Absolute Bollard

Gordon Campbell interviews Reserve Bank Governor, Dr Alan Bollard

After the economy has hit the iceberg, how much effort should you devote to manning the pumps, and how much in trying to dodge the icebergs that keep on coming ? And when do you abandon ship, and spend your retirement working on ways how the economy might survive the sort of icebergs that are likely in future ?

Since the recession hit 18 months ago, Reserve Bank Governor Alan Bollard has stayed on board. To date, he’s used fairly orthodox tools to try and keep New Zealand’s holed and listing economy afloat. He’s been pulling on interest rates, and jawboning the banks like it was 1999. In early May, he even seemed ready to shoot down anyone trying to lower the lifeboats, and paddle off towards the mirage of a recovery. If there is going to be anyone speculating on the future direction of the good ship SS New Zealand it will be Captain Bollard, and the fair weather bankers offshore.

Of late, Bollard has been fighting the recession on at least three fronts : (a) in slashing interest rates again and again (b) actively taking on prudential supervisory roles with respect to finance companies, banks and (soon) insurance companies and (c) creating a window for banks to swap high quality mortgage securities to help them through any liquidity problems they may be facing.

In addition, Bollard’s public commentaries on the economy (within and beyond the RBNZ’s Financial Stability reports ) have been more forthright than anything publicly from the Beehive, or from Treasury. His recent signal for instance, that interest rates would be held at 2.5 % or lower until the end of 2010 was a remarkable attempt at killing several birds at once.

Take your pick about the motives. Was he trying to stifle a premature speculation-driven ‘recovery’ that could only torpedo a more sustainable export–led one? Was he trying to stop people from fixing in low mortgage rates, on mistaken faith that interest rates would soon bounce back higher ? Was he trying to stop an inflow of speculative money chasing those same illusory higher rates, and thereby kicking up the exchange rate ? Or was it simply a reflection that Bollard really did think the New Zealand economy would be tanking for this year, and all of 2010 as well ?

The unprecedented action – and its multiple meanings – only underline just how much of a casino that the formerly staid business of central banking have become. Around the world, as the Economist noted recently, central bankers are tossing out the old rule book of inflation targeting, pure and simple. Scoop sat down with Alan Bollard recently, to talk in general terms about his job, without frightening the markets.

Campbell : You’ve been governor since September 2002. Looking back, what been the most satisfying moment during your tenure in the job?

Bollard : Well, I came in at reasonably calm times, but at a time when there was inflation pressure starting to mount. I suppose we’ve been through a big series of price bubbles, so we’ve really tested our price targeting over that period. I think it has, broadly speaking, worked. So I don’t think I’d point to one thing there. But the fact we’ve gone through what in some ways has been the biggest price shocks since World War II – or the Korean War anyway – and come out the other side with the economy still in reasonable shape is satisfying –

Campbell : And what part did you play in that ?

Bollard : Well, partly a timing one. I mean, at what stage in that cycle do you have to get in and start pushing monetary policy to slow down borrowing. And to slow down purchases of assets where you can see price bubbles coming. And at what stage can you see what’s happening…? People on the outside probably think that we have a more complete, more up to date view at any one point than we really do. People have to be realistic about that. Then… its knowing just how hard do you push without squeezing the economy too much, and without negatively [affecting] that part of the New Zealand economy that is vulnerable, which is the trading sector.

Campbell : And is this the sort of job where you can say well, my goal for the New Zealand economy has been achieved, and its now time to ride off into the sunset ?

Bollard : Well…stuff happens and stuff keeps on happening. So I don’t think anybody in this position will ever be in that place, unless you want to close down the economy, and let that ride off with you as well.

Campbell : What I’m saying is – did you come into this job with a goal in mind, that you have yet to achieve ?

Bollard : No. Well, I did in the sense that I wanted to help New Zealand’s macro-economic stabilization, so that people could get out and do the best they could for New Zealand. But I didn’t come in with a targeted view that we were going to go through a massive price acceleration worldwide, and then a massive recession – and that I was the person to help us get through that.

Campbell : People, I would wager, probably have very little idea what you do, day by day, week by week. What did you do last week ?

Bollard : (Pauses) Last week was a long time ago. I was overseas.

Campbell : Try yesterday then. What did you do yesterday ?

Bollard : Well, I mean this week….we’ve been working on some things in house around bank supervision. We’ve been doing out usual monitoring of the international economy for monetary policy purposes. And we’ve also been doing a number of things in the organization around making sure we’re running our monetary settlement systems, all our computer systems satisfactorily.

Campbell : When you say you monitor the global situation – presumably, that’s not upstairs with a telescope ?

Bollard : Well, a bit of it is upstairs with a telescope. But I mean, compared to weather forecasters, we don’t know if its sunny or rainy out there right at the minute. We’re relying on last year’s data which is being revised. We’re relying on talking a lot to businesses. We’re relying on business opinion surveys. We’re relying a heap on all the data that comes out of Statistics New Zealand and other sources. We’re relying on some short term indicator ,models, and we’re relying on our more heavyweight models of the economy. But just at the minute, most of all- we’re relying on what we see happening overseas. That’s been the big driver. We’ve had some big shocks, they’ve all been negative. Particularly from late last year through to now, we’ve just had to change our mind on our trading partner growth profile, and that’s been a big feeder.

Inflation – past and future

Campbell : In New Zealand, the central bank has had the one main focus, on price stability – and the main lever, interest rates. Has the global recession invalidated that focus ?

Bollard : Well, we’ve in actually a luckier position in many ways in New Zealand than overseas, with the global recession. Partly it hit us later, and less. That’s made it easier, any way. Apart from that, we’re a small, full service central bank. There aren’t many of them left in the world. So, we’re doing not just monetary policy, but we’re looking after bank regulation, we’re looking at financial stability, we’re looking at non-banks and insurance companies. We’re looking at payment settlements systems, we’re pushing out cash through the system. We’re doing foreign reserves management, we’re doing liquidity management. All those functions are bringing quite a lot of information about what’s happening around the economy. And actually yes, we’ve got a primary goal in monetary policy of inflation targeting with the interest rates, and we also have a statutory responsibility on financial stability with some other tools. We’re a bit unusual to do it all in one organization.

Campbell : I wasn’t saying inflation targeting was the only thing you did. Here and elsewhere though, the question mark regarding central banks has been – has the recession actually invalidated that primary focus ?

Bollard : Well, I’d say no. But it has stressed [put stress on ] that primary focus. But I’m saying less for us than others. A lot of banks overseas are saying : I wish we had a financial stability function.. I wish we did prudential supervision. I wish we had the tools –

Campbell : All those are fairly recent concerns aren’t they ? During the 90s in particular the perception of the job has been that we were one of the inflation-targeting central banks par excellence

Bollard : We were the first. We set the…

Campbell : And what I’m wondering is if that approach and that prime focus will survive the recession. Are we expecting that when the crisis blows over that we will return to the pre-2007 focus and settings ?

Bollard : Well look, to me that depends on whether we think we are going to be stuck with ongoing macro-stability problems. Yes we are. Are we going to be stuck also with ongoing financial stability problems ? Those are the two parts of the shop. Two different things. No, we think we will ultimately get over the financial stability problems. And that will be back to fair weather, there. But will we still have macro-stability ones, you bet. There will be monetary policy…will it be focused on inflation targeting ? Well, I think so. I think we’ve proved that we can interpret that broadly enough that at a time when there isn’t direct inflationary pressure as there is at the minute, we can add a lot of stimulus to the economy. But will you have people going around trumpeting about inflation targeting around the world ? Probably less so.

Campbell : That is the perception. That rightly or wrongly, central banks will emerge from the crisis with a bigger role in the markets, a bigger role in devising the framework of regulation, and a bigger role in the process of prudential supervision. I’m assuming that will be the case here, too.

Bollard : Well, yeah. And its easier here, because its all in one organisation. Whereas in a lot of countries like the UK, they have to argue between institutions about who just does what, and how they co-ordinate.

Campbell : Inflation targeting plainly wasn’t enough to prevent the build-up of imbalances that presaged the crisis, and for obvious reasons, it has been insufficient to deal with failing banks and financial market stress as the crisis has developed. In your views, is there a need for new tools to regulate the financial sector to prevent such crises in future ?

Bollard : Well, monetary policy and inflation targeting was never intended to regulate the financial sector, fullstop. It was hoped that it would help prevent the build-up of external imbalances, which it hasn’t done so much here. But on financial stability, everyone around the world has been looking at what are the appropriate tools to stop banks going through this sort of story again. Some of it has to do with the buildup of those very big asset inflation bubbles. Some of it has to do with the operating behaviour of significant important world financial institutions. They’re not here. We’re an observer…a lot is going on institutionally, in the northern hemisphere. There are some big stoushes between different institutions who would all like to set the standard for new regulation…that’s yet to clarify.

Campbell : Even at the monetary policy level, shouldn’t someone have seen that the prior narrow focus may have been inadequate? Given that not only this meltdown but the Japanese crisis in the 1990s and even the Great Depression all occurred against a backdrop of price stability ?

Bollard : Well, I don’t think people should have expected price stability to automatically deliver financial stability. And it hasn’t. And that hasn’t been a surprise from our point of view. Should people have seen the depth of fragility of the financial sector or the financial imbalances ? Maybe. A of people talked about it, but no-one quite new how the bubble was going to burst. That certainly reflected on regulatory failure.

Campbell : So, given its wider role here, is there anything that a central bank can do to prevent price bubbles from forming, rather than just helping to clean up after they have burst?

Bollard : Well, if we always had the attitude we should at a certain point, be trying to stop them on the formation side, rather than just the clean-up side… that was an Alan Greenspan arguiment and it wasn’t always accepted by a lot of central banks. That attitude was one that said it was just too hard to see it coming, let them prick the bubbles and then clean up the mess. That wasn’t our view but really, monetary policy is limited on what it can do on all of that –

Campbell : What tools can pre-empt it?

Bollard : I don’t think you’re going to find anything which does that perfectly. You should expect to have interest rate control at the same time as you’ve got capital and liquidity controls in the financial sector… but you know, ultimately, interest rates are only going to work to a certain extent and you may need to have regulatory step-in, at certain points.

Campbell : There is a lot of talk around the need for central banks to become adepts at macro-prudential supervision and systemic risk analysis…. Are you able and willing to take on such tasks ?

Bollard : Well, we have taken on such tasks on the prudential supervision side. So we regulate the banks and we’ve got tougher on those and we have got more powers. We’re also now taking on finance companies and savings institutions. And assuming the government passes the appropriate law, insurance companies as well. But the big one of those is banks. And to do that, we’re extending the traditional main [indecipherable] we’ve had, which is capital/adequacy ratios, to include liquidity requirements…Generally. we’re much closer to the banks than we used to be, on that. On financial stability, there aren’t the sort of holistic tools available to ensure financial stability across the whole place. But we’ve been using a mixture of things. Through our financial stability reports we monitor all that…but some of it does amount to us saying we think this, so vulnerability is in there. We’re not automatically in a position where we can address all this.

Campbell : Won’t that – and shouldn’t that – serve to politicize your role? Because some of these decisions involve the allocation of public funds , the public shouldering of debt, the buildup of regulatory power etc. Shouldn’t all that be done with much greater public accountability ?

Bollard : Well, if there’s public financing involved, as for example with the deposit guarantee schemes then it must be done with the appropriate other parts of government – which are typically, the Minister of Finance and Treasury. Actually I mean, the law is very clear on this. If there are public appropriations to be made, we can’t do them. Generally those are done – that is, the deposit guarantee scheme is done under the Public Finance Act. The Minister of Finance takes it over, and he has delegated that to Treasury. We are advising Treasury who are technically closer to a lot of the institutions.

Campbell : What I was getting at is that this recession will – and maybe should – undermine another plank of the pre-2007 consensus, that central banks be as far removed from politics as possible. That’s what the appeal of the single focus was – that it made monetary policy look like a technical fix, and not a political decision. As Reserve Bank powers expand, won’t the illusion of political independence be harder to sustain ?

Bollard : Well, political independence…we are clearly specified to be politically independent on the creation of monetary policy. Not on the setting of the goals but on the operation of them. I’m sure that is going to continue. On financial stability and prudential supervision, our Act has specified a careful intermixture of responsibilities, some of which are with me, the Governor – and some of which are with the Board of the central bank, some of which are with the Minister of Finance. Sometimes each party has got a veto, some of it is Orders in Council. So….if for example, we believe a bank should be put into statutory management, there is a recommendation to the Minister of Finance. Its his decision, not ours. There are a number of checks and balances. Outside monetary policy, we are not a clearly, fully independent body. It is specified where our powers are though.

Campbell : Yeah and it’s the de facto exercise of those powers that raises the accountability issues. You widen the array of tasks you have a role in, and the clean clear lines of independence get blurred.

Bollard : In a period of great stress, yeah. They can get blurred. Although we’re always very careful to make sure we’re following the powers. But what has happened over the period of this recession is that, we, the Minister, and Treasury have been pretty close together on a number of things. Because stuff has happened pretty quickly. Sometimes things happen, sometimes its only rumour and you have to give stability and certainty. So I think it has been very appropriate that we have been seeing the Minister much more than we used to. And are close to Treasury on all of that. And we’re part of the government for that – and that’s the way it ought to be. We don’t stand aloof.

Exchange rate

Campbell : Can and should the Reserve Bank be trying to sustain a stable exchange rate over time?

Bollard : What we would like to do is apply price stability in a way that it helped assure exchange rate stability – at levels that weren’t at odds with fundamental drivers through the economy. I’m using my words a bit carefully here. We know we can’t directly impact it. Sometimes under certain conditions things we do, do indirectly impact it – sometimes unfortunately. At the moment, my worry is that we could see some sort of premature recovery triggered by people thinking for example, that ist time to climb back into the financial markets that led to borrowing that led to in turn, over time led to rates going up.. And led in time to the same pressure on the exchange rate. We wouldn’t want that again.

Campbell : It has been the yo yo swings in the nominal exchange rate that have hurt and deterred exporters – and people could say, well the Swiss National Bank bought currency recently to drive down the Swiss franc. Is that sort of thing a regular option in New Zealand ?

Bollard : We have done that. We made that decision three years ago. When we wanted to be able to buy and sell foreign currency at a point that we thought were extreme points on the cycle – to try and knock off the top of the cycle and knock off the bottom…We didn’t think we could do a lot more than that. That’s roughly been what’s happened. In terms of short term volatility,we don’t think we can iron out short term volatility. But you see, most short term volatility over the last three years has derived off US dollar movements –

Campbell : Right. Which are beyond our control. The contrary risk is that once this crisis passes, central banks will be too slow to raise rates, and to wind down their credit programmes – thus unleashing inflation. Is that going to be a problem in New Zealand ?

Bollard : Well yes, it is a risk. Partly because we don’t have a certain view about how the future is going to go, when we are going to see the upturn and how strong it will be, and how persistent…and how much untightening it will require. I’d say the bigger risks for us are how the big Northern Hemisphere economies read that and react to that. Because while we’re still doing quite orthodox stimulatory policy, they’re not. They’ve got into unorthodox stuff and some of it will be very hard to unwind, and it will be very slow to unwind. At some stage they’re going to have to say well in a year of reasonable growth, we’re going to have to start tightening. That will probably still have to happen at a time when unemployment is increasing. That is going to be a tough call.

Campbell : And on the downside – if prices keep falling and deflation deepens, what tools will then be left in your toolbox – for a central bank that wants to promote growth ?

Bollard : We don’t think that we have necessarily reached the bottom of traditional monetary policy – if we need to. I should say though that we’re not worried about deflation in New Zealand. If you mean, prices continuing to go down on a medium term basis. We think New Zealand would be the last country in the OECD to worry about that. But if you’re thinking about hr economy still contracting well yeah – monetary policy is designed to give stimulus, and we’ve still got to see some of that happening…If we felt we’d got to a stage where we thought monetary policy wasn’t having its normal orthodox impact, we have prepared to do other things…I’m talking about [such things as] quantitative easing. I should say I’m not expecting to have to use them as I see things at the minute. Because we see them as really imperfect tools, I’m hoping we never will.

Campbell : What about things like negative interest rates ? Is that situation likely ?

Bollard : We’re not really expecting that. We’re not looking to have to counter that, to have to go there.

Campbell : For most of the past decade and a half, the Reserve Bank could only claim to have controlled inflation if it ignored the fact that inflation was raging on in house prices and asset prices. Fair criticism ?

Bollard : We didn’t ignore that. We had a slow impact on it. But we had an impact on it. You would have seen the impact on it. We finally brought it down. From hindsight – and absolutely from hindsight – we might have pushed a bit harder, earlier. But we were having quite an impact on pushing up the exchange rate. And we werewanting to avoid doing that. If we’d pushed harder, we would have probably pushed up the exchange rate further, with an even tougher time for the exporters.

You’ve got to remember we were pushing harder and faster than almost any other country in the OECD. And we were getting a lot of flak for that. For those critics who come back and say we should have gone further, no. I go through the files and three years ago, you were criticizing us for going so hard.

Campbell : That only illustrates the feedback loop involved with the Reserve Bank’s actions. To spell it out : you may use high interest rates to dampen inflation but those high interest rates attract overseas funds, that drive up the exchange rate and push inflation higher – leading the Reserve Bank to pull even harder on interest rates, and onwards and upwards it goes –

Bollard : No, I disagree with your logic on that. But finish your question.

Campbell : Well the people on the sidelines complaining at the time were the exporters who were being caught in the high interest rate/high exchange rate trap. Wasn’t there an error built into the process, in that you were fostering the conditions you were trying to treat ?

Bollard : We didn’t have any impact of increasing inflation. We arguably did have some impact on exchange rates. Actually that pushed down some prices and decreased inflation.

Campbell : Where’s the error of logic ? I thought the high interest rates brought in funds that fuelled the availability of credit – and besides pushing up the exchange rate, the process fosters inflation by lowering the cost of imports.

Bollard : No, as we pushed up the interest rates, that made it more attractive to save, and less attractive to consume. Having said that, New Zealanders through that period were very strongly consumption focused and we seemed to need to get higher nominal rate in New Zealand than in other OECD countries, to slow them down. We were encouraging savings by pushing up interest rates. The exchange rate side of it relates to the fact that New Zealanders in consuming, were consuming more than their budgets and were borrowing. The banks were lending to them. How were the banks financing that ? Not from domestic deposits because New Zealanders weren’t providing those – the banks were funding them by going offshore and getting international funds. They then had to swap those foreign currency funds into New Zealand dollars – because they were lending in New Zealand dollars – via the third leg of the transaction. Going through Eurokiwi and Uridashi bonds. And that’s what the Japanese housewife and Belgian dentists were dojng- covering that exchange rate for us. Arguably, some of that trade did push up the exchange rate. As it pushed up the exchange rate, this made it more expensive for New Zealanders to buy imports (sic) which slowed things, but it did hurt traders. The exporters.

Campbell : So if the Australian banks were central to this process in the late 90s, early 2000s – could and should the Reserve Bank have better managed the credit addiction being fed by the banks ?

Bollard : Well, we might have gone out a little bit earlier to the banks and pushed at that end. You know, the lending rather than the borrowing end. We did do that, a couple of times around ’06. Saying, we are getting a bit concerned about how much you’re lending, and on what terms. And the banks did start to respond. They were a little bit slow but some of them did respond on that. Should we have done that a bit earlier? Yeah, from hindsight, probably a bit. But there’s a limit. Actually, to what you can do. Actually Kiwibank was the one that was lending so much through that time, It was really sparking a lot of that competition and lower lending rates. but y’know…that was just the market.

Current Account Deficit

Campbell : In your view. did the reform process in the late 1980s and early 90s create any structural weaknesses in the New Zealand economy that make a chronic current account deficit likely ?

Bollard : Looking back, what’s happened out of the reforms is that the government accounts got in very good shape. That’s been very valuable through this [current] period. Corporates, through that very tough period in the late 80s, early 90s..they have responded by getting their balance sheets in very good order. They have gone into this nasty recession with very healthy balance sheets –

Campbell : Thanks to the boom times ?

Bollard : Well, I mean, look at the late 90s, early 00s, Corporates suffered much worse at that time than they are now. Because their balance sheets were a mess at that stage. They’re not now. The part of the economy that hasn’t had its balance sheets in order is the household sector. Somehow, the household sector came out of the ‘87 crash thinking they shouldn’t go into equities and have come through that longer period thinking that property investment is the way to go, and that houses never go down in price. And that’s what you should load up the balance sheet on. And once you’ve done that, you can feel reasonably secure about borrowing,and leveraging and consuming.

Campbell : Surely, you shouldn’t be sheeting that home entirely to households. Because there was another player in that, namely the banks – who were a ready source of temptation, and it was the availability of easy credit that made those levels of household lending possible.

Bollard : Well, I wouldn’t accept that just because banks want to offer to lend, that households should blindly go out and borrow. Every supermarket sells goods, it doesn’t mean every household goes out and gorges itself . You’ve got to make sensible decisions about all that – so I do think households have to bear responsibility for making sensible decisions for themselves both now, and in the future.

Deposit guarantee scheme

Campbell : You said in the Reserve Bank’s Financial Stability report last November that there’s a moral hazard associated with such guarantee schemes. Where’s the moral hazard ?

Bollard : The wholesale guarantee scheme ?

Campbell : Yes.

Bollard : Is that a quote?

Campbell : That’s in the Financial Stability Report [summary] that you sign at the front.

Bollard : The wholesale one, I’m not sure. The retail one has its distortions in it, we always knew that. They were unavoidable. They’re trying to find a boundary line between deposits and non-deposits, financial institutions that are in, and corporates that are out. (pauses.)

Campbell : And looking ahead, are there moral hazards involved with the wholesale deposit guarantee scheme ?

Bollard : I don’t want to comment on that further publicly. The reason being that just purely from a procedural point of view, when we talked about that earlier, we were still the lead agency on that. Now, we’re not. Now we’re an adviser to Treasury. Because that’s a public finance matter and it will be the Minister who will make decisions on that, not us.

Campbell : Hmmm. Because it goes to the questions earlier on accountability. We had an example in January and again in March where without recourse to Parliament, the fees that banks have paid for getting the advantage of this scheme have been reduced.

Bollard : That’s within the power of the Minister.

Campbell : Does that seem fair ? And robust ?

Bollard : Well, the Minister has got those powers. Parliament gave him those powers in the Public Finance Act. So I’m not equipped from a political economy point of view to comment on that but its quite clear..

Campbell : That he can do it ?

Bollard : And changing the fees was just an adjustment around pricing. Initially we had to have a stab at the pricing. And as we saw the markets staying closed for much longer and much tougher than we expected, we decided to adjust the pricing.

Campbell : Yes, but from the punters point of view, as the bank debts roll over and the taxpayers gradually take responsibility for more and more of that debt, the banks get to pay less and less for the privilege.

Bollard : Well, that’s really a question for the Minister, who has to make a decision on those things. But I would point out that Australia’s rates have gone down, and the UK’s rates have gone down, for similar schemes. That was really because the markets through that period were really risky. And uninviting. More so than we thought when we initially designed it.

Campbell : Yes, but in one direction we are being told that Australasia’s banking system is the soundest in the world. In the IMF global ratings, Aussie banks comprise the majority of those with triple A ratings. The banks here have also been relatively liquid, with fewer of the toxic instruments that undermined the US and UK financial systems. You could conclude that of all those in the developed world, our banks needed these guarantees the least. Why did we provide them?

Bollard : Well, the answer to that is there is still a structural weakness around Australian banks. That is, that they are funded offshore, largely. And are funded quite short term. Now, we’ve always been aware of that potential funding vulnerability. So what you comment on is right, but really relates to the asset side of their balance sheet. They haven’t taken on bad assets like a lot of banks. But on the liabilities side, that is more difficult. And when we saw the term funding markets closing up last year, that was a real issue for them.

Campbell : With unemployment here on the rise, is there any reason to think that defaulting New Zealand mortgages would pose a stability risk to those Aussie-owned banks?

Bollard : Well, we have been looking at that. I mean, that’s not a recent feature..They can see impaired assets. And asset impairment is growing quite significantly at the minute. But from very, very benign levels. And we don’t think it is going to grow back to the sort of levels we had in the late 90s. Its is going to grow through this year, and it is going to hit their profits through the year and that’s yet to happen…particularly in property development. Bits of agriculture could be quite susceptible. but we don’t think its going to be very bad.

Campbell : That debt exposure in agriculture – is that a real concern, because the IMF did pick up on it last well.

Bollard : We did look at that, and went around and talked to the banks 18 months ago now to start slowing that down. And they have slowed it down. Because, we were concerned in the dairy sector quite a lot of borrowing, on the back of big increases in dairy prices and big increases in dairy farm prices…there is some significant exposures , in some of the newer conversions. But we are reasonably confident there are not going to be major problems there.

Campbell : The multiple of debt exposure [ in agriculture ] to value added worth in agriculture is very high – its mentioned in last the Financial Stability Report – and it looks to a lay person, a bit alarming

Bollard : You’d need to see it against the value of assets. As to whether there was any fragility in the pricing of those assets.

Campbell : Well, the IMF last Monday also expressed concern at the risk the dairying conversions may pose.

Bollard : Well, I think they’re probably repeating things that we told them. We’ll need to go through the cycle on this. We’’ll need to see what happens over the next two years. But as I say, we’re not overly worried but we talked to banks about the direction they were pushing it, and it [lending to agriculture] is slowing down significantly now.

The Future

Campbell : Is the era of massive bank funding of credit over, in your opinion? Even if just due to the recession, are we over the hump as regards the availability of easy credit ?

Bollard : That’s a good question, and we can’t be definitive. We do have a picture in our mind about what the new world looks like. And it’s a world where global imbalances are much reduced, and with it, th appetite for funding. It doesn’t mean we’re automatically clear about how we go through the transition. In my view, that new world has New Zealand’s external balances much reduced. And that implies that the household sector starts to go through more balancing, borrows less, invests more, saves more. Yeah, we are already starting to see that happening. But a lot of this short term, so it’s a bit hard to know how much of this is going to persist.

Campbell : The bank profit estimates released on Monday [18 May] didn’t look like things are slowing down. Here…have a look.

Bollard : Oh, these are just the producer price inputs and outputs. And I think they’ve just looked at the output minus the input for the banking and finance sector.

Campbell : My point being – and whether this was the intent or not – putting the taxpayer on the hook for the banks’debt through the wholesale guarantee scheme removes the risk discipline that the banks might otherwise face for the credit worthiness of their lending. Couldn’t people look at this and think – holy cow, these guys are now going to think that all their Christmasses have arrived ?

Bollard : Well,,,,(pauses ) yeah, the New Zealand taxpayer is providing services for the banking sector now that it hasn’t in the past. And part of those will reduce the cost of funding to the banks. In doing that, its only intending to partly compensate for the very nasty financial conditions. And the general cost of funding to the banks has gone up quite considerably through this period. No question about that. Theyre paying a heap more for deposits and they’re paying a LOT more for international funding by the government guarantee.

If your question is – should the government be standing in there while the banks are still making profits that’s a question that the government can be asked.

Campbell : Its the taxpayer who is standing in there.

Bollard : Well alright. The taxpayers’ involvement here is less than in the Northern Hemisphere – where really, they’ve taken on a very big burden. Actually, the banks here have hardly used the government guarantees.

Campbell : Yet.

Bollard : Well, at all. And in fact. We’ve been out there pushing them to use it more. [But] instead of going out to the international markets under the New Zealand government guarantee, generally they have been getting funding from their parent, under the Australian government guarantee.

Campbell : Isn’t it a bit early to be making a call [verdict] on this , though ? It is only via a gradual roll-over of debt that the taxpayer stands to pick up more and more of the burden of the guarantee. So, by this time next year, do you have any figure in your head as to what the level of exposure under this scheme will be ?

Bollard : We’ve sort of looked at numbers. You’re talking about the wholesale guarantee. The thing is as the [international] markets ease, and banks are more active going out to them, its most likely the New Zealand government will start to push the fee price up to the banks, to make it less attractive to do it under the guarantee. So you will find there is a much reduced taxpayer subsidy, as conditions improve. Its ,much easier for the wholesale guarantee to reduce the subsidy because the government changes the price all the time.

Already we’re seeing in the Australian markets, we’re seeing some of the Australian banks – who had been borrowing under the Australian guarantee – also looking at what the market looks like for funding without the government guarantee….so if the markets loosen up, you’re gig to see the banks avoiding this guarantee scheme.

Campbell : So, are there clear bright lines between what parts of the banks liabilities are being met by the guarantees and what isn’t ?

Bollard : No. That’s decision taken by Treasury on a case by case basis. When a bank wants to go out for significant funding, they have to go to Treasury for their proposal. Now there ‘s only been a few of them so far. In fact, until last week there has really only been one significant one.

Campbell : Was that the ANZ one ?

Bollard : Yes. And if anything ,we were worrying that the others weren’t going out. Now, over this last week, BNZ has started an East Asian one. And Westpac has just completed, or is in the market …

Campbell : So what’s the ballpark estimate – to return to that question – of what the taxpayer liability will be in a year’s time?

Bollard : Can’t answer that. Because they get their funding from a while range of sources for different tenures and they are doing mixing and matching at any time. Treasury will have a view about the potential taxpayer exposure …but as I say if it looks like there will be a lot of activity going on, that means the market is getting better, and that’s when we will get interested in increasing the fee.

What we’ve been saying to the banks is – we don’t want you going into comfort zone, closing down your balance sheets and not lending. We want you to keep lending – particularly to the business sector to fund New Zealand investments through this nasty recession. And reluctantly, they’re doing that but only with tightened lending conditions. So from outside of the street, we’ve been more worried about that. But its Treasury’s job [regarding] the taxpayer interest.

Campbell : In conclusion, Ben Bernanke at the Federal Reserve has thrown away the central banking rule book. When you look at some of your equivalents in the US and the UK you seem like the only guy still cleaving – relatively speaking – to the straight and narrow.

Bollard : We have been quite orthodox. But only because we have been able to be, as has Australia. Because we haven’t faced those terrible toxic assets, the huge asset buildup that happened in the Northern Hemisphere…. so I wouldn’t preach to any of them.