs.[3]
Its headquarters are in Washington, D.C., United States.
IMF conditionality is a set of
policies or conditions that the IMF requires in exchange for
financial resources.[6]
The IMF does not require collateral
from countries for loans but rather requires the government seeking
assistance to correct its macroeconomic imbalances in the form of
policy reform. If the conditions are not met, the funds are
withheld.[6]
Conditionality is perhaps the most controversial aspect of IMF
policies.[15]
The concept of conditionality was introduced in an Executive Board
decision in 1952 and later incorporated in the Articles of Agreement.
Conditionality is associated
with economic theory as well as an enforcement mechanism for
repayment. Stemming primarily from the work of Jacques Polak in the
Fund's research department, the theoretical underpinning of
conditionality was the “monetary approach to the balance of
payments."[8]
Some
of the conditions for structural adjustment can include:
In some quarters, the IMF has
been criticized for being 'out of touch' with local economic
conditions, cultures, and environments in the countries they are
requiring policy reform.[6]
The Fund knows very little about what public spending on programs
like public health and education actually means, especially in
African countries; they have no feel for the impact that their
proposed national budget will have on people. The economic advice the
IMF gives might not always take into consideration the difference
between what spending means on paper and how it is felt by
citizens.[18]
For example, some people
believe that Jeffrey Sach's work shows that "the Fund's usual
prescription is 'budgetary belt tightening to countries who are much
too poor to own belts'.[18]
" It has been said that the IMF's role as a generalist
institution specializing in macroeconomic issues needs reform.
Conditionality has also been criticized because a country can pledge
collateral of "acceptable assets" in order to obtain
waivers on certain conditions.[17]
However, that assumes that all countries have the capability and
choice to provide acceptable collateral.
One view is that
conditionality undermines domestic political institutions.[19]
The recipient governments are sacrificing policy autonomy in exchange
for funds, which can lead to public resentment of the local
leadership for accepting and enforcing the IMF conditions. Political
instability can result from more leadership turnover as political
leaders are replaced in electoral backlashes.[6]
IMF conditions are often criticized for their bias against economic
growth and reduce government services, thus increasing
unemployment.[8]
Another criticism is that IMF
programs are only designed to address poor governance, excessive
government spending, excessive government intervention in markets,
and too much state ownership.[18]
This assumes that this narrow range of issues represents the only
possible problems; everything is standardized and differing contexts
are ignored.[18]
A country may also be compelled to accept conditions it would not
normally accept had they not been in a financial crisis in need of
assistance.[15]
It is claimed that
conditionalities
retard social stability and hence inhibit the stated goals of the
IMF, while Structural Adjustment Programs lead to an increase in
poverty in recipient countries.[20]
The IMF sometimes advocates “austerity
programmes,” cutting public spending and increasing taxes even
when the economy is weak, in order to bring budgets closer to a
balance, thus reducing budget
deficits. Countries are often advised to lower their corporate
tax rate. In Globalization
and Its Discontents, Joseph
E. Stiglitz, former chief economist and senior vice president at
the World Bank,
criticizes these policies.[21]
He argues that by converting to a more monetarist
approach, the purpose of the fund is no longer valid, as it was
designed to provide funds for countries to carry out Keynesian
reflations, and that the IMF “was not participating in a
conspiracy, but it was reflecting the interests and ideology of the
Western financial community.”[22]
Joseph
E. Stiglitz, former chief economist and senior vice president at
the World Bank,
criticizes these policies.[21]
He argues that by converting to a more monetarist
approach, the purpose of the fund is no longer valid, as it was
designed to provide funds for countries to carry out Keynesian
reflations, and that the IMF “was not participating in a
conspiracy, but it was reflecting the interests and ideology of the
Western financial community.”[22]
The
Reserve Bank of New Zealand is the central
bank of New Zealand. It was established in 1934 and is
constituted under the Reserve Bank of New Zealand Act 1989.[1]
The Governor of the Reserve Bank is responsible for New Zealand's
currency and operating monetary policy. The Bank's current Governor
is Mr. Graeme Wheeler. Employees of the bank operate under the
framework of a managerial hierarchy.
The
Reserve Bank's primary function, as defined by the Reserve Bank of
New Zealand Act 1989 is to provide "stability in the general
level of prices."[2]
The
Reserve Bank is responsible for independent management of monetary
policy to maintain price stability. The degree of price stability is
determined through a Policy Target Agreement with the Minister of
Finance.[3]
Policy Target Agreements are public documents and hence a government
cannot secretly change the targets to gain a short term surge in
economic growth.
The
mechanism of this is the Official
Cash Rate (a percentage) which affects short term interest rates.
The Bank will provide cash overnight at 0.25% above the cash rate to
Banks against good security with no limit. Furthermore the bank will
accept deposits from financial institutions with interest at 0.25%
less than the official cash rate.[4]
Banks
that offer loans at interest higher than the official cash rate will
be undercut by Banks that offer cheaper loans, and banks that loan
out lower than the official cash rate will make less compared to
other banks which can simply deposit their money in the Reserve Bank
with a higher rate of return. The Reserve Bank borrows and offers
loans with no limit on volumes in order to ensure that the interest
rate in the market remains at the Official Cash rate level.
Through
controlling this, the Reserve Bank can then influence short term
demand in the New Zealand Economy and use this to control prices.[5]
Adjustments
to the official cash rate are made eight times a year. It can make
unscheduled adjustments but does not usually do so.
Fractional-reserve banking
Like
all modern monetary systems, the monetary system in New Zealand is
based on fiat
and fractional-reserve
banking. In a fractional-reserve banking system, the largest
portion of money created is not created by the Reserve Bank itself,
80% or more is created by private sector commercial banks.[6]
Functions
and powers of Reserve Bank
Bank
to act as central bank
8
Primary function of Bank
Bank's
primary function not affected
-
Except
as provided in sections
9 to 12, nothing in this Act or in any other Act whether passed
before or after the commencement of this Act limits or affects the
obligation of the Bank to carry out its primary functi
Formulation
and implementation of monetary policy
New
Zealand’s Overseas Debt, The Banks, And The Crisis
-
by Geoff Bertram
On
1 November 2008 the New Zealand government radically changed course
on its long-standing fiscal strategy and its avoidance of overseas
borrowing, setting aside in the process any constitutional checks and
balances on giving public subsidies to foreign capital, all in the
middle of the weekend before the General Election, and with minimal
public disclosure and no effective public debate. The beneficiaries
of the sudden taxpayer largesse were the major banks, and the form of
assistance was a Government guarantee on the wholesale funding of
those banks’ balance sheets. The decision was bipartisan, in the
sense that John Key (then Leader of the Opposition) was even more
keen to help than Michael Cullen, then Minister of Finance.
Parliament has yet to have a serious debate on the guarantee issue,
and probably won’t until (unless?) the costs start to escalate,
since both major parties were implicated in the decision.
The
big banks operating in New Zealand are owned by Australian parents.
New Zealand ownership of banks these days is limited to small fry
like Kiwibank, Taranaki Savings Bank (TSB), and the Southland
Building Society. So the story of the Government wholesale funding
guarantee is a story of New Zealand taxpayers being asked to pick up
the funding risks of foreign-controlled private businesses. The
justifications offered by the bank spokespersons and on the New
Zealand Treasury Website are uninformative and generally
unconvincing. (1)
Needless
to say it was the banks themselves which, under cover of rushed
commitments by governments in the USA and Australia in late September
and early October 2008, raced in to ask the New Zealand government to
guarantee their offshore borrowing. Most local media coverage at the
time (2) effectively assumed that because the financial crisis in the
USA had a global dimension, New Zealand should just copy what the
then Bush Administration was doing without looking at the detail.
Many local commentators also took for granted that since the
Government had already moved (on 12 October (3)) to guarantee local
currency retail deposits of up to $1 million in the banks and
approved finance companies (4), extending the guarantee arrangement
to wholesale funding in foreign currencies was simply a change in
degree, not in kind. Wrong.
The
effect of the wholesale guarantee is that when the banks go off to
New York or London to sell taxpayer guaranteed commercial paper to
overseas investors, they are no longer selling private IOUs. They are
selling New Zealand government debt in disguise. The security the
investors get for the money they lend is not the creditworthiness of
the banks that nominally issue the paper. It’s the ability of the
New Zealand government to raise revenue from the taxpaying public to
pay off the debts, if the banks go under. There’s no doubt that the
overseas investors are happier to lend to a highly rated sovereign
borrower than to Australian private banks, and it may well be true
that the procedure lowers the cost of the banks’ funding (though
how much of that cost saving comes through to New Zealand borrowers
rather than going to the shareholders as extra profit is pretty
difficult to work out). But the risk the Government is running on
behalf of the New Zealand public is that once the banks have rolled
over their existing loans and replaced them with new guaranteed ones
(a process which should be completed in the next year), a worsening
of the international financial situation that takes down any one of
the major banks will leave taxpayers directly liable for its offshore
borrowings, which means billions of dollars in foreign currency.
The
worst case consequences of a global financial crash with the
wholesale guarantee in place would blow away the Cullen
superannuation fund several times over. So do we trust our officials
and politicians to get it right? Do the banks in New Zealand really
need a wholesale guarantee at all? Why should the banks not pay the
going market rate for commercial credit, if they continue to go
overseas to fund their New Zealand dollar lending activities? Do they
really have to go overseas at all to fund their balance sheets? These
are the sort of questions addressed in this article.
The
official story is still that we can all relax because everything is
fine. The banks are to pay allegedly handsome fees for accessing the
guarantee (less handsome since Treasury halved the fees in January
2009 (5)) and the Treasury view is that the contingent liability for
taxpayers is so “remote” that it “do[es] not meet the
definition of contingent liability” (6). It was therefore entered
as a zero in the Crown financial statements for March 2009 - which,
coincidentally, was the month in which the first guaranteed finance
company went under, triggering a retail deposit guarantee (7).
Treasury now concedes there may be more to follow. Since the
contingent liability will come home to roost in the Government’s
overseas debt, the place to start the analysis is New Zealand’s
international indebtedness.
A
Brief History Of The Overseas Debt
New
Zealand ’s overseas indebtedness has waxed and waned over the past
century, but it is currently at a historically fairly high level,
around 90% of Gross Domestic Product (GDP). Chart 1 shows the long
run trends. From the late 1800s to the mid 1930s the Government’s
offshore debt was between 60% and 90% of GDP and private offshore
ownership of the economy was another 50% of GDP approximately. Then
official debt was almost all paid off following Walter Nash’s
famous London trip of 1938 to confront the Bank of England, and after
the First World War the private overseas ownership of New Zealand
assets dropped to around 20% of GDP, a ratio which held fairly steady
until the 1960s before rising gradually over the following decade.
The sharp rise in the country’s international indebtedness
1974-1988 was led by renewed Government borrowing, with private
sector external net debt (including foreign equity ownership) falling
as a ratio of GDP until Labour took power in 1984 and then picking up
as Roger Douglas’ policies took hold.
Chart
1
After
peaking in 1986-87, Government debt began to drop out of the picture
as the country’s overseas indebtedness was privatised, along with
(and to a considerable extent because of) the sale of State-owned
assets. The decade of rising net debt from 1986 to 1996 in Chart 1
was driven mainly by foreign direct investment as overseas investors
picked up the bargains tossed onto the table by privatisation with
deregulation. By 1996-97 the New Zealand government no longer owed
any net debt in overseas currency, although its local currency bonds
continued to be bought and held by overseas investors, and some
public sector agencies, including the Reserve Bank, hold foreign
currency assets, making the net position of the public sector
somewhat murky. (8) New Zealand’s indebtedness is thus no longer
(at least for the moment) a matter of Government finances. Yet this
country is still one of the most highly indebted in the Organisation
for Economic Cooperation and Development (OECD). Chart 2, from a
December 2008 Reserve Bank study (9), shows New Zealand ranked just
above Iceland.
Chart
2
Before
concluding that New Zealand is another Iceland crisis in the making
(10), it has to be noted that the net debt position is only half the
story, because it is the difference between two much bigger numbers –
gross assets and gross liabilities. Chart 3, also from the December
2008 Reserve Bank study, plots both dimensions (net debt and gross
leverage) for the developed countries. It shows that New Zealand,
Australia and Greece are heavily indebted in the net sense, but are
not heavily leveraged – that is, the extent to which they have been
drawn into globalised finance, and hence exposure to its crises, is
limited, especially compared with Iceland where the sum of gross
assets and liabilities was between 800 and 1000% of GDP.
Chart
3
The
Banks And The Current Account Of The Balance Of Payments
What
has been driving the debt up in the past two decades is a sort of
pyramid scheme that New Zealand residents have been running with the
rest of the world, with the banks as promoters and middlemen. The
overseas debt grows each year by an amount equal to the current
account deficit on the country’s balance of payments. That deficit
is in turn almost exactly equal to the annual cost of servicing the
outstanding debt; see Chart 4. Basically New Zealanders have been
borrowing to pay the interest on past borrowings; or to put the same
thing another way, once debt servicing has been looked after,
households’ living standards have been based on debt-funded
consumption spending.
Chart
4
The
Current Account Deficit, Investment Income Account Debits (Gross And
Net) On The New Zealand Balance Of Payments, And Debits Attributable
to the Banks: March Years 1987-2008
Sources:
Statistics New Zealand, Tripe (2004) Table 2, David Tripe for updated
data.
In
the long run, such a process of borrowing to fund current consumption
has to come to an end, as the growing stock of debt reaches the limit
of what can sustainably be serviced. New Zealand homeowners may not
yet have quite hit that ceiling, but they have been getting closer to
it over the past decade as they borrowed against the rising market
value of their houses. The downturn in house values as the bubble
bursts is now eroding the security that underwrote the borrowing
spree, and consumers have started cutting back their spending and
raising their savings rate in order to strengthen their individual
balance sheets. To the extent that this means fewer imports, the cut
in consumption contributes to a much needed rebalancing of the New
Zealand macro-economy, which may eventually yield a trade surplus
sufficient to service the country’s debt without running up yet
more debt. But falling consumption also translates to lower
production and more unemployment in New Zealand.
The
macro-economic options for New Zealand now boil down to three : if
the private sector does not continue to increase its overseas
indebtedness, then either Government must return to borrowing
offshore on a large scale, or the balance of payments current account
deficit will have to be eliminated. The rest of this paper focuses on
the private borrowing channel, where the Australian-owned banks have
served as willing intermediaries and profited handsomely in the
process. That party is now almost certainly over, but the hangover is
just starting.
The
past decade’s growth of New Zealand’s overseas debt has been
driven by the banks. In 1988 the banks’ net offshore debt (that is,
their non-resident funding minus their claims on foreigners) was 12%
of New Zealand’s GDP and 19% of total net debt (Chart 1). By early
2008 this had risen to 54% of GDP and 62% of the total net debt. In
June 2008 as the global financial meltdown got fully underway, the
banks accounted for 72% of the country’s total net indebtedness, on
the Statistics New Zealand data for the international investment
position , or (more correctly) 84% if we take account of the
Australian banks’ equity stakes in their New Zealand subsidiaries
(Table 1).
Table
1 : New Zealand International Investment Position At June 2008,
NZ$million
| New Zealand’s
International Assets
|
| Equity assets
|
52,098
|
| Lending
|
77,683
|
|
|
Banks
|
21,723
|
|
|
General government
|
8,976
|
|
|
Monetary authorities
|
20,210
|
|
|
Other sectors
|
26,774
|
| Total International
Assets |
129,780 |
| New Zealand’s
International Liabilities
|
| Equity liabilities
|
63,115
|
| of which banks |
17,300 |
| Borrowing
|
225,858
|
|
|
Banks
|
138,881 |
|
|
General government
|
17,574
|
|
|
Monetary authorities
|
273
|
|
|
Other sectors
|
69,131
|
| Total International
Liabilities
|
288,974
|
| New Zealand’s Net
International Asset Position
|
| Net position of the
banks: lending only
|
-117,158
|
| Net position of the
banks including parents’ equity in NZ subsidiaries
|
-134,458
|
| Net international equity
|
-11,018
|
| Net international debt
|
-148,176
|
| Net international asset
position
|
-159,194
|
Source
: Statistics New Zealand, Hot
off the Press;
bank disclosure statements at www.rbnz.govt.nz
Who’s
Who In The Banking Sector
There
are basically three classes of financial institutions in New Zealand
: the locally incorporated banks which sit on the commanding heights,
the finance companies that scavenge around their feet, and the local
branches of overseas incorporated banks. The 1980s and 1990s saw the
rise of the five major banking groups to dominant status at the
expense of finance companies, building societies and other informal
arrangements. By the mid 1990s the major banks held over half of
households’ financial wealth, provided 70% of household credit and
80% of business credit, and accounted for over 85% of the assets of
all deposit-taking institutions. (11)
The
continued dominance of the major banks is clear in Table 2 which sets
out figures for the 19 registered banks operating in New Zealand in
2008. Seven of these are locally incorporated (which is a requirement
in order to operate a retail banking business); the other twelve are
branches of overseas banks engaged in wholesale lending and
investment finance for large corporates. ANZ-National, ASB, Bank of
New Zealand, and Westpac are locally registered and their operations
dominate the sector. Kiwibank, Rabobank, TSB and Southland Building
Society are minor players in the retail sector with less than 2% of
bank assets each.
Table
2 : Registered Bank Data
|
|
Assets NZ $billion
|
Net after-tax profit, 12
months to September 2008
|
% of total assets
|
| New Zealand Incorporated
|
|
.
|
|
| ANZ National Bank
Limited
|
122.9
|
1,163
|
34.3
|
| ASB Bank Limited
|
62.9
|
485
|
17.6
|
| Bank of New Zealand
|
64.2
|
785
|
17.9
|
| Kiwibank Limited
|
8.2
|
35
|
2.3
|
| Rabobank New Zealand
Limited
|
5.5
|
34
|
1.5
|
| Southland Building
Society
|
*
|
|
|
| TSB Bank Limited
|
3.4
|
42
|
0.9
|
| Westpac New Zealand
Limited
|
52.3
|
559
|
14.6
|
| Total
|
319.4
|
3,103
|
89.2
|
|
|
|
|
|
| Overseas Incorporated
|
|
|
|
| Total assets after
netting out locally incorporated
|
38.6
|
|
10.8
|
|
|
|
|
|
| Total, all registered
banks
|
358.0
|
3,874
|
100
|
|
|
|
|
|
| * Newly registered 2008.
|
|
|
|
All
five major banks operating in New Zealand are owned overseas,
primarily in Australia. From the point of view of the Australian
regulator - the Australian Prudential Regulation Authority (APRA) -
they are “affiliates” of the parent banks for regulatory
purposes, and the parents are restricted in the amount they are
allowed to advance to their New Zealand subsidiaries by Australian
Prudential Standard (APS) 222 section 32 (12). What this means in
practice is that if the banks want to expand their lending to New
Zealand households and firms beyond the amounts that other New
Zealand households and firms are willing to deposit with the banks,
then they can get funding from their Australian parents only up to
the limit set by APS 222. Further expansion of lending then has to be
funded from some other offshore source. That other source has been
the offshore market for 90 day and similar commercial paper.
The
Increasing Foreign Exchange Exposure
The
bank lending surge since 2000 coincided with a period when global
financial markets were overflowing with funds looking for willing
borrowers. More and more of the funding liabilities on the banks’
balance sheets therefore came to consist of overseas currency raised
on the commercial paper markets in New York and London. Chart 5 shows
the changing structure of the banks’ funding liabilities over the
past two decades. At the end of January 2009 the total funding
liabilities were $329 billion of which $131 billion, or 40%, was from
offshore. Of this, $60 billion was from “associates” (basically,
the parent banks in Australia) and $71 billion was from other
offshore sources. $90 billion of the offshore funding was in foreign
currency. The available statistics do not enable that foreign
currency funding to be decomposed between associates and other
offshore investors, but these figures do enable us to set the
boundaries with reference to Chart 5. If all associates’ funding is
in foreign currencies, then the banks’ direct exposure to the
foreign money market is $30 billion. If all $60 billion of
associates’ funding were in New Zealand dollars then the exposure
would be $90 billion, but Table 3 below indicates that there are only
$39 billion of non-resident $NZ liabilities, which means that
associates’ foreign currency funding is not less than $20 billion
and thus indicates a possible upper bound figure of $70 billion for
the exposure.
Chart
5
To
those who were worried about the resulting exposure of the New
Zealand banking system to a contraction in that market, the
comfortable answer was provided that all the foreign exchange
exposures were “fully hedged”, which seemed to suggest that if
one set of foreign currency loans matured and had to be repaid while
new foreign loans were not available, the banks would simply raise
$NZ funding, convert it to foreign currency under the hedging
arrangements, and pay off the loans. In other words, so long as a
supplier of $NZ funds was in existence, the banks should be able to
switch from foreign currency to local currency funding for their
local currency loans.
In
May 2008, the Reserve Bank of New Zealand set up a special facility
to enable precisely this process to occur. The Bank stood willing to
accept high grade mortgage securities as collateral against an
extension of $NZ credit to the trading banks. The banks have possibly
as much as $120 million worth of such mortgages on their books as
assets, which would be more than enough to pay down their outstanding
90 day foreign currency borrowings from the overseas markets.
Insolvency is nowhere in sight : no toxic assets, adequate capital
and reserves, virtually nothing on the balance sheet to show why,
with liquidity support from the Reserve Bank, there is any possible
problem the banks cannot deal with on their own. I say “virtually
nothing” because the consolidated balance sheet of the New Zealand
banking sector in Table 3 below does have a conspicuous currency
mismatch : about $80 billion more foreign currency liabilities than
foreign currency assets.
A
Primer On Fractional-Reserve Banking In An Open Economy
As
financial intermediaries, banks are generically in the business of
borrowing from one group at the lowest available interest rate, to
lend to another at a higher interest rate. Usually the borrowing
consists of taking deposits from a wide range of customers, and
lending out the deposited funds at the higher rate. Deposit
liabilities are generally shorter term than the loan assets, which
means that a typical bank always faces some risk that depositors may
want to take their money out faster than the bank can recover funds
from maturing loans. Banks therefore hold some reserves to cover
against funding shortfalls; under normal circumstances these are
typically well below 10% of total liabilities. The simple textbook
bank balance sheet thus contains four items which balance up :
| Liabilities
|
Assets
|
| Deposits
|
Loans
|
| Capital
|
Liquid reserve assets
|
| Total liabilities =
|
Total assets
|
When
a bank makes a loan, this appears as an asset in the bank’s balance
sheet, and the stream of interest payments on the loan is recorded by
the bank as income from that asset. The funding for the loan is
recorded as a liability in the balance sheet. This is all simple and
straightforward when the bank is a locally owned entity in a closed
economy. Then all assets and liabilities are in the same currency,
the capital and reserves backing up the operation are locally owned,
and the regulatory authority and central bank (the issuer of local
currency or “high powered money”) are local.
In
even this simple theoretical world, crisis for a bank can arise from
two directions. On the liabilities side, a bank can face a run on
deposits which it has to meet from its liquid reserves. If the
reserves are inadequate and outstanding loans cannot be called in
fast enough, then the bank faces a liquidity shortfall and will
“fail” to pay its depositors. It may then have to be wound up, or
placed in receivership until the value of its assets can be realised
by sale or through the maturing of loans.
On
the assets side, problems arise if loans turn bad – which can
happen if, for example, the borrowers who use the funds to purchase
real assets such as land, houses or productive equipment are
subsequently unable to pay the interest, and at the same time the
resale value of the real assets drops so that the loan amounts cannot
be recovered by foreclosure. In this case the bank’s deposit
liabilities remain the same but the falling value of assets has to be
matched on the balance sheet by a fall in capital, which represents
the shareholders’ equity in the bank. Beyond the point where
capital is driven down to zero, the bank is insolvent in the sense
that it has no long run means of paying out its depositors, unless it
can attract new capital with which to acquire more and better assets.
This
distinction between illiquidity and insolvency is an important one in
comparing the US banking problem with the situation in New Zealand.
US banks and other financial institutions, having engaged in
sub-prime lending against the security of houses whose value has
collapsed leading the borrowers to default on payments, are faced
with insolvency unless some outside party (such as the US taxpayer)
buys up enough of the toxic assets to restore the balance sheet at
least to zero balance (in which case the shareholders’ shares are
worthless but deposit liabilities are covered). The New Zealand
banks, however, have not engaged in lending beyond prudent limits, if
by “prudent” we mean within the capacity of borrowers to meet the
servicing costs under normal conditions. Until and unless house
prices here drop 20-30%, most mortgage borrowers will still have
positive equity; and so long as they have jobs and incomes, most of
them will remain able to pay the costs of their debt. And besides,
New Zealand home owners do not enjoy the ability of US residents to
simply walk away from a mortgaged property and leave the lender to
pick up the tab, and this is another factor contributing to the
strength of the asset side of the banks’ balance sheets here
compared with the USA.
Now
extend the analysis to an open economy where the bank takes deposits
in foreign currency, converts the proceeds to local currency, and
lends out the local currency. Obviously the bank will make a profit
if the local currency gains in value against the foreign currency,
and will lose if the exchange rate goes the other way. It makes
obvious sense to protect against this by taking out a hedge contract
which ensures that the balance sheet position can be unwound at a
predetermined exchange rate. The hedging arrangements will be “off
balance sheet”, but they should ensure that there are no major risk
exposures hidden from the reader of the balance sheet.
On
And Off The Balance Sheet
Table
3 has the consolidated balance sheet for the New Zealand banks as a
group. What is striking about these figures is the lack of any
apparent basis for a sense of crisis sufficient to justify taxpayer
resources being committed to wholesale deposit guarantees. On the
September 2008 data, the banks held just over $300 billion of New
Zealand dollar assets plus $60 billion of claims in foreign currency.
Against this $360 billion of assets, they had nearly $220 billion of
New Zealand dollar deposits and $22.5 billion of capital representing
the shareholders’ stake in the businesses.
Table
3
|
|
Liabilities, capital and
reserves
|
Aug-08
|
Sep-08
|
|
Assets
|
Aug-08
|
Sep-08
|
|
|
|
|
|
|
|
|
|
|
|
NZ dollar funding
|
|
|
|
NZ dollar claims
|
|
|
| 1
|
NZ resident
|
177.6
|
179.6
|
|
NZ resident (Non M3)
|
277.2
|
277.9
|
| 2
|
Non-resident
|
40.0
|
39.0
|
|
Non-resident
|
7.6
|
9.0
|
| 3
|
Total 1+2
|
217.6
|
218.6
|
|
Sub-total to here
|
284.9
|
286.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NZ resident (M3
institutions)
|
15.0
|
15.1
|
|
|
|
|
|
|
Total
|
299.9
|
302.0
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency funding
|
|
|
|
Foreign currency claims
|
|
|
| 4
|
NZ resident
|
10.2
|
9.9
|
|
NZ resident
|
4.0
|
4.2
|
| 5
|
Non-resident (?all
wholesale?)
|
80.1
|
80.7
|
|
Non-resident
|
11.6
|
6.6
|
| 6
|
Total 4+5
|
90.3
|
90.7
|
|
Total
|
15.6
|
10.8
|
|
|
|
|
|
|
|
|
|
| 7
|
Capital and reserves
|
22.6
|
22.5
|
|
Foreign currency fixed
assets and equity investment
|
0.1
|
0.1
|
| 8
|
Other Liabilities
|
19.6
|
27.9
|
|
Shares in NZ companies
|
0.4
|
0.4
|
|
|
|
|
|
|
Other Assets
|
25.4
|
35.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NZ Government bonds and
Treasury bills
|
1.5
|
1.4
|
|
|
|
|
|
|
NZ notes and coin
|
0.5
|
0.5
|
|
|
|
|
|
|
Claims on the Reserve
Bank
|
6.7
|
9.3
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
350.1
|
359.6
|
|
Total assets
|
350.1
|
359.6
|
|
|
|
|
|
|
|
|
|
|
|
Memo items:
|
|
|
|
Memo items:
|
|
|
| 9
|
funding from associates
|
50.7
|
50.4
|
|
financial claims on
associates
|
7.1
|
6.6
|
| #
|
total non-resident
funding
|
120.1
|
119.7
|
|
total non-resident
claims
|
19.2
|
15.6
|
None
of these items present any problem at present; there is no burden of
toxic assets and the local deposit funding is secure (and made more
so by the retail deposit guarantee on deposits up to $1 million
announced by the Government on 12 October 2008). So far, so good. Of
the remaining $120 billion of “foreign currency funding”, $10
billion is owed to New Zealand residents and probably at least $10
billion of the “other liabilities” can safely be ignored. That
leaves $100 billion of offshore liabilities, within which is (see
above) $30 billion-$70 billion of (mostly short term) debt
outstanding in New York, London, and possibly other international
financial markets.
If,
as has always been claimed, these liabilities are “fully hedged”,
the uninitiated might well suppose that somewhere out there are
counterparties with a contractual obligation to provide the banks
with all the foreign currency required to pay off the loans as they
mature, at a pre-set exchange rate. If the banks can’t roll over
their loans as they expire, surely (the uninitiated (13) might think)
they can pay them off simply by raising funds in New Zealand and
using these to exercise the hedge contracts? Even $70 billion is far
less than the amount available to the banks from the RBNZ under the
latter’s May 2008 mortgage-swap-window arrangement (14). So if, in
October 2008, the banks reported difficulty in rolling over their
90-day commercial paper, the obvious response from Government would
have been that they should turn to the RBNZ for liquidity and
exercise their hedge contracts to exit their foreign currency
exposures.
There
would obviously be some interesting collateral effects – the RBNZ
would have to issue a large tranche of new bonds to mop up the New
Zealand dollars created; and the exchange rate of the New Zealand
dollar would presumably take a hit (not necessary a catastrophic one,
since a significant tranche of the country’s overseas debt would be
being eliminated along with a corresponding part of the current
account deficit, so that forward looking investors might well think
the New Zealand economy’s future looked much improved). But – and
this is the central point – the problem would be resolved through
the normal process of exercising commercial contracts freely entered
into by the parties, with no involvement of the fiscal authorities.
The banks’ collective balance sheet would move from having a huge
mismatch between foreign currency liabilities and foreign currency
assets (with all the attendant risks this involves) to a roughly
balanced currency composition of assets and liabilities (15).
What
About The Reserve Bank?
New
Zealand Herald
Economics Editor Brian Fallow pointed to precisely this mechanism in
an article before the wholesale funding guarantee was introduced
(16):
“Extending
a Government guarantee to banks' wholesale sources of funding makes
sense only if it is the lesser evil of something very evil indeed.
Its defenders insist the alternative is that a key source of funding
dries up, which would require a savage contraction in the
availability of credit to New Zealand households and businesses, and
take the recession to a whole new level of pain.
“The
overseas commercial paper markets, from which the banks derive on
average … about a fifth of their funding, are frozen, posing an
obvious problem for the banks when they need to roll over that
borrowing…. No one really knows how long this market will remain
dysfunctional. Ah yes, say the banks, but even when the market starts
functioning again, New Zealand banks won't be able to compete for
funding with issuers that have Government guarantees. Not even with
their clean balance sheets and high credit ratings.
“Even
if that turns out to be true, they have an alternative source of
funding to tide them over. It's called the Reserve Bank, which has
announced facilities to lend them money, on security, as the lender
of last resort. There was no mention of this in John Key's ‘we've
got to do this and we've got to do it fast’ press conference on
Sunday. There is a world of difference between guaranteeing the
retail deposits of New Zealanders and guaranteeing wholesale funding
extended by the very Northern Hemisphere banks whose disregard of
risk has brought the world to this pass”.
Gaping
Hole In Regulatory Net
What
was it, then, that made it impossible for the banks simply to use
Reserve Bank advances to pay down their offshore debts? After all the
hoopla about floating exchange rates and financial market
globalisation, why did the much hyped hedging arrangements not
provide a hedge? Here we encounter a gaping hole in the New Zealand
regulatory net, such as it is. The banks’ hedges, it turns out, are
not hedges at all in the normal sense of the word. The New Zealand
banks did not protect their ability to repay their foreign currency
borrowings by taking out simple insurance contracts. They plunged
into the arcane world of swaps and derivatives, far from any
regulator’s scrutiny and with only a bare flicker appearing on the
information disclosure screen. As Bedford describes it (emphasis
added). (17)
“Heavy
reliance on short-term international debt … entails substantial
rollover risk. Although a remote possibility in normal circumstances,
the recent financial market turmoil demonstrates that, in the event
of an especially severe global financial shock, even a fundamentally
creditworthy country may not be able to refinance maturing
international debt at any
price.
The resulting net capital outflow would place downward pressure on
the exchange rate and likely trigger significant economic disruption.
It is critically important, therefore, to conduct rigorous analysis
of the potential for rollover risks of this kind to crystallise and
also develop contingency arrangements to cater for the effective
closure of key international credit markets.
“[There
are] a variety of channels through which instability in the
international financial system can affect the external balance sheet
and the net international investment position (IIP) – falling asset
valuations, higher cost and/or reduced availability of international
credit, and the impact of movements in the exchange rate. An
effective hedging strategy can, in principle, offset the effect of
the third of these channels…
“[
New Zealand’s] total stock of foreign currency debt outstanding
amounted to nearly 60% of GDP in the second quarter of 2008, with the
banking sector accounting for a sizable fraction…. Most
of the associated exchange rate risk is hedged using financial
derivatives. The annual hedging survey conducted by Statistics New
Zealand indicates that, in March 2008, more than 80% of gross foreign
currency debt was hedged using derivatives,
with a further 11% hedged ‘naturally’ against assets or other
receipts.
“The
four largest New Zealand banks obtain offshore (debt) funding in two
ways. First, they receive funds directly from their Australian
parents, typically in the form of a ‘loan’ between the parent
institution and its New Zealand subsidiary. Second, the banks issue
substantial quantities of debt securities in international credit
markets. Although these securities could, in principle, be
denominated in New Zealand dollars ($NZ), in practice the banks have
been able to achieve a lower overall cost of funding by issuing in US
dollars or euros and subsequently swapping the proceeds into $NZ. The
counterparty to the swap transaction is typically a highly-rated
supranational institution that has been able to use its strong credit
standing to issue $NZ-denominated bonds in, for example, the Japanese
retail market (Drage et
al.,
2005). The swap also ensures that the exchange rate risk associated
with the banks’ foreign currency borrowing is hedged ”.
To
translate : the banks got themselves into a critical situation in the
commercial paper markets in October 2008 because they had been
cutting their cost of offshore funding by doing complex off-balance
sheet swap deals that made them bigger profits than just borrowing
New Zealand dollars up-front. This process, alas, involved taking on
major exposures in foreign currency against which the banks failed to
arrange protection for themselves. Hence their plea for the New
Zealand taxpayer to ride to their rescue.
The
point here is that it was cheaper to raise funds by the roundabout
route precisely because the banks were taking on a large slab of
extra risk, accepting a mismatch of maturity dates between the
foreign currency loans they raised and the counterpart transactions
by which they swapped those loans into New Zealand dollars. The risk
of the global financial market freezing up was a contingency against
which the banks took out no protection (presumably they considered
the contingency “too remote” to worry about, the same position
now adopted by the New Zealand Treasury with regard to taxpayers’
exposures). When the markets actually did freeze up the banks’ next
move was clear and simple : the uncovered risk the banks had been
taking a profit on was in fact a gun pointing at the head of the New
Zealand economy and Government. The payoff from that leverage is the
wholesale funding guarantee, which has shifted the banks’ funding
risk onto New Zealand taxpayers.
The
Detail
Foreign
exchange swaps are a way for two institutions to benefit mutually
from their different borrowing power in different markets (18). The
“highly rated supranational institution” in Bedford’s passage
above might be, for example, the World Bank. Because it is bigger and
has a more heavyweight profile in international markets, the World
Bank can raise NZ dollar loans (“Eurokiwis”) in offshore markets
such as Japan at a lower interest rate than a New Zealand-based bank
can do. At the same time the New Zealand bank can borrow US dollars
in the New York or London market at much the same interest rate as
the World Bank. The World Bank needs US dollars and the New Zealand
bank needs New Zealand dollars; the cheapest way for both of them to
get what they need is for the World Bank to borrow the NZ dollars and
the New Zealand bank to borrow the US dollars, following which they
swap the loan proceeds by lending to each other at interest rates
that share the overall gain due to the World Bank’s ability to pay
a lower interest rate on Eurokiwis. The World Bank ends up with US
dollars at a rate below what it would have to pay if it went direct
to the market for those dollars; and the New Zealand bank gets New
Zealand dollars at an interest rate below what it would have to pay
to borrow the money directly.
To
this point there is no problem. The New Zealand bank’s balance
sheet shows its funding as a US dollar liability and the separate
deals by which those US dollars were converted into New Zealand
currency, to be lent out domestically, are off-balance sheet and out
of sight. The shareholders (in Australia) are better off because
funding costs are lower and so profits on the bank’s lending
business are higher than they would otherwise be. The World Bank is
happy because its borrowing costs are also lower.
The
problem is the maturity dates of the various deals. The New Zealand
bank will borrow the US dollars for a 90 day term by issuing
commercial paper, and so will have to roll over the loan every three
months, while the World Bank wants long term funding for its
operations - say three years. Then the New Zealand bank has to be
successful in rolling over its US dollar debt (4x3)-1 = 11 times
before the swap deal matures and the World Bank repays the US
dollars. If the New Zealand bank faces a frozen market during the
three year term of its loan to the World Bank, it is stuck with a
foreign currency exposure that it cannot meet on time.
This
maturity mismatch is inherent in the procedure chosen by the New
Zealand banks to fund the liabilities side of their balance sheets.
The foreign currency to repay their borrowings will come to hand in
due course – but not in time to cover an emergency such as
September-October 2008. The NZ bank could deposit a slab of its
mortgage assets with the Reserve Bank in exchange for NZ dollar
funds, exchange these to US dollars on the open foreign exchange
market, and pay off the maturing 90 day debts, but in the process it
would drive the New Zealand dollar exchange rate down against itself,
and force the RBNZ to expand its balance sheet. The alternative is
for the New Zealand government to guarantee new offshore fundraising
in US dollars, roll over the maturing loans, and hope to hold the
line through to the maturity date of the other side of the swap deal,
at which point the originally borrowed US dollars return to the bank
and the overall position can be liquidated.
The
bank can credibly threaten to restrict its domestic lending and
trigger an economic contraction if it is forced to go the more costly
route via the RBNZ discount window. In contrast, a Government
guarantee can be made subject to various conditions regarding the
bank’s lending behaviour while the guarantee is in place, and can
carry an impressive looking price tag (since even a tiny percentage
of huge gross amounts will look large). These essentially seem to
have been the calculations behind the wholesale funding guarantee
scheme announced on 1 November 2008, in the middle of the weekend
before the General Election.
To
evaluate the contingent liability for taxpayers, one has to envisage
two possible states of the world economy. In one scenario, the
October 2008 meltdown was a one-off event never to be repeated; the
wholesale guarantee was therefore merely a confidence booster while
the banks got their funding back on track, and the outcome would be
that the banks would make it through to the maturity dates of their
swap contracts while the Government collected its fees. By taking
that view, the Government would be gambling on the global crisis
being short lived.
In
the alternative scenario, financial crisis is persistent and
recurrent, and the effect of a wholesale funding guarantee is that
New Zealand taxpayers carry substantial risks on behalf of the banks’
Australian owners. The whole house of cards could come down before
the swap contracts mature, leaving the New Zealand government forced
to go offshore to borrow foreign currency to meet its guarantee
obligations. The privatisation of the overseas debt that was such a
striking feature of the 1985-1995 period would be rapidly reversed
and New Zealand would be back to heavy sovereign indebtedness. The
only comfort to be taken would be that the Reserve Bank might well
put statutory managers into the defaulting banks to seek to recover
the taxpayers’ losses – but partial or full nationalisation of
foreign-owned banks is a very different matter from the same action
applied to a domestically-owned institution.
Guarantee’s
“Remote” Risk Not Looking So Remote Now
Which
scenario was the New Zealand government gambling on when it committed
taxpayers to underwrite the banks’ funding? The answer is to be
found in the notes to the December 2008 Crown Financial Statements,
page 32, note 20:
“As
the likelihood that the guarantees will be called is considered
remote, they do not meet the definition of a contingent liability and
is [sic] therefore excluded from the statement of contingent
liabilities and assets on page 23”.
The
note went on to state that retail deposits in 64 institutions,
totalling $126 billion, had been guaranteed by 31 December 2008, but
that no wholesale securities had yet been guaranteed.
By
March 2009, Treasury’s note 20 to the Crown financial statements
had been subtly modified (19) :
“The
likelihood that the guarantees will be called is considered remote.
Therefore they do not meet the definition of a contingent liability
and are excluded from the statement of contingent liabilities and
assets on page 23. However if a guarantee is not considered remote a
provision will be made for any potential loss in these financial
statements”.
Before
the ink was dry on this statement, Mascot Finance Ltd went into
receivership owing debenture holders $70 million for which taxpayers
are now liable. (20) Treasury acknowledged “there may well be
others”. So much for the “remoteness” of the risk on the retail
deposit guarantee. What then of the wholesale funding guarantee on
foreign currency borrowings? By February 2009 three of the major
banks – BNZ, ANZ-National, and Westpac – had signed up for the
schems (21). By early March the BNZ had secured actual guarantees on
$US280 million of new borrowings. (22) The global financial situation
remained extremely weak, and the maturity profiles of the banks’
funding had shortened substantially as they rolled over debt on less
and less favourable terms. The likelihood of a wholesale guarantee
being called gets less remote by the month.
Privatise
The Gains, Socialise The Losses
A
tendency to socialise the banking system’s losses and risks, while
leaving their managements unscathed and shareholders protected as
much as possible, has been a common theme across the major Western
economies in the past six months. In the USA, hundreds of billions of
dollars of tax funds raised from the mass of the population have been
channelled into bailouts for the rich, the insiders, and the “too
big to fail”. In New Zealand’s case the process was more subtle,
involved a different part of the banks’ balance sheets, and
confronted taxpayers with a contingent liability rather than a direct
call on their cash. So both the problem and the policy response are
different in New Zealand (and Australia) from what has been happening
(and featuring in the media) in other developed economies.
An
increasingly common complaint about the bank bailouts in the USA is
that public money is handed over to private organisations to manage,
without enough safeguards and without sufficient constraints on the
subsequent behaviour of the “insider” bank managements regarding
what they do with the funds. In the New Zealand case the issue is not
that taxpayer cash has been handed over. It is that taxpayers have
given the banks an underwriting guarantee with few apparent
safeguards, and with no apparent conditions placed on how the banks
are to use the guarantee to restructure their balance sheets over the
period while the guarantee lasts. The opportunity seems to exist to
bring the country’s overseas debt down sharply, and in the process
to move towards solving the current account deficit problem that has
plagued the economy for decades, by cutting net investment income
debits as debt servicing costs associated with the banks’ balance
sheet liabilities become payable domestically in New Zealand dollars,
rather than offshore in foreign currency. The currency mismatch on
the banks’ balance sheet looks an obvious target for policy.
But
having kept the Australian shareholders safe, the representatives of
the New Zealand taxpayer seem to have no desire to influence the
future evolution of banking in this country. Treasury is content to
collect fees on the guarantees and to impose prudential safeguards.
The Reserve Bank insists that the guarantees are fiscal policy and so
not its business (let alone its responsibility). No other Government
agency seems interested (though the Auditor General might care to
check out the Treasury’s view on the contingent liabilities
associated with deposit guarantees).
It’s
time for more robust public debate about how a major bank failure
that triggered a guarantee would play out under the Public Finance
Act. The Reserve Bank would have power to put in a statutory manager
and to keep the bank trading, but actual nationalisation of a major
bank (effectively removing it from the control of its parent), which
might be the appropriate course of action, would require political
will and decisiveness, potentially in the face of a full scale
confrontation with Australia. If the New Zealand government has a
contingency plan, it would be reassuring to know about it. If it is
relying on Treasury advice that there is no contingent liability, a
wake-up call may be in order.
Endnotes
:
(1)
See Geoff Bertram, “The Banks, The Current Account, The Financial
Crisis And The Outlook”, Policy Quarterly 5(1) : 9-16, February
2009, pp.14-16 for discussion of a list of claimed reasons. Parts of
this article are based on that earlier piece. For the official
documentation go to http
://www.treasury.govt.nz/economy/guarantee/wholesale .
(2)
With the honourable exception of Brian Fallow in the New Zealand
Herald.
(3)
For documentation of the retail deposit guarantee go to http
://www.treasury.govt.nz/economy/guarantee/retail
(4)
The approved list is at http
://www.treasury.govt.nz/economy/guarantee/retail/approved. The first
approved company to go under and trigger the guarantee was Mascot
Finance in March 2009.
(5)
http
://www.nbr.co.nz/article/treasury-concedes-original-bank-guarantee-fees-too-high-39939
(6)
http
://www.treasury.govt.nz/government/financialstatements/monthend/pdfs/fsgnz-7mths-jan09.pdf
p.30.
(7)
The example of Mascot Finance is illuminating in exposing the
hollowness of official reassurances. As the Dominion Post reported on
4 March 2009 : “Mascot Finance was put into receivership only seven
weeks after securing a guarantee. At the time Mascot signed up for
the guarantee it had stopped taking deposits and was 'reviewing' its
future. But it was not in breach of its trust deed and had
significant cash reserves, the Treasury said”. Adam Bennett in the
New Zealand Herald of 3 March 2009 revealed that “Treasury 'had no
idea' of Mascot Finance's woes”. The Treasury notice of the
collapse is at to http
://www.treasury.govt.nz/economy/guarantee/retail/claims. Treasury
thinks the cost to taxpayers will be less than the $70 million owing
to depositors : “While the company has $70 million in debenture
holders, the cost to the Government is likely to be less than this,
as remaining assets are also applied to satisfy the debt and the
guarantee is for eligible deposit holders only”. http
://www.treasury.govt.nz/government/financialstatements/monthend/pdfs/fsgnz-7mths-jan09.pdf
p31.
(8)
Reconstructing reliable figures on the net public overseas debt is a
considerable task which is not undertaken here. Chart 1 uses the net
public external debt data from the Statistics New Zealand Infoshare
Website, which shows net public external debt as 3.5% of GDP at March
2008. This does not reconcile with the Reserve Bank of NZ (RBNZ)
statistical datasets, probably because it excludes government bonds
“held for non-residents” by New Zealand-based agents. RBNZ Table
D0 at http ://www.rbnz.govt.nz/statistics/govfin/d0/hd0.xls indicates
that at February 2009 there are still $15.5 billion of Government
securities held “for non-residents” which may (but quite possibly
does not – a matter for further research) include the $9 billion
held by identified non-residents in Table D2 at http
://www.rbnz.govt.nz/statistics/govfin/d2/hd2.xls. This, of course, is
still a gross figure; public sector overseas assets (including those
held on the RBNZ balance sheet) would have to be netted out to get
the net public external debt. .
(9)
Paul Bedford, “The Global Financial Crisis and is Transmissions to
New Zealand – An External Balance Sheet Analysis”, RBNZ Bulletin,
December 2008, pp18-29. The chart is from p19.
(10)
Michael Lewis, “Wall Street on the Tundra”, Vanity Fair April
2009. http
://www.vanityfair.com/politics/features/2009/04/iceland200904?printable=true¤tPage=all
.
(11)
Clive Thorp, “Financial Intermediation Beyond The Banks”, RBNZ
Bulletin 66(2) : 18-28, p18.
(12)
http ://www.apra.gov.au/ADI/upload/APS-222-January-2009.pdf
(13)
Until I started the research for this paper, I was myself one of
these simple souls.
(14)
A guess at outstanding residential mortgages is about $160 billion,
of which up to $120 billion are “solid” in the sense that they
represent less than 80% of the value of the respective properties.
After the RBNZ has taken off a “haircut” on this, there should
still be up to $100 billion of assets on the banks’ books which can
be converted to $NZ liquidity by completing some administrative
procedures with the RBNZ.
(15)
As a Reserve Bank Bulletin article noted in December 2008, “Adverse
valuation effects … can … be hedged by matching the currency
composition of international assets and liabilities”. ( Bedford,
op.cit. p20).
(16)
“Aussie Banks Hide While We Panic”, New Zealand Herald, 21/10/08.
(17)
Paul Bedford, “The Global Financial Crisis And Its Transmissions To
New Zealand – An External Balance Sheet Analysis”, RBNZ Bulletin
December 2008 pp.18-29, pp21, 23-24.
(18)
The description which follows is loosely based on Roger Bowden and
Jennifer Zhu, “Kiwicap : An Introduction To New Zealand Capital
Markets”, 2nd edition, Dunmore Press 2005, pp210-213.
(19)
http
://www.treasury.govt.nz/government/financialstatements/monthend/pdfs/fsgnz-7mths-jan09.pdf
p30.
(20)
http ://www.treasury.govt.nz/economy/guarantee/retail/claims, and
Adam Bennett, “Treasury 'had no idea' of Mascot Finance's woes”,
New Zealand Herald, 3/3/09.
(21)
http
://www.treasury.govt.nz/economy/guarantee/pdfs/wfgf-anz-deed-v2.pdf ,
http
://www.treasury.govt.nz/economy/guarantee/pdfs/wfgf-bnz-deed-v2.pdf,
http
://www.treasury.govt.nz/economy/guarantee/pdfs/wfgf-west-deed.pdf .
(22)
http ://www.treasury.govt.nz/economy/guarantee/pdfs/wfec-bnz-2b.pdf
and http
://www.treasury.govt.nz/economy/guarantee/pdfs/wfec-bnz-2c.pdf .
