Secret Banks' Business

Sun Herald

Sunday February 24, 2008

David Potts

LEVERAGING, an item of faith among fund managers until about six weeks ago, has done its dash as the best way to boost value. Never mind that, among nations, Australia is one of the most leveraged of all.

This could explain why our sharemarket has done far worse than Wall Street and will continue to do so. At first glance, the market looks decidedly odd. After all, it's the US that is near, or in, a recession, not us. And why have bank stocks been mauled the most when it's supposed to be their US counterparts that are embroiled in low-doc home loans to borrowers who had no hope of paying them back?

Well, the truth is out. It's because our banks are among the biggest users of the international money markets, which have now seized up. They might not have pushed dodgy home loans but they have found plenty of other subprime areas, including overgeared corporations, private equity (but really debt) funds, margin lending and even, heaven help us, extreme financial engineering in the US corporate bond market.

And that is only what we know. The mind boggles as to what they have been up to in derivatives. No wonder, then, global investors don't share the same relaxed view of our banks they have of themselves.

Anything leveraged with debt - and that includes investing in it - is being marked down savagely.

The irony is that it appears to be hedge funds, heavily leveraged themselves, that have been doing most of the short selling of bank stocks. Not that we will ever know for sure because the authorities don't monitor short selling, just as they ignore the banks' exposure to derivatives.

If, as the money market rates are telling us, the credit crunch is getting worse, then not only will the cost of servicing the debt borrowed offshore rise but we're getting to the point where the banks won't be able to raise the money they need.

Then what happens? The banks will have to cut back lending and, as the repercussions of their risky behaviour bites, they will also have to raise more capital. Either way, dividend payouts by the banks have peaked. And the market knows it.

© 2008 Sun Herald

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