Brian Fallow: Back from the brink, but long, slippery path ahead

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American lawmakers may have pulled the United States and the rest of us back from the brink of economic calamity, but the path down from the clifftop remains long, tortuous and slippery.

A key unknown is how many cents on the dollar the US taxpayer will end up paying for these distressed assets.

The higher it is, the greater the moral hazard - the debilitating precedent of privatising the gains and socialising the losses, increasing the risk of it happening again and/or of maladroit reregulation.

The lower it is, the more damage is yet to be done to banks' capital.

"Oh dear, how sad, never mind," you might think. But every dollar wiped off their equity represents many dollars less lending power in the global banking system. Investors, including the vaunted sovereign wealth funds, who have already been burned will not be in any hurry to recapitalise banks.

Tighter credit means weaker growth. So one of the ways this will hurt the New Zealand economy is by significantly weaker growth among our trading partners and lower export commodity prices.

The other is more direct. The spectacle of credit markets seizing up has been a scary one, given that our banks rely on non-resident sources for a third of their funding.

Assuming the bailout achieves its immediate purpose and imported credit starts flowing again, you would not expect it to get a whole lot cheaper.

New Zealand's net international liabilities - most of which are debt - stand at $160 billion or 90 per cent of GDP. In a risk-averse, credit-constrained world, that is not a happy position to be in.

Many households live in the shadow of a mountain of debt run up during the housing boom. Restoring to more normal, sustainable levels the ratios of debt to income, house prices to income and debt-servicing costs to income will take three things.

One is a fall in real house prices. The Reserve Bank is talking about a 24 per cent fall from its peak last year; others put it higher.

The second is the passage of time and rising incomes - assuming the jobless picture does not deteriorate as rapidly as it has in the US.

And the third is a shift in behaviour towards spending less and saving more or paying down debt.

So whether a business is in exporting or chasing the discretionary dollar, the outlook is discouraging.

- NZ Herald

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