Bernard Hickey: Why the worst is yet to come

The United States stock market has just completed its biggest six-week rally since 1938 because, it is said, there are "green shoots" of recovery appearing in the US economy and around the world.

Even here, real estate agents are pointing to a recovery in activity in the property market after a stronger March and suggest a rebound is coming.

Some investors and business owners are thinking the worst may be over.

Unfortunately, I don't agree. Here are five reasons I think the credit crunch and the global recession are far from over. If anything, things will get worse.

1 The International Monetary Fund (IMF) forecast last week that financial institutions globally would have to declare capital losses of US$4 trillion ($7.2 trillion) on the toxic debt they hold over slumping property and other markets. So far, banks have declared only about a third of these losses.

When their losses are declared, governments are likely to have to nationalise these banks. New Zealand's banks (and their Australian parents) are sound and are unlikely to have to book anything like the same losses as banks in the US and Europe.

But they do depend at least partially on funding from these global banks, which is why they won't be able to cut mortgage rates much, or at all.

2 The US banking system is far from fixed. US president Barack Obama and his Treasury secretary, Timothy Geithner, have yet to settle on a way to clear toxic assets from the banking system. They want to avoid nationalising the banks because it seems politically unacceptable.

Most expert observers, including the IMF, think this is the only way to solve the problem. The political heat is growing over unending bailouts for banks. This will extend over the time it takes to clean up the toxic debt mess.

3 Global de-leveraging has only just begun. Banks and others were leveraged 20 to 30 times their equity before the property bubble burst.

Now they will have to suck back trillions of dollars from loans around the world to get that leverage down to 15 or so.

That de-leveraging is on top of the effect of losing US$4 trillion in equity. As much as US$120 trillion worth of lending will have to be wound down or recalled. That's almost 700 times New Zealand's gross domestic product.

4 Economic output in the OECD is forecast to fall more than 4 per cent this calendar year. That means demand for New Zealand's exports, including our agricultural products and tourism, will soften substantially through the rest of this year.

Our recession is likely to last well into next year and unemployment is expected to head over 8 per cent.

5 Our government and Reserve Bank have reached the limit of the fiscal and monetary stimulus they can pump into the economy.

The Government can't afford to increase its spending because it would prompt an expensive credit rating downgrade by Standard and Poor's.

The Reserve Bank can't cut its official cash rate too much lower than the present 3 per cent because banks cannot pass on much of the cut to borrowers.

This is because savers here will not tolerate term deposit rates below 3 per cent and because overseas funding costs remain high. Our only choice is a long, grinding recession dominated by higher savings rates, lower spending and a gradual de-leveraging of the over-priced property market.