Former New Zealand Reserve Bank governor Alan Bollard warns that, although lessons were learnt from the global financial crisis, new risks have emerged that could trigger a repeat contagion.
Phone lines ran hot: in Washington, New York, London and Frankfurt regulators were desperately using the weekend to try to understand Lehman’s complex and rambling balance sheets. Could any of the operations be saved? Who would foot the bill? If the bank failed, could it bring others down, too?
The timing was awful: the US was caught up in a presidential election, with hopefuls such as the inexperienced Barack Obama making uninformed comments on the economy. The US Government had already rescued another large bank, Bear Stearns, poured funds into Government-sponsored mortgage lenders Fannie Mae and Freddie Mac and refinanced the AIG insurance group. But this time, it decided to let Lehman Brothers go into bankruptcy, triggering the largest such failure ever.
US Treasurer Hank Paulson insisted that all the negotiations be concluded before world markets opened for business on Monday, September 15. By this, he meant the Asian markets – he had forgotten that New Zealand markets opened some hours earlier, the first in the world. As the news came through, our financial markets took a beating.
Over the next week, we watched the news spread around the world, other banks panicking as they tried to assess their exposure to Lehman and to other failing institutions. We watched our newly installed electronic payment systems experience a record number of transactions, and demand for New Zealand cash reached new highs.
But our biggest worry was the Australasian banks and whether they could survive the Northern Hemisphere meltdown. We had been monitoring these institutions closely and they looked sound, but the securitised-mortgage contagion was getting closer.
It was becoming clear that the world was heading for a global recession. The Reserve Bank knew it needed to move fast and interest rates needed to come down; over the next four months, we slashed the official cash rate from 7.5% to 3.5%.
It was difficult timing because New Zealand also had a general election under way. On Sunday, October 12, Prime Minister Helen Clark was preparing to launch the Labour Party’s election campaign when she received a call from newly elected Australian Prime Minister Kevin Rudd to say he was planning a bank guarantee scheme in Australia and was determined to announce it that afternoon. This timing was unhelpful, leaving the New Zealand Government in a very difficult position, with the risk that Kiwi deposits might drain out of our banks and cross the Tasman.
Manning the phones
Luckily, we had been making preparations confidentially and knew we had to respond with our own scheme, even though this could distort our market and cause problems for some smaller financial institutions. In the following weeks, we all manned the phones, answering thousands of phone calls from worried Kiwis. We briefed Cabinet and Opposition Leader John Key about the deteriorating outlook. It was pleasing that neither the Government nor the Opposition sought to make political capital out of such a fragile situation.
Overseas, the news was bad – the contagion was spreading. Within a month, the world’s equity markets had lost half of their value, about $30 trillion, by far the largest loss in value the world had ever seen. Across the Northern Hemisphere trade slowed, unemployment started rising, economic growth forecasts were slashed and political opposition was growing. The US Government response was slowed by an unwilling Congress, but eventually it slashed interest rates, put in place a huge troubled-asset relief programme (known as Tarp) to back up the financial system, and designed new arrangements for the Federal Reserve to buy government bills and keep funds circulating in a depressed economy. This came to be known as quantitative easing and led to huge growth in central bank balance sheets. What had started as a banking crisis had morphed into what came to be known as the “great recession”.
It took several years to implement, but eventually the US and Europeans designed major banking reforms, tightening regulation of securitised assets and splitting the sprawling conglomerate institutions into separate investment banks and traditional trading banks. That had been less of a problem in New Zealand, but here we designed new macro-financial policies – ways to regulate bank financing and lending behaviours – that we could use in addition to interest-rate policies in order to stabilise the financial system. These have now become a standard part of the Reserve Bank’s toolkit.
Banks in Asia had suffered badly during the 1997 Asian financial crisis, but this time proved more resilient. However, we soon discovered that a financial crisis could quickly spread to the real economy: the great hubs of Singapore, Hong Kong and other coastal Chinese cities suffered a severe downturn in trade. China responded with a $1 trillion stimulus package, arguably the biggest financial stimulation the world had seen, focused mostly on infrastructure spending, with part of it morphing into today’s “Belt and Road Initiative”.
Within a couple of years, China was said to have used more cement than the US did in the whole 20th century, and the result can be seen today in the big Chinese coastal cities. This expenditure continued to drive growth in the region, but it has had several other effects: some Chinese corporates, state-owned enterprises and provinces have built up very high levels of debt, and there is increasing concern about some of the competitive foreign investment that has taken place throughout Southeast Asia.
China’s assertive economic policies and the current US Administration’s tariffs and trade sanctions have also affected the region’s geopolitics. Trade imbalances have grown since the global financial crisis, and this has become the big point of contention in the US-China debate and a driver of anti-global rhetoric and economic nationalism.
Antiglobalisation is resurgent following the 2016 Brexit referendum and US presidential election. That has been a complex story of migration, trade competition and automation, some of it worsened by the global financial crisis.
The large Western banks have tried to avoid being drawn into this dispute, which is largely being fought out in the manufacturing sectors of the largest economies. But the financial system cannot escape being used as an instrument by the US Government to implement its growing economic sanctions on countries.
There have been some other big changes: much of the Asia-Pacific region has recently grown from being poor and rural to being middle-income and urban. For Asia-Pacific millennials, tertiary education rates, especially for females, have increased; marriages are taking place later; fertility rates have dropped; workers are entering the labour force later and leaving it later in life; retirement ages are growing; and life expectancy is extending. This has occurred faster than we expected.
Much of the strong economic growth has been driven by growing labour forces, but the region’s working-age population has now peaked, and in countries such as Japan, is rapidly declining. Much of the region is anxiously wondering whether they, too, could be subject to the low productivity and low growth of “Japanisation” – where deaths outweigh births and sales of adult diapers now outweigh those of baby nappies.
The front line of these demographic changes are the millennials, with their different consumption patterns, their digital lifestyles, their shunning of family-based welfare systems and their new savings patterns: much household saving in the Asia-Pacific now takes place by buying apartments, leading to building booms, congested urban development, unoccupied living spaces and risks of construction bubbles and debt build-up. We need to remember that the global financial crisis was originally triggered by a building bubble, and that is still on the minds of regulators throughout the region.
Holding property can turn out to be an illiquid, inflexible, low-return investment, and not a good way to solve the major financial problem that lies ahead – funding retirement income. In addition, use of property as a financial instrument can make traditional monetary policy very difficult.
The global financial crisis bubble was associated with lower tax rates, a shift of income from capital to labour, and higher returns on property and equities. That, in turn, has contributed to increasing inequality among some households in some countries.
The good news is that, in many cases, including the US, poverty has decreased. But in many manufacturing industries, especially those affected by cheaper competition, lower-middle-income workers have suffered. In addition, high- and very-high-income earners have become even better off, and their international mobility makes them very difficult to tax equitably. Baby boomers are angry about low returns on savings, and millennials are angry about low wage growth. Not surprisingly, the upshot has been significant pockets of political dissatisfaction.
The past decade has also seen big technical advances that have affected existing practices in industries, firms and workplaces both positively and negatively. One example is the flowering of “fintech” – those data-driven new business technologies that are disrupting traditional banking, savings, insurance and business services – often bypassing traditional providers that are stuck with expensive real estate, big balance sheets and outdated lending requirements. Huge electronic commerce platforms have changed the face of marketing, retailing and financing in the past decade, led by China, where mobile payments are now 10 times those in the US. Treasuries are grappling with the problem of lost sales tax revenues. Competition regulators are now more worried about electronic-platform providers than about banks, and maybe financial regulators should be, too. The global financial crisis surprised us when we saw modern financial instruments such as securitised mortgages sparking contagion through the whole financial system. We have yet to see whether emerging new financial providers could be susceptible to an equivalent digital contagion sparked by cyber hacking or financial mismanagement.
Meantime, we are very worried about the likely effects of the growing trade wars. It is too early to judge, but the stakes are high – trade growth has been the big driver behind the immense improvement in living standards through the Asia-Pacific region; over the past few decades, half a billion people have been lifted out of poverty and into the middle-income bracket, surely the greatest economic advance ever seen. We are now on the alert for signs that these trade frictions could weaken exchange rates, hurt commodity prices, hit stock markets or cause financial volatility, against an unusual background of tightening monetary policy and loose fiscal policy in the US.
As a big trader, New Zealand has always been susceptible to these tensions. But one international platform where they play out is coming closer: in just over two years, New Zealand will commence its year of hosting Apec. The organisation is a voluntary, consensus-driven one, where for 30 years we have promoted regional economic ties and tried out new ideas for trade and investment. As the upcoming chair of Apec, New Zealand will have to contend with continuing antiglobalisation pressures, big-economy tensions, climate-change damage and financial risks in the region. It sounds daunting, but there are many positives: We have learnt some of the lessons of the global financial crisis; banking regulation is tougher; banking chiefs are more cautious; economic demand is still growing; and the Asia-Pacific region is tied ever more closely by its trade flows.
September 2018 should be a month much better than September 2008.
Dr Alan Bollard is executive director of the Apec Secretariat in Singapore. During the global financial crisis he was Governor of the Reserve Bank of New Zealand and during the 1997 Asian financial crisis he was Secretary to the Treasury. This article represents his personal views.
This article was first published in the September 8, 2018 issue of the New Zealand Listener.