Scoop Election 08: edited by Gordon Campbell

How US Financial Meltdown Will Affect NZ Election

September 18th, 2008

By Gordon Campbell


Click to enlarge

*****

So, what impact is the world’s biggest financial crisis since the Great Depression having on the New Zealand election campaign? Of course, this is nowhere near as crucial as what happens to Winston Peters but…. hello ? Apart from a few cracks by Michael Cullen about John Key’s work experience with Merrill Lynch – now swept away in a firesale to Bank of America – there has been nothing much so far beyond a lot of worried looks.

One reason being that National’s fiscal and economic policy is STILL a mystery. Also, the main shockwaves from the Wall Street carnage have yet to reach New Zealand, and no-one seems to know what will happen when they do.

A few things we do know. National’s extra round of tax cuts – to the extent they are premised on further government borrowing offshore – now look riskier, and will cost us more than seemed likely a month ago. Are they unaffordable ? We can’t know until National finally get around to telling us the size and structure of the tax cuts they have in mind. It would be helpful if the financial crisis now motivated both major parties – in the name of transparency – to put all their economic and fiscal policy cards on the table.

The crisis backdrop seems pretty clear, regardless. The cost of borrowing money from foreigners is going to rise. Banks will pass that on. That matters, given that New Zealand households are already up to their eyeballs in debt, and with more than $40 billion of housing related borrowing coming up for renewal over the next six months.

Over that time, the New Zealand economy looks likely to be hit by seesawing forces – mainly deflationary ones, some of them triggered by the US financial crisis. Commodity prices for our agricultural goods are expected to ease and the cost of borrowing and debt servicing will rise, as the lines of credit belatedly tighten up in the wake of the Nightmares on Wall Street, and ripple on through pension funds, and into the small regional banks in the global credit and investment chain.

Thankfully, oil is now below $100 a barrel. This will help remove some heat from the inflationary combo of imported energy costs and the first round of tax cuts that kick in on October 1st It is still unclear whether that will give the Reserve Bank much headspace for further interest rate cuts needed to fight both the deepening local recession, and the deflationary impact of the global tightening of credit. It is a situation that leaves little room for extravagance.

Trouble is, extravagance is what voters are expecting from National. The promise of bigger tax cuts – and more of them – has been bankrolling National’s lead in the polls, and the general mood for political change. National can’t back down now, even though stability is called for. Basically, National is hoping that voters will see the storm clouds on the horizon but still take the tax cut bait, and run. That’s a great way to win an election, but not a very good way to run an economy.

Over the next 18 months, the financial crisis will also put heat on National’s plans to finance infrastructural development via PPP’s – large, heavily debt-financed projects that will now cost more to devise, and to service. On overseas experience, PPP’s pose risks of budget blowouts because of deliberately under-pitched contracts. The safety net against those kind of rorts with PPP’ – as with the crisis in the US financial sector – is greater regulation.

National however, stands for de-regulation. It is the ‘hands off’ party of economic management. That puts it out of step with the current angry and panicked mood in the US and within the wider global economy – which has good reason for feeling pissed off with the Bush administration’s ‘light handed’ approach to financial market management. The current financial crisis has been caused by a deadly double whammy hitting in succession – first the sub-prime mortgages going sour, then the rippling collapse of the speculation in derivatives, or so called credit default swaps. Across the political spectrum in the US, the blame for that has been laid on insufficient regulation.

That is not something that National – and many of its friends in business – want to hear. By and large, they remain locked in a 1980s mindset of liberalizing markets – where regulation is seen as a bureaucratic evil, and an unnecessary cost to business. Some times it can be. Yet such views also seem immune to empirical evidence from reality – which, as Stephen Colbert says, has a well-known liberal bias. No amount of BNZ and Air New Zealand bailouts, or Tranzrail and Telecom fiascos seem able to change the anti-regulatory mindset. It’s a cult.

On that score, the US political system seems a bit more flexible. In a rare example of quasi-unity, Barack Obama and John McCain have both been calling for greater regulation of financial markets Here’s Obama’s diagnosis :

Eight years of policies that have shredded consumer protections, loosened oversight and regulation, and encouraged outsized bonuses to CEOs while ignoring middle-class Americans, have brought us to the most serious financial crisis since the Great Depression.

Interestingly, Obama has homed in on the philosophy of unfettered markets : “ Certainly I don’t fault Sen. McCain for these problems, but I do fault the economic philosophy he subscribes to.” McCain has used a different language to promise much the same thing. While a self described –de-regulator in the past, McCain has committed himself in the wake of the current crisis, to increased regulation of financial markets :

“It is essential for us to make sure that the U.S. remains the pre-eminent financial market of the world … “The McCain-Palin administration will replace the outdated and ineffective patchwork quilt of regulatory oversight in Washington and bring transparency and accountability to Wall Street.”

One can readily see the need for a drastic response. The size of the toppling giants involved is staggering. At the time it went under, Lehman Brothers held assets worth $650 billion, making it the biggest bankruptcy in history. The AIG insurance group – currently the subject of an $85 billion temporary bailout from the US taxpayer – is the 17th biggest firm in the world, and is headed for liquidation. Looking ahead, Morgan Stanley is also teetering on the brink of collapse – or tottering towards a fire-sale merger with a major bank, along the lines of Merrill Lynch’s ‘rescue’ by Bank of America.

However, these massive disasters and re-alignments pale when put up against the slow disintegration of the credit default swaps market. Only ten years ago, this was an obscure neck of the financial woods, frequented by banks and bondholders. But as, Time reported last March, the CDS market had exploded to where it was worth $45 trillion by late 2007. That is twice the size of the entire US stock market, six times the size of the US mortgages market and roughly ten times the size of the US treasuries market. Out of control, in other words.

I can’t claim to fully understand credit default swaps – but from the outside, they look like financial chain letters where all the focus was on the risk to the guaranteed, without due attention to the risk involved for the guarantor. Famously. investor Warren Buffett once called credit default swaps “ financial weapons of mass destruction,” which still didn’t stop him from trading in them. As Time said in its March report :

Credit default swaps are insurance-like contracts that promise to cover losses on certain securities in the event of a default. They typically apply to municipal bonds, corporate debt and mortgage securities and are sold by banks, hedge funds and others. The buyer of the credit default insurance pays premiums over a period of time in return for peace of mind, knowing that losses will be covered if a default happens. It’s supposed to work similarly to someone taking out home insurance to protect against losses from fire and theft.

Except that it doesn’t. Banks and insurance companies are regulated; the credit swaps market is not. As a result, contracts can be traded — or swapped — from investor to investor without anyone overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults.

Unfortunately, commercial banks – you know, the ones that handle deposits and finance loans and that are supposed to be more heavily regulated than finance companies in order to protect the investor – got in on the CDS act. The top 25 banks in the US reportedly hold over $14 trillion in credit default swaps. That’s scary, now that they are also being hammered by the defaults on mortgage-related business, either directly or through their subsidiaries.

What began as a cheap way to earn more cash in a booming economy – when defaults were unlikely, and look like they’ll always be some else’s problem – are now coming back home to roost as the US economy heads into decline. It is this Merrill Lynch mindset – where you take the short term profits and assume you’ll always be able to wing your way out of trouble –that Cullen will use as a rationale for Key’ not being entrusted with the reins of government.

Who let the fox into the chickenhouse In the US? People looking for other prime causes for the current crisis are also pointing to the repeal of the Glass -Steagall Act in the late 1990s. For good reason, this Depression era legislation had created a firm division between traditional commercial banks (as mentioned, these were heavily regulated to protect depositors) and the freer, standalone finance houses. The speculative sins at the root of the current crisis owe a lot to the riotous blurring of those roles over the past decade. Of course, there is some grim consolation in seeing that the scrapping of this distinction has now enabled Bank of America to buy Merrill Lynch, and for Barclays to mop up the valuable bits of Lehman Brothers.

Longer term, the crisis will require John Key to adapt to a new, far more sober reality. To date, Key’s approach to economic management – so far as we know what it is – has shared some elements in common with McCain’s. In fact this recent Washington Post article by two McCain advisers

strongly echoes what we have seen to date from National. Cut taxes. Slow the growth of government spending. Abolish gratuitous government programmes, aka ear-marks. Here’s how the Key/McCain approach reads :

By maintaining strong control over the growth of government spending, Mr. McCain will bring the budget into balance. His long record of fighting against excessive government spending, his plans to veto earmarks and reverse the spending binge of the past few years, and his strong commitment to balancing the budget can make this goal a reality.

All very well, but hardly enough to balance a budget that has to incorporate major tax cuts as well. Labour has set the ball roiling in this respect. Both Cullen and Key now havesome explaining to do in the next few weeks, as to how they proposes to manage the government revenues – in the light of the cris, and the expectation National has aroused of extra, even bigger major tax cuts partly financed by extra borrowing. This is a terrible time to be planning to expose the country to greater debt.

Free financial markets regularly deliver the same message. Bereft of effective regulation, they operate in costly, socially damaging ways. Routinely, the firms involved need to be rescued by the taxpayer. It would be re-assuring if both major parties showed they’ve taken that lesson from the current crisis on board.

ENDS

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    1. 10 Responses to “How US Financial Meltdown Will Affect NZ Election”

    2. By Michael Collins on Sep 18, 2008 | Reply

      “National however, stands for de-regulation.” There needs to be a better word than “de-regulation” for the right’s position on financial matters. Maybe “corporate regulation” or “financial free for all.”

      Here (the United States), since 2000 we’ve had a government that is best characterized as a kleptocracy – pick every apple in the orchard then move on to devastate another crop. The theft has been relentless.

      You are right about the boundaries disposed of by modifying the Glass -Steagall Act.

      The brain behind the regulatory fixing is none other than former Sen. Phil Graham (R-TX), McCain’s financial guru. Make no mistake about it, McCain has only come out in favor of regulation in the past few days. He’s been an opponent of anything other than a rigged game his entire career. The last financial crisis, the Savings & Loan crisis of the ’80′s, saw the Senator peddling influence for the worst of the S&L’s with regulators. He was cited as doing so by a congressional committee.

      The “fundamentals” of the people of the United States are sound. We don’t approve of these leaders. There were numerous elections stolen starting with 2000, most critically the 2004 presidential election. The media here is a part of the corporate structure, owned by the very corporations “donating” to politicians who, in turn, rig the game for them.

      The people will bounce back. However, the system needs a complete overhaul.

      Be wary of any “de-regulation” party. It really means that the corporations make the rules with the help of the legislature and executive branch. Socialism for the very rich, not so free enterprise for the rest of us.

    3. By Rhema Vaithianathan on Sep 18, 2008 | Reply

      Excellent analysis , thanks. I think the irony in the US meltdown is that the classic problem of any light-handed regulatory environment: i.e. it privatises the profits and nationalises the losses. The problem is one of political economy. No politically elected body can credibly claim that they will allow markets to fail – yet, for markets to work their magic that is exactly what has to happen. Given that Governments cannot help but bail these firms out, taxpayers have to start acting like they are lenders of last resort and undertake active prudential overview. Free markets in the finance sector is a chimera — produced by capitalists, marketed by Governements and bought by a gullible public.

    4. By John Monro on Sep 18, 2008 | Reply

      Gordon, thanks for a blast of realism.

      The National party still has to drag itself out of last century, voting National, with its policies firmly 30 years out of date, and utterly inappropriate for the massive changes coming to all our economies, would be like voting for the Whigs. National’s policies are those of a quack, who can offer nothing but bleeding, purging and cupping, and when the patient fails to get better, can only offer the same, but more rigorously applied. But Labour aren’t that much better, while they have done something to ameliorate the worst excesses of the monetarist dogma that enmeshes us all, they are also stuck to the old way. For instance, our electricity market isn’t working, it never could, of course, but rather than scrap the whole nonsense, they’ve been content to fiddle around at the edges, with spectacular lack of success. Billions of dollars to be spent on pointless new roading programmes, talk about burning money. The supposed separation of the Reserve Bank Governor and the politicians, an absurd pretense that there is some sort of fiscal independence, and every few months we treat the Governor to a hushed silence as like a magician he produces a percentage out of a hat. It’s our misfortune this is more like Tommy Cooper than Gandalf. And for all the crowing about the government’s fiscal prudence, during this Labour administration NZ’s total overseas indebtedness has doubled from about $100 billion to over $200 billion. The monkeys at Wellington Zoo could run a “successful” economy borrowing at that rate.

      It is quite evident that neither party have woken up to what is actually happening, the complete collapse of the world’s financial system, and the globalised economy that depends on it.

      We are all in for a very rough few years (probably about 20 years) while we reorganise our societies to a fully sustainable economy, recognising the limits to growth, with the social, economic and political policies that will be needed to shape this.They will be nothing like National’s or Labour’s present policies. We will look back on the last thirty year of the last century and the first eight of this as a sort of collective madness.

      We also urgently need an effective national debate and discourse, and at the moment our inept and cynical media are entirely unable to help us provide this.

    5. By Iain Parker on Sep 19, 2008 | Reply

      From Samuel Jackson, English author, critic (1709 – 1784)
      “Integrity without knowledge is weak and useless, and knowledge without integrity is dangerous and dreadful.”

      From Toward Prosperity, by Roger Douglas 1987
      page 137;
      The arguments in favour of financial deregulation had been going on for sometime. In 1966 a report published by the Monetary and Economics Council recommended financial reforms to improve competition and efficiency. By the time Labour was elected in July 1984 most of the work to enable a float to be put into practice had been done years before by officials in the Reserve Bank and Treasury. We did not need to spend time, as we did on aspects of tax reform, working out the detail. Government and the bureaucrats knew what had to be done.
      page 140;
      One of the uses of government bonds is to keep the amount of money in the financial system in balance. Under previous administrations, when government departments spent more than the government received in tax , more money was injected into the banking system than was withdrawn by taxes. As a result there was more money to spend on the same amount of goods and services in the real sector and inevitably prices(inflation) rose. The financial sector is distinct from the real sector of the economy. The former handles the buying and selling of financial assets, the real sector produces, uses, buys and sells tangible items or services.

      From Helen – Portrait Of A Prime Minister – by Brian Edwards – Published 2001
      Pg 222
      Brian Edwards to Colin James:
      “If those who voted National in 1990 thought they were voting against ‘Rogernomics’ and in favour of a more caring and humane society, they must have been sorely disappointed.”
      Colin James:
      ” The National Party in government after 1990 acted out of character. Instead of conservatively managing the status quo bequeathed by Labour, it pushed on with reform, extending it into the social services and wages policy. In fact the first two years of the National government can be seen as almost seamless continuation of the policy revolution begun by Labour.”

      Brian Edwards:
      “Observers of the political scene, as Bob Chapman notes, might have had a sense of deja vu:”…..the incongruity of a kinder, more gentle policy coming down from the leadership, and Ruth Richardson’s fire and brimstone in action. Bolger plays Lange to Richardson’s Douglas, a Minister of Finance quite out of his control. Bolger looks benign, he often feels benign. But National has seen the light. Douglas had the answer and their Minister of Finance is there to finish the job.”

      In recent times, the New Zealand Bankers Association, in their Banking In New Zealand Fourth Edition of 2006 and the New Zealand Reserve Bank in their March 2008 Bulletin Vol. 71, No.1, themed issue Money and Credit containing gems like this;
      - There is no legal restriction on the type of institution that may create money in New Zealand.
      - . While the Reserve Bank creates fiat money, in practice, a much larger share of money is created by registered banks and other private institutions. In the process of creating money, these private institutions also create credit, which by enabling the funding of investment, contributes to the economy’s ability to grow.
      Both have detailed the processes of “Created Credit” and set about trying to normalise it, and the Bank of International Settlements in their 2007 Triennial Survey of Central Banks has acknowledged the existence of “Derivatives” with a “Notional” value of $516 Trillion dollars, and Mergers and takeovers reached $4.1 trillion worldwide last year.
      Leveraged buy-outs touched $753bn, with an average debt/cash flow ratio hitting a record 5:4. Most here who are familiar with the Debt Based Monetary System wont be shocked at such a figure, but those of you not so familiar I assure you, I can show you the survey right here and now if asked
      http://www.bis.org/press/p071219.htm

      The current Labour Executive you have had the Non Government Financial Institutes that exist within our government by puppet strings, because although they have had integrity they have not had the knowledge to protect us, put National back in, you will have them back in the drivers seat.

      The only time in modern history that the boom bust cycles of the now debunked Magic of the Markets have ever been stabalised, is when nation have implemented Social Credit, spending their own money supply into circulation debt free by the building of and ongoing maintanence of its vital infrastructure. Removing foreign interest from the first step of the money chain, removing it from having to be factored into every step of production, thus reducing the cost of finance by two thirds, thus reducing the cost of living by two thirds, thus reducing the need of taxation by two thirds. It has been done successfully in Canada 1935-74 and in NZ 1935-61, it can easily be done again. Just Google-Social Credit- you will find the tried and tested answers to combat the commercial pyramid scam that is the Central Banking Network.

    6. By Dave McArthur on Sep 19, 2008 | Reply

      Tonight (18 Sept) Richard Griffin lambasted Michael Cullen on National Radio for reminding NZers that John Key worked for the failed Merrill Lynch. Richard argued this is a cheap shot for John’s ML experience is now irrelevant as, heck, it was 9 years ago.

      It might be irrelevant if John now evidenced greater insight into the devastating impact of his currency trades on the average person and had returned the wealth he gained in the process. There is no evidence he has. It seems safe to assume that when push comes to shove he will continue to react as he traditionally has by treating New Zealanders as commodities rather than as human beings with civic rights.

      It is clear from the Sunday Star Times article
      profilehttp://www.stuff.co.nz/sundaystartimes/4392717a24815.htm
      that John was oblivious to the real forces shaping our society in 1981 and remains oblivious still. In particular he fails to understand the lethal nature of our addictive use of mineral oil/gas. He was making his millions trading in a credit system based on a market system that valued mineral oil at an insane 0.04 cents per man-hour of labour equivalent. His behaviour then was certainly psychotic and probably psychopathic.

      Now the price has risen 10-fold, the delusion is exposed and predictably the credit system based on it is collapsing as the resulting inflation destroys community wealth on scale. His lack of insight means he neither understands the cause of the collapse nor the investment strategies that can avert untold misery. So as Prime Minister when faced with the impacts of the depletion of cheaply extracted mineral he will tend to react by imposing desperate and unsustainable measures such as more repressive legislation like the Emissions Trading Scheme, the Student Loans Scheme and the Electricity Reforms, borrowing frantically and selling the family silver to sustain the addictive habit of NZ Inc.

      Michael Cullen is right to point to John’s limitations. In doing so he reminds us he is remarkably similar to John and that he has changed very little from the man he was in the Roger Douglas Administration. Like John he too still shows little insight into the fatal addictive use we make of mineral oil.
      Witness the vast subsidies he has arranged for car (including SUV) and truck owners.
      Witness the $billion subsidies he has arranged for the money traders via KiwiSaver and how he has opened the way for the complete privatisation of superannuation.
      And today’s news that Wachovia Bank may be merged into Morgan Stanley which in turn may come under the control of China’s Citic Group reminds us that Michael effectively sold TransPower to Wachovia in 2003, failed to prevent the privatisation of Vector and the return of the Wellington region grid into foreign control and has embedded National’s Enronian Electricity Reform legislation into our national technology structure, thereby destroying much of our electrical potential.

      And John and Michael have plenty of company, in and out of Parliament. In Parliament even the Green Party caucus has come out endorsing the Enronian Emissions Trading Strategy (see my most recent blogs), thereby setting the seal on our capacity to break our destructive addictive uses of carbon.

      My most recent blog (www.bonusjoules.co.nz)catalogues my prophecy on the day Sarah Palin was elected Republican VP candidate that she would cause a surge in support for the party. This is because in her role as Alaskan Governor she reflects and enables the delusions of car/jet users of all parties to persist (Alaska = eternal energy in the form of mineral oil). I suggested this was the critical factor shaping the presidential candidates. Last night my prophecy came true. The New York Times reported:
      Federal Aid to Detroit Seems Likely
      By DAVID M. HERSZENHORN Published: September 17, 2008

      “….But with billions of dollars in financial backing already authorized for Wall Street, and with Election Day fast approaching, Congressional leaders seemed uninterested in denying help to large employers of blue-collar Americans.
      Even as lawmakers in both parties unleashed a barrage of questions about the wisdom of a government rescue for the American International Group, support seemed to be growing quickly on Capitol Hill for $25 billion in loan guarantees to assist the ailing auto industry.
      Both presidential candidates, Senator John McCain of Arizona and Senator Barack Obama of Illinois, have voiced support for the loan guarantees — an unsurprising stance given the critical importance of the main auto-producing states, Michigan and Ohio, to the electoral map this fall.
      .. “The support that we got was again very encouraging,” said Robert L. Nardelli, the chairman of Chrysler. ..
      Alan R. Mulally, the chief executive of Ford, was even more upbeat. “It was a great day,” he said. When a reporter asked what Mr. Mulally might say to people who viewed the loan guarantees as a bailout, he replied in a chipper voice, “I would characterize it as an enabler.”

      I suggest that this, when combined with the massive aid packages to the armaments industry, indicates the presidency is being shaped to “enable” a major war as the US credit system implodes.

      And how will the New Zealanders vote? We are already have. Like our American brothers and sisters we have cast our crucial votes at the petrol pump and at the airport terminals and with our acceptance of the ETS and the Electricity Reforms. And those of us who are addicted to uses of mineral oil at its current 0.4 cents per man-hour of labour equivalent are going to make pretty toxic neighbours for the rest of humanity. Think Fairfax and terror –and know that’s just the entre. I think I would rather have that P lab back next door, thoroughly evil as it was.
      Thank you for this platform SCOOP News.

    7. By stuart munro on Sep 19, 2008 | Reply

      A nice piece of work Gordon, but I doubt NZ Politicians will learn anything from American financial misadventures.

      There are traditionally two kinds of people in the world, the stupid , who refuse to learn from their own mistakes, and the wise, who not only learn from their own mistakes, but try to learn from other people’s mistakes as well.

      If you listen to NZ politicians you will readily discover that they never make mistakes. As a result, they can have learned nothing from the last thirty years, they are inevitably members of the first group, not the second.

      I wouldn’t feed them to my notional dog.

    8. By Jum on Sep 20, 2008 | Reply

      - Labour Supporters -

      Walking and Cycling Across Auckland’s Waitemata Harbour Bridge
      (You can do these things over the Manukau!)

      The Get Across Campaign ( http://www.getacross.org.nz ) is organising a rally at 2.00p.m. Sunday 21st September under the Auckland City end of the bridge.

      All Labour people have a chance to show your support for the PM and Labour by turning up. Enjoy.

    9. By Evelyn Gilbert on Sep 22, 2008 | Reply

      John Key,
      Was in November 1999 The managing director of debt for Merrill Lynch his job? overseeing the development of new financial instruments such as derivatives. The same derivatives now causing the collapse of the global finance system. Added to that he was an upon invitation only advisor to the Federal Reserve. According to the Feds website three others were advisors that year.
      One for Lehman, one for Citigroup and one for UBSWarburg, together with John Key’s Merrill Lynch four banks most hurt by the Subprime crisis

      http://findarticles.com/p/articles/mi_qa3715/is_/ai_n8869409.

      I think John Key has a very good reason not to want to talk too much about his role as a banker.

    10. By James on Sep 25, 2008 | Reply

      Iain Stuart you have hit the nail on the head. I tip my hat to you sir.

      Now, how do you propose that New Zealand implement the Social Credit system, when the only party advocating it (the Democrats for Social Credit) is languishing out of parliament with a substantially diminished membership from the glory days of Bruce Beetham, and lacking any kind of media coverage (unsurprising, given who owns the media)?

    11. By James on Sep 25, 2008 | Reply

      Apologies that should be Iain Parker (I don’t know where Stuart came from).

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