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John Paine: September 2007 Finance Newsletter

John Paine: September 2007 Finance Newsletter

Well it’s been an interesting time since my last GLOBAL VIEW with the global “credit crunch”, and the New Zealand non-bank liquidity crisis.

The sub-prime mortgage debacle which led to the credit crunch was something that was inevitable and predicted in my April GLOBAL VIEW and earlier Easy cheap money and poor credit control first came to roost in the U.S. market. But it could have happened anywhere - and probably still will.

It’s fine borrowing a large proportion of the money needed to buy a house when prices are going up. But it leads to tears for borrowers and lenders alike when house prices are stable or going down –especially when central banks are attempting to combat inflation by raising interest rates.

You don’t have to be a rocket scientist to figure that out.

What’s different this time is previously the effect was limited to a relatively small number of lenders in the country – and possibly the economy - in which the problem first occurred.

But now it’s being felt world wide as the mortgages have been packaged into debt instruments - like collateralised debt obligations – which have been sold down to investors worldwide. The idea was to spread the risk as different types of financial assets made up the debt instrument.

Hedge funds seeking high returns for their investors have been a classic example of buyers of these instruments.

But now the real problem for the holder of the debt instrument is nobody knows where the risk – say a defaulting mortgage in Texas – lies.

And if you don’t know where the risk lies you can’t price the debt instrument.

And if you can’t price it you can’t sell it.

And if you can’t sell it you have to bring the original loans back on to your balance sheet.

And if you bring loans back on to your balance sheet it throws your ratios out and makes it harder to borrow the money to lend.

And so on.

But enough of that. It’s all about the perception of risk – whether it be investing in a multimillion dollar hedge fund, a non-bank lender, or the carry trade.

Largely as a result of the flight from risk the carry trade has come under pressure and the New Zealand dollar has thankfully returned to more sane levels.

But expect currency volatility to remain. On the 16th of August The NZD had its largest one day fall in 21 years and has fluctuated considerably since then.

But the most disturbing event here - since the 9 recent finance company collapses - is investors are withdrawing their funds from non-bank institutions, presumably to the safer haven of banks.

It’s not that all of these institutions have bad loans. Many are well managed and have good assets. It’s just that investors don’t know where the risk lies and whether the higher return they get is worth the risk.

As the old saying goes “The return of your money is more important than the return on it”.

So if more finance companies fall over it will be because of problems of liquidity – investors withdrawing their money and not reinvesting it - not necessarily non-performing loans.

The real danger is lack of confidence. Finance companies, and other non-bank lenders, perform an essential part of the economy financing a multitude of activities banks will not. This includes property developments, second mortgages, small businesses, restaurants, bars, used cars, whiteware, TVs, stereos and so on. And the worst result of lack of confidence is it can lead to bank runs which really do cripple the economy.

In all, this lack of confidence has led to many non-bank lenders here not making new loans. Fortunately at Global Pacific we know the ones that still are.

The government is responding by bringing forward regulations in which all deposit takers – including finance companies, building societies and credit unions – will have to be registered with the reserve bank which will oversee their compliance.

Credit ratings will become more important –although I’m not sure that everyone understands them and realises how easily they can become out of date in the finance industry.

The interesting thing now is the reaction the central banks and governments have to all this.

The central banks in England, Europe, Australia, Japan, and Canada left their official rates at 5.75%, 4.00%, 6.50%, 0.5%, and 4.5% respectively. Most acknowledged downside risk associated with the market turmoil. The New Zealand Reserve Bank followed suit this week leaving the OCR here at 8.25%. Reserve Bank governor Alan Bollard said

“The outlook for economic activity and inflation has become more uncertain since we reviewed the OCR in July.”

The U.S. Federal Reserve makes its interest rate decision on 19th of September – the current rate there is 5.25% Central banks, including the New Zealand Reserve Bank, have injected billions of emergency funding into the markets as the yield between treasury bills and bank bills widened through demand for liquidity. As banks become nervous about lending to each other, their appetite for government securities increases.

The U.S economy seems to be slowing and house prices falling. Most analysts expect the U.S. Fed will ride to the rescue with lower interest rates, but many commentators believe any cut would have minimal effect. There is a view that a bail out now will only postpone another “bubble” just as the dot-com bubble was replaced by the housing bubble and now the credit bubble. But the Fed may end up with little choice. A credit crunch is a self sustaining destructive spiral and something will have to be done to stop it. For Dr Neville Bennett’s view on Bail Outs

We’ve always tended to look to the U.S. as the barometer of the world economy, but now things may have changed. Asia is the new economy and Australia and New Zealand are experiencing commodity price booms. Dairy prices here are up near 120% in world terms over the last year. Our terms of trade are at a 28 year high.

House sales may be down but prices continue to defy gravity with a 13% plus growth in national property values for the year ended August 2007. This has made the typical New Zealand household richer. The latest Household Savings Indicator report from Spicers shows our average net worth rose $40,800 in the past year and by around $188,000 since 2001.

But certain property assets – like inner city apartments and “coastal” sections - are showing definite signs of over supply. High section prices and increased interest rates yet to hit home, mean fewer people can afford the traditional Kiwi bach. Guaranteed capital gains are already a thing of the past so demand from investors is drying up.

Fractional ownership – where 4 or 5 people share the ownership of a bach they would only use for few weeks a year anyway – is gaining popularity and we see this as the way of the future.

So I would expect buyers to be wary of buying any property asset with the expectation it will rise in price quickly in real terms. They will need to be more selective in buying both residential and commercial property – and be far more conscious of position in both, and yield in the latter.

For examples of how position over rides everything, see the article about property prices in California

In the meantime the equity markets have been remarkably resilient. The world economies – like China - continue to power on and the money has to go somewhere. It’s only the large “Private Equity” transactions – which relied on cheap money for leverage – that seem to have suffered badly.

Meanwhile private placements to “Eligible Persons” – that is investment opportunities that do not require a prospectus – continue to be offered. For the definition of an Eligible Person phone me or respond to this email and I’ll send it to you.



John Paine B.Sc. Dip BIA Global Pacific Corporation Limited P O Box 3229,

Auckland, New Zealand

Email Web site


Please note that all opinions and statements expressed in this newsletter are indicative of my opinion only. Global Pacific Corporation Limited issues no invitation to rely on the information contained in this newsletter and intends by this statement to exclude liability for any such opinion and statement.


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