Who's talking about Ireland now?

It became very tedious a few years ago to listen to continual unfavourable comparisons of New Zealand with Ireland coming from the kind of commentators on New Zealand economy and politics that read the Wall Street Journal.

Given that Ireland was an EU member, a short plane flight from continental Europe, I was never sure that the comparison should carry much weight.

Nevertheless it might pay to note that Ireland has, perhaps predictably, been a major victim of the global financial crisis, with GDP this year predicted to fall 10% below its peak.

Paul Krugman's description of the situation there may have some lessons for New Zealand.

How did Ireland get into its current bind? By being just like us, only more so. Like its near-namesake Iceland, Ireland jumped with both feet into the brave new world of unsupervised global markets. Last year the Heritage Foundation declared Ireland the third freest economy in the world, behind only Hong Kong and Singapore.

One part of the Irish economy that became especially free was the banking sector, which used its freedom to finance a monstrous housing bubble. Ireland became in effect a cool, snake-free version of coastal Florida.

Then the bubble burst. The collapse of construction sent the economy into a tailspin, while plunging home prices left many people owing more than their houses were worth. The result, as in the United States, has been a rising tide of defaults and heavy losses for the banks.

Where Next? Kevin Rudd and the Historic Role of the Social Democrat

The Murdoch press in Australia has been in a tizzy over Kevin Rudd's seven thousand word essay on the global financial crisis in the Monthly. It declares neoliberalism dead and gives a call to arms for social democrats.

I was struck by this warning about the possible rise of various kinds of extremism if social democratic governments fail to make progress.

Social-democratic governments across the world must rise to the further challenge of developing a practical policy response to the crisis that rebuilds shattered economic growth, while also devising a new regulatory regime for the financial markets of the future. This is our immediate challenge. But if we fail, there is a grave danger that new political voices of the extreme Left and the nationalist Right will begin to achieve a legitimacy hitherto denied them. Again, history is replete with the most disturbing of precedents.

But much of the rest of the analysis is, by now, fairly conventional. The politics of tarring the Liberals with a "failed ideology" is too good to resist though of course.

Not for the first time in history, the international challenge for social democrats is to save capitalism from itself: to recognise the great strengths of open, competitive markets while rejecting the extreme capitalism and unrestrained greed that have perverted so much of the global financial system in recent times. It fell to Franklin Delano Roosevelt to rebuild American capitalism after the Depression. It fell also to the American Democrats, strongly influenced by John Maynard Keynes, to rebuild postwar domestic demand, to engineer the Marshall Plan to rebuild Europe and to set in place the Bretton Woods system to govern international economic engagement. And so it now falls to President Obama's administration - and to those who will provide international support for his leadership - to support a global financial system that properly balances private incentive with public responsibility in response to the grave challenges presented by the current crisis. The common thread uniting all three of these episodes is a reliance on the agency of the state to reconstitute properly regulated markets and to rebuild domestic and global demand.

The second challenge for social democrats is not to throw the baby out with the bathwater. As the global financial crisis unfolds and the hard impact on jobs is felt by families across the world, the pressure will be great to retreat to some model of an all-providing state and to abandon altogether the cause of open, competitive markets both at home and abroad. Protectionism has already begun to make itself felt, albeit in softer and more subtle forms than the crudity of the Smoot-Hawley Tariff Act of 1930. Soft or hard, protectionism is a sure-fire way of turning recession into depression, as it exacerbates the collapse in global demand. The intellectual challenge for social democrats is not just to repudiate the neo-liberal extremism that has landed us in this mess, but to advance the case that the social-democratic state offers the best guarantee of preserving the productive capacity of properly regulated competitive markets, while ensuring that government is the regulator, that government is the funder or provider of public goods and that government offsets the inevitable inequalities of the market with a commitment to fairness for all. Social democracy's continuing philosophical claim to political legitimacy is its capacity to balance the private and the public, profit and wages, the market and the state. That philosophy once again speaks with clarity and cogency to the challenges of our time.

Where next? First in an occasional series.

The global financial and economic crisis is only one of the developments that make 2008 appear to be a bit of a watershed. There's clearly a lot of thinking internationally about this new era and I'm just going to link to some of it.

In the realm of ideas, things are up for grabs in a way they haven’t been for several decades now. That is what makes the present both an anxious and an exhilarating time.

That from Francis Fukuyama, courtesy of The Washington Note.

Fukuyama is among those who see a possible end to the Reagan era in US politics. Specifically on financial deregulation, tax cuts and foreign policy. The first two aspects might be relevant to other countries.

There are three core Reaganite ideas that need to be reformulated or discarded altogether if the United States is to navigate the current crisis and restore its credibility in the new era. The first has to do with deregulation and the role of the government in the economy more broadly. The Wall Street collapse and the big recession we are heading into occurred for reasons intrinsic to the Reagan model, that is, because the government had permitted the emergence of an enormous, wholly unregulated shadow finance sector under the belief that this sector would be self-correcting. Financial market liberalization had proven highly dangerous in any number of earlier cases, most notably the Asian economic crisis of 1997-98 and the Swedish banking collapse of the early 1990s, but these warning signs were not heeded and no one imagined that this could happen to the United States itself. In this the Democrats were fully complicit, not just in their support for loan expansion by Fannie Mae and Freddie Mac, but in Clinton Treasury Secretaries who pushed financial market liberalization on the developing world. The current crisis of course has many other causes, such as the more than $5 trillion of excess savings pouring into the country from China and other Asian countries after 2002, but the idea that history was on the side of ever-expanding deregulation was ultimately an important cause of the collapse. The Reagan-era joke, “Hi, I’m from the government and I want to help” doesn’t sound so ironic in light of the Fed and Treasury’s heroic efforts to keep the economy from walking further off a cliff.

The trick in redefining the model is not to overdo it on the regulatory side. The financial sector is very different from other parts of the economy because failure there imposes enormous spillover costs on everyone else, and is why Congress ended up having to vote for the $700 billion bank bailout in September. Labor market deregulation, by contrast, has had very beneficial effects in driving down unemployment rates and permitting much more rapid adjustment to changing conditions. American income distribution has gotten excessively skewed towards the wealthy, but we don’t want to fix that problem by returning to a trade union dominated labor market.

The second big Reaganite idea that needs to be rethought concerns taxes and spending—i.e., fiscal policy. Reagan introduced the notion that tax cuts would be self-financing because all taxes smothered growth; he was also responsible for promoting the idea that virtually all new government spending outside of defense would necessarily be wasteful. While there is some rate of taxation for which this is true, the actual tax cuts enacted both in the 1980s and in the early 21st century have simply served to deepen fiscal deficits and further skew income distribution to the wealthy. The impact of these deficits was for many years masked, however, by the fact that foreigners were wanted to hold their ever-mounting reserves in dollars, a phenomenon that put off the final reckoning but ensured that the fiscal crisis would be much more severe when it finally arrived.

This attitude towards taxes and spending has rendered the American political system incapable of confronting, first, the huge looming entitlement crisis over social security and Medicare, and second, energy. The single best thing we could have done for ourselves in the past generation was to impose a stiff carbon tax in periods when energy prices were relatively low; it was also something that no politician had the courage to take on. No one is going to be talking about increasing taxes until we are out from under the current recession, but in the long run Americans will have to learn to pay their own way.

Secondly, take a look at Ian Macfarlane's lecture to the Lowy Institute last week. Macfarlane was for a decade the Governor of the Reserve Bank of Australia. He reviewed the financial crisis and its effect on Australia before discussing possible regulatory developments.

When it is time to rebuild the regulatory system, I have no doubt that it will have to be more all-encompassing than formerly, but I don't see any likelihood of us returning to the old price-control type system that we had 30 years ago. To me the major challenges will be to:

- rein in what is left of the "shadow banking system";
- be able to measure the aggregate gearing ratio of the financial system and use this as a guide to policy;
- incorporate the risks arising from the reward structure of management into the regulatory framework;
- do something to address the inherent pro-cyclicality of conventional risk management frameworks and systems of bank supervision;
- resist the calls for self-regulation. As one astute commentator observed -- "self-regulation is to regulation as self-importance is to importance";
- bring some of the derivative instruments, particularly credit default swaps back onto an exchange so we can at least measrue their extent and the risks embedded in them, as well as reduce counterparty risk.

Trans-Tasman contrasts in response to financial crisis

The Australian government dedicated half its surplus or $10.4 billion dollars to a stimulus package. The money goes out before Christmas to those most likely to spend it; pensioners and their carers, low income families and first home buyers ($14,000 from the State when you buy a house! That's twice the Howard government level.)

This was done without any detailed Treasury modelling because both officials and politicians were of the opinion that immediate action was needed. In particular it appears that Australian and international experts are not very confident of the continued health of the Chinese economy which is the main driver of growth in resource rich Australia.

The economy is still dominating the front pages and Rudd has announced the goal of avoiding recession and developing regulations in response to the crisis that will be a model for international developments. This is consistent with his extraordinary ambition to be seen as a player on the world stage.

I suppose that it is no surprise, given the Election season, that by contrast the front page news on the New Zealand Herald website at the moment is that Lockwood Smith has been known to make a dick of himself. Who knew?

Cullen will be happy to find that fishhooks in the detail of the Government's bank guarantee were big news in Australia this morning. So Australian moves are not without percieved missteps.

Meanwhile the outcome of the NZ election is not a topic of great interest.

Preparing for worse if that's possible

The response to the G7 communique and Paulson's subsequent press conference seems to be very negative. Many commenters hoped that the G7 would move to a British style scheme of partial nationalisation of the banks. Paulson's press conference suggested he is moving ahead with that but is still looking for private capital to assist also and the G7 communique is very vague. (The authority to buy equity in the banks was not in the original rescue package put forward to congress but clearer heads prevailed and it now seems that the bailout package will look very different.

It's really not reassuring when Paul Krugman says "Paulson sounds terrified" and others comment that he is loosing all credibility. But given that he has downplayed the crisis at every turn for the last 18 months this is perhaps not surprising.

Lets hope that Morgan Stanley does survive the weekend.

Australian Response to Financial Crisis

Treasurer Wayne Swan is in Washington and New York this weekend, attending the G20 meeting and lobbying bigwigs. I've just listened to his interview with Barry Cassidy on Insiders, and I don't think you could really describe him as calm and collected. It seems that there is no government program that will not be reconsidered in light of the financial crisis.

Back in Canberra the Foreign Minister Stephen Smith has announced that the finance subcommittee of the Cabinet will meet later today.

What are New Zealand's alleged leaders doing this weekend?

THE government's cabinet budget committee will meet later today to take any action deemed necessary from key meetings of the International Monetary Fund and Group of 20 finance ministers in New York today.

Foreign Minister Stephen Smith said there was a growing realisation that the international financial crisis was worse than originally thought.

Update: Account of Clark's campaign opening speech just up, she does at least announce a deposit guarantee scheme.

How are New Zealand's banks really doing?

We were told on Morning Report Friday morning that the Reserve Bank believes that New Zealand banks have $60 billion of overseas debt to turn over in the next 40 days. I've listened to that several times to be sure that is really what was said.

That figure appears to be nearly half of New Zealand's GDP.

My limited understanding of the situation at the moment is that internationally banks are simply not lending money to other banks.

Worse still other nations are moving to guarantee or buy stock in their banks. Australia seems likely to increase its guarantees on its banks (which admittedly own ours) in the next few days.

We're told that the Reserve Bank has moved to allow banks to borrow from it secured by the value of mortgages. However I can't help noticing that the total value of New Zealand houses is about $2.11 billion, so there better be some hefty mortgages on commercial property out there if that's really going to solve the problem.

Could someone, preferably the boss of a bank and the leader of a major party, say something reassuring but convincing about the position of New Zealand's banks?

Finally, if you were Jim Anderton and you'd set up a government owned bank that doesn't borrow overseas you would have to be pretty happy with yourself.


Update: Clark has just announced a deposit guarantee scheme.

Keep Physicists Off Wall Street

I've long been of the opinion that overly complicated and insufficiently commonsensical analysis of risk by theoretical physics and mathematics Ph.D's may have played an unfortunate part in the creation of the incredibly complicated arguments that dressed sub-prime mortgages up as AAA investments and thus contributed to the current parlous state of international credit markets.

Dave Bacon seems to agree and has a great idea to avoid this state of affairs in future; increase science funding to keep theoretical physicists away from money markets!

The State of the Free Market

Could I second the Hive's plea that we all take the US financial crisis more seriously?

I can't resist arguing the cause of social democracy though. John Quiggin here in Brisbane has a great trade for those who argue that the current difficulty is not some failure of "the free market" on account of the US not being a free market. I'll have to quote it almost in full

I will agree that
(a) the US is not a free-market economy, and its failures do not constitute evidence against the claim that a pure free-market economy is the best possible form of social organization
(b) no other actually existing society is, or has ever been, a free-market economy, and no actual or conceivable events anywhere constitute evidence against the claim that a pure free-market economy is the best possible form of social organization
(c) In discussion with parties to the agreement, I will not contest the claim that a pure free-market economy is the best possible form of social organization

All I ask in return is that the counterparties to the deal agree not to advocate, oppose, criticise, or comment on any policy or political position that might actually be implemented, to ensure that the purity of the free-market ideal is not compromised by actual experience.

John is also willing to make the same offer to Marxist-Leninists for pretty obvious reasons.

He also thinks we might have seen the back of neoliberalism, I'd post a link including his assessment of the New Zealand situation but his site seems to have crashed just at the moment.

Short Selling in New Zealand?

A propos of yesterday's comments on short selling in New Zealand, it appears that neither the Australian newspaper nor the regulatory body ASIC are of the opinion that the practice is insignificant.

In a hurried decision yesterday, ASIC revealed covered shorts could be taken in dual-listed stocks such as BHP Billiton, Rio Tinto, ANZ Bank and Lion Nathan, as the stocks were at risk of being savagely shorted on their secondary exchanges in London and New Zealand.

This is in marked contrast to the points of view on Morning Report Monday. Not my bailiwick this issue, but it must be possible to find the truth one way or the other.

In general the ban on short selling seems to be attracting increasing criticism.

Who has their eye on the ball in New Zealand?

The Peters censure and the start of the election campaign make it difficult to focus on external events.

But it would be a pretty good bet that the consequences of the financial meltdown in the US will have some impact on the public consciousness in New Zealand before November 8.

It seems that the buy-up of bad mortgages in the US may go ahead in some form, despite being criticized on all sides. The US stockmarket's rush of blood to the head on Friday has faded, the dollar is down and oil prices are way back up.

According to Nouriel Roubini in the Financial Times, who has been right before, the next victims of the crisis will be the hedge funds and then private equity firms.

The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years.

Even private equity firms and their reckless, highly leveraged buy-outs will not be spared. The private equity bubble led to more than $1,000bn of LBOs that should never have occurred. The run on these LBOs is slowed by the existence of “convenant-lite” clauses, which do not include traditional default triggers, and “payment-in-kind toggles”, which allow borrowers to defer cash interest payments and accrue more debt, but these only delay the eventual refinancing crisis and will make uglier the bankruptcy that will follow. Even the largest LBOs, such as GMAC and Chrysler, are now at risk.

But we should all be thinking about the effects on the real economy in the US and elsewhere. Roubini again

The real economic side of this financial crisis will be a severe US recession. Financial contagion, the strong euro, falling US imports, the bursting of European housing bubbles, high oil prices and a hawkish European Central Bank will lead to a recession in the eurozone, the UK and most advanced economies.

European financial institutions are at risk of sharp losses because of the toxic US securitised products sold to them; the massive increase in leverage following aggressive risk-taking and domestic securitisation; a severe liquidity crunch exacerbated by a dollar shortage and a credit crunch; the bursting of domestic housing bubbles; household and corporate defaults in the recession; losses hidden by regulatory forbearance; the exposure of Swedish, Austrian and Italian banks to the Baltic states, Iceland and southern Europe where housing and credit bubbles financed in foreign currency are leading to hard landings.

Thus the financial crisis of the century will also envelop European financial institutions.

By the way, New Zealand did not ban short selling over the weekend, unlike the US, the UK and Australia among many others. We were told by several people on Morning Report Monday that this is because the practice is rather limited in New Zealand. I hope that either that is the case or that the people arguing that the short selling ban is a bad idea are right.