I’ve finally finished wading through the paperweight (as is the norm) aka the Savings Working Group report. Having read the initial commentary, I wasn’t that excited about the prospect but often in these reports there are useful nuggets of information. The main noise is around saving more and adjusting savings incentives especially to promote Kiwisaver.

What is not clear though is to what extent we have an actual savings problem. Our gross saving is at the low end of the OECD with Portugal and Greece below us along with two nations that might surprise: The US and the UK (page 121). There is also difficulty in analysing the differences between household and business saving. NZ is a country of small businesses and often business and household financials are closely interlinked. There is no definite conclusion around this issue and the report asks for further research into this topic, especially around data collection.

The macro level is really where the problem can be seen. When looking at the growth in national wealth, it’s clear to see that housing revaluations are the key driver (page 127) of growth since 1999. In fact “property revaluations explain nearly all changes in household net worth since 2001 (page 130). This is another way of demonstrating that we haven’t actually created any productive wealth: we’ve simply revalued our housing base and used that to fund increased consumption. That consumption has been funded by debt and that is why we have a serious debt problem.

So can we save our way out of this problem? Looking at the data on household incomes one would have to say “no chance”. Market incomes have fallen (yes fallen) for the bottom half of the population between 1988 and 2007 (page 140). That is simply astounding. This at a time when house prices have risen 490%. This is the cause of the deepening inequality between the owners of property and the renters. Even with benefits added in income for the first four deciles has remained largely the same (page 141).

Poor choices? Or simply no income with which to save. I think we must face the fact that half of our population is existing on meagre income. They cannot save and are likely to be in debt simply by virtue of not having enough cash to afford purchases or expenses outside of the simple basics of living. Those who have managed to get on the property ladder have prospered primarily because their asset has risen substantially in value. That is where their  savings lie. It should be noted though that, for many, this increased wealth is purely on paper.

At this point it might be worth looking across to data from Australia (page 128. Aussies actually have more of their wealth in residential property than Kiwis do (50% vs 46%). Investment in shares in much the same (8% vs 9%). The big difference is in long term assets. Aussies have 19% in Pensions and Superannuation whereas Kiwis have 2%. To balance that out Kiwis have 22% in business and farm assets against Aussies holding just 9%. So for Kiwis businesses and farms are their pensions. This is not an exact comparison but it’s clear that there is not much to separate the two countries other than Aussies invest in public companies and Kiwis keep it private. It also shows that Australia may have the same debt problem we do though they have benefitted more from the commodities bubble than NZ.

The oft quoted statement (from Ministers, the RB and other officials) that Kiwis should save more is somewhat optimistic. Save more from what exactly?

So what can we do? Well we can look at the other side of the savings coin and that is our expenditure. As a country we have essentially borrowed our GDP for the last 20 years. This is reflected in our current account position which has left us with a Net Foreign Liability (NFL) of 85% of GDP. Poor investment and low labour productivity (not sure where the NZBR gets its numbers from) has left is with nearly 40 years of negative current account balances (pages 20-24). The simple explanation is that we have consumed more than we have sold (plus all that accumulated and compounding interest). This consistent deficit should have seen NZ with a consistently weak currency (to allow the balance of payments to correct) but this has not been the case. NZ’s high real interest rates have been attracting overseas investment looking for a high yielding home (page 26). NZ is seen as a safe place to invest and, in an era of low global rates, has seen major inward flows which have not just funded the current account deficit but also the major revaluation in house prices.

The accumulated current account deficit has pushed interest rates thus forcing up the currency . This in turn has made imports even cheaper fueling the spending boom and embedding the circularity of higher prices in the economy (page 39). The bottom line here is that our currency is too high. This has been noted for some time but successive governments have chosen to ignore the problem, hoping that regular comments will help keep a lid on its appreciation. A 2010 IMF study estimated “that stabilising NFL would require the real effective exchange rate to depreciate by 20%”….that’s to just keep NFl where it is now. To reduce “NFL to 75% of GDP over 15 years would require the real effective exchange rate to depreciate by 25%” (page 36).

That would put the NZ$ at between $0.55-0.60. Ouch!

That is the real story to come out of this report. To summarise:

- We don’t save much because half the population has had no increase in income for 20 years.

- The other half have increased wealth due to large revaluations in house prices.

- The top 2 deciles have seen increases in wages and this is where most of the real saving is coming from (if any).

- Debt funded consumption has seen interest rates rise thereby sucking in more investment flows and boosting the currency.

- We have borrowed to live and really have no spare cash to save.

- The best form of saving is paying down debt, both private and public.

- The only way to improve our position is to export more and import less.

- The primary way to export more and import less is to engineer a significant and lasting depreciation in the currency.

- The second option is to develop and invest further in export based industries.

Adjusting tax incentives and boosting Kiwisaver are not going to help us out of this malaise. Only strong and decisive action can help us from here. So what would I recommend? That’s too much for this post but at a high level some of the following (most of which I have written about previously).

- Lower the exchange rate by direct intervention.

- Cut interest rates as well as bringing down the cost of mortgages which are still very high.

- Restrict bank credit by raising asset requirements.

- Build a self-sustaining energy sector.

- Introduce a basic income to replace welfare and superannuation.

- Liquidate the overseas portion of the Cullen Fund (now whilst markets are at 30 month highs).

- Invest more in the productive export sector.

- Oh and let’s have a land tax whilst we’re at it (this was ruled out by the government in the terms of reference!).

Next week: The Welfare Working Group reports…..can’t wait!

One of the greatest financial inventions is leverage: the ability to create an asset of value in excess of your original investment.

Simply put this is how you can buy a house with no deposit or a small one. Consider the reality of leverage:

You buy a house for $500,000 and put down a 10% deposit of $50,000.

In a few years (certainly recent times) you sell it for $600,000. You have just made $100,000 from an investment of $50,000…a 200% return. Of course you have to subtract your interest but that is what you would have paid in rent anyway or so the theory goes.

In recent years this has been the name of the game. Between 2000 and 2008 New Zealand house prices rose 169%……..!! Yes that’s an incredible number………21% per annum on average. No wonder people thought this was an easy game. No wonder leveraged investments in property became the biggest game in town. But hold on: we are talking about houses not tulips. How could such an unusual bout of asset inflation happen right under the noses of the inflation focused RBNZ.

Well house prices are not included in the CPI calculation. Call me old fashioned but that’s ridiculous.

The major problem with any bubble is that it ends. In this case NZ has not had the same end as the USA with its sub-prime mortgage induced property collapse though the NZ finance company sector did its best to compete.

But the leverage has not been washed out of the system yet. House prices have recovered from the 2008-9 fall and now are back up close to their historic highs. Why is this? Why hasn’t the NZ housing market fallen back to more realistic levels?

There’s no clear answer but I’d like to suggest one: It’s not in the interest of the banks for prices to fall heavily. Why? Because they are the ultimate owners of the housing stock. If they lend 90% to a borrower and the price of that house falls 10% then the borrower has lost their equity and the bank owns the rest. That’s how leverage works on the downside. If the price falls further than 10% the borrower is into negative equity. So far so normal. The bank will just hoover up any savings or other assets held by the borrower. But at some point the bank is left holding the security. Banks don’t like that very much so they seek to sell the asset and recover as much cash as possible. If the borrower cannot cover the loss then the bank has to write that off.

But in a bubble situation the banks have to be very careful not to knock down the price of all property. Otherwise their entire lending portfolio will take a hit not just the one loan which went bad. So banks have a vested interest in keeping prices from falling too far.

Back in 2008 I called for land prices to fall 30%. They haven’t yet but it’s simply a matter of time. In fact they only fell 8.5%…not much of a fall considering the enormity of the rise. Wages are not rising at a rate which can cover the compounding interest on the debt pile (see upcoming post on debt) so the strains of maintaining the illusion will continue to show through. Therefore the banks have a big part to play in making sure house prices do not rise or fall too much whilst they reorganise their lending practices.

What needs to happen? Well a reversion to traditional lending practices will come back into vogue: where you can borrow 2-3 times your salary. Imagine that. Median wage in Christchurch is somewhere between $30-40,000 depending where you look and the average house price is $360,000. Scary……so the banks who are operating on the interest/cash flow model (see upcoming post on definancialisation) will find switching back to the traditional model simply isn’t possible as house prices would fall by rather a lot. You couldn’t find a house for under $200,000 these days so we would have to see a severe correction, probably in excess of 30% though very low borrowing costs would help ease that.

It’s clear that the same financial practices that we have seen employed in the global bond markets have also been applied to residential lending. The valuation model shifted from the established practice of ability to repay the mortgage to the ability to cover the interest. Why? Because the price of the house would always go up. Really? Isn’t delusion fun. The fact is that prices did go up….and up…and up. As they say the market can be wrong a lot longer than you can be right.

All this creates a major dilemma for banks (who are probably aware, one hopes, of their position) and regulators who clearly are not (always happy to be surprised): How to withdraw leverage (which was a ponzi scheme) from the residential mortgage market without causing a crash? How to realise that we have been deluding ourselves as to the  ”value” of our houses. How can we explain that 169% rise? Did we suddenly become more wealthy? Er no our trade balance for the period March 2000-2008 was minus $30.7bln!!!!

No we simply revalued our property again and again for no reason other than the banks were happy to go with the valuations (also pushed it has to be said by overseas immigrants paying cash prices) which just kept going up. If house A in one street sold for 20% more then all the other houses must be worth 20% more. Housing became a commodity and so was able to enjoy the commodity style price action……….of course housing isn’t a commodity as people actually live in them. And that is what is keeping the market afloat…..but don’t look too hard at the numbers. They might make you wonder exactly what it all means.

More on that in the upcoming posts on debt and definancialisation.

New Zealand joins its larger and more illustrious economies, the U.S. and the U.K., on the slippery slope with the release today of pretty poor employment numbers. 29,000 jobs lost is no small number for a small economy and with retail numbers looking very soft as well, the Reserve Bank will soon be reaching for the “cut” lever on its interest rate management dashboard.

Regardless of the credit crunch, employment really is the key to how the economy will fare. As long as people are employed then somehow they can get by and service their debts. Well mostly. But now this will see a deeper problem emerge and that is one where people simply cannot service mortgages or debt in any way.

This will reverberate throughout the whole economy. Added to this is a report out today showing house sales down 40% in the last quarter and 53% lower last month from the previous year.

Ouch.

We’re starting to see real signs of a weakening house market here in New Zealand. Sales for Auckland’s top real estate company are down over 50% and a recent auction saw a 6% clearance rate.

I decided ton investigate this myself in Christchurch and looked at some properties recently. One i saw was a 3 bedroom unit which had been bought for $375,000 a year ago. It could be rented for about $350 a week maybe a bit more if it had some money spent on it. It wasn’t in great condition but looked a reasonable investment property.

It was auctioned yesterday and passed in at $317,500. It still hasn’t sold.

We’re not really seeing this come through into prices yet because we only get the median price which is often misleading. In fact it can go up if a few properties sell in the higher brackets and none in the lower levels.

But it’s clear that prices are falling quite heavily in many areas and there is a buyers strike on at the moment.

Although there is the belief that property prices increase regardless the market is clearly starting to realise that capital gains are not guaranteed and therefore investors are starting to look more closely at the maths.

Mortgage rates are 9.5% for 2 years fixed. Yields are 3-5% and prices are falling. Even with the negative equity tax break that’s a big yield gap to fill. There is also the issue of not being able to borrow 100% of the price anymore.

With many fixed rates rolling over this year to much higher rates, the squeeze is really on. This will really start to impact when banks ask for properties to be revalued and then ask for extra equity.

Property investors, like banks, are facing a major liquidity crisis.  Price falls of 10-20% may not be as outlandish as previously thought.

Keep going guys, Alan Bollard pleads. He asks banks and businesses not to hibernate. What?!

Is he suddenly the Finance Minister? It’s really quite odd to see a central bank governor talking like this especially since the last few years he’s been going on about house prices and overborrowing without doing a great deal about it.

Now he’s saying don’t let credit constraints get in the way.

At the same time the Commerce Minister tells investors to get savvy or get “burned”. I love it especially from a Labour government where many ministers have invested in property themselves. Financial literacy? We’d certainly like some.

The facts are very simple. Too much leverage, much of it unseen, caused an asset bubble. That bubble is now deflating and there will be some major fallout. Add to that concerns over global food and energy prices and you have a perfect storm. So for banks now to put the shutters up whilst they count the cost is simply sound business practice.

Westpac has already adjusted its loan criteria. This just fuels the need for lower house prices and demonstrates the role that banks have played in the boom. Yes the interest rate is important but only at the margin. The real issue is how much will they lend: 100% or 65%.

It’s a big difference in what people can afford to pay.  Now landlords have the power as they can raise rents and people will just have to bear it. So along with an increase in mortgagee sales we will see an increase in rent arrears if rents increase beyond peoples’ means.

So it’s a bit late for the officials to weigh in with their comments. They have had plenty of time to look at banking regulation and have completely missed the boat.

I’m trying hard not to overuse the word “tsunami” but it just fits so perfectly. It’s powerful but can’t be seen until its almost upon you but it can be felt. Witness the animals who headed for the hills before the Tsunami of Christmas 2004. Animals have a different vibration, a different level of energy and resonance which enable them to to be more fine tuned to natural disturbances. Humans have lost that ability, well most of us.

So it’s hard to realise what may be coming our way. Listen to the Westpac economists predicting more rate rises on the back on a very tight employment situation, burgeoning inflation and booming commodity prices. The Kiwi (NZ$) continues to surge forward to record highs against the US$ on the back of very high interest rates. So what is the problem.

Household debt is the major concern here, the fault line as it were. Stories today and from the past week lead me to believe serious problems are now emerging: The Joneses going under because of a slowing real estate market; a serious downturn in house prices where sales below the Registered Valuation (RV) are happening; people being kicked out of their homes; water shortages for farmers; a very strong currency; interest rates really starting to bite; banks having to go to the market to raise money to shore up balance sheets; layoffs on the increase and business confidence sinking.

Yet commodity prices continue to rise: oil, food and metals.

It’s not a pretty sight. What’s a central banker to do? Raise interest rates to squash inflation? Of course they will but maybe if they take their heads out of their discredited forecasting models they may realise that actually people are being squeezed left, right and centre. They don’t have any more money even to pay higher bills never mind higher interest rate charges.

We can’t change the fact that we have experienced a money supply induced asset bubble but we can change the way in which we deal with it.

Bollard be brave: if you need to do anything to interest rates just cut them. If you can’t see what’s coming then close your eyes and feel it.