Central Banks Ride To The Rescue

The Age

Friday September 19, 2008

Marc Moncrief and Peter Martin, with Eric Johnston, Vanessa O'Shaughnessy

SIX of the world's central banks have taken unprecedented joint emergency action to prop up global financial markets, as a deepening crisis of confidence threatens to plunge the world into recession.

Facing potentially the worst financial crisis since the 1930s depression, central banks in Europe, North America and Asia last night pumped US$180 billion ($A225 billion) into markets to try to prevent the global financial system from seizing up

The joint action came as more of the world's big financial houses, including the venerable US investment banks Morgan Stanley and Goldman Sachs, became the focus of intense speculation about their solvency.

Fear also gathered momentum in Australia where, despite repeated assurances about the strength of local banks, the dollar slipped below 80 US cents again and the sharemarket plummeted close to a three-year low, further eroding the savings of millions of people.

Shares in Macquarie Bank, the one-time sharemarket darling dubbed the "millionaires factory", crashed another 23% amid speculation that it may be forced into an alliance with a commercial bank.

The world's major central banks were jolted into emergency action late yesterday Australian time when the foreign exchange forward market in Asia effectively ceased functioning - threatening to halt billions of dollars worth of vital international commerce in its tracks.

Said one Australian market observer: "You can't do a trade in the foreign exchange forward market in US dollars, which is the only currency that matters."

Companies - particularly finance companies like banks - raise money on credit markets to pay for their day to day operations. The drought of US dollars would have made it not only more expensive but nearly impossible to raise funds.

The Bank of Canada, the Bank of England, the European Central Bank, the US Federal Reserve, the Bank of Japan, and the Swiss National Bank all contributed to the rescue effort, with the biggest flush of dollars coming from the US central bank.

Within an hour of the unprecedented flood of US dollars into Asian and European markets, the foreign exchange forward market was working again and prices were not too far above normal.

But the central banks' action did not save the Australian sharemarket from suffering another day of heavy losses.

After the market dropped as much as 4.1% during the day, some investors returned later, containing the fall to 2.4% by the close, putting it at its lowest since December 2005.

Macquarie Bank's dive followed a rout among investment banks on Wall Street, triggered by concerns about credit market turmoil and the demise of stalwart firms like Merrill Lynch, which was sold to Bank of America, and Lehman Brothers, which filed for bankruptcy.

Any unwinding of Macquarie - unthinkable just days ago - would not only be a financial nightmare, but would represent a major headache for governments here and around the world.

Through its fast-growing asset management business, Macquarie owns and operates billions of dollars of essential infrastructure including airports, toll roads, communication towers and Britain's biggest water utility.

Nearly every major global bank would have some form of debt or trading exposure to Macquarie while millions of small investors have exposure to Macquarie's listed and unlisted funds. -- With ERIC JOHNSTON, VANESSA O'SHAUGHNESSY

As world economy shakes, rattles and rolls, Marc Moncrief looks at what it means for jittery Australians concerned about their financial future.

MY SUPER

SUPERANNUATION is the first place most Australians will see the effects of what is happening in the US, and it is probably where the direct impact will be felt most.

Most people keep their super in a "balanced" fund, which invests their money in both "growth" assets (such as shares and property) and "income" assets (such as bonds). The typical balanced fund has about 70% of its money in growth assets, meaning that's the money directly at risk from sharemarket falls.

However, it's important to remember that the sharemarket falls are coming at the end of a massive run. Shares have risen about 10-fold since compulsory superannuation began in 1989. Many super managers have also been responding to stress by changing the way they allocate their investments.

MY HOUSE

LOTS of factors affect house prices, from interest rate fluctuations to plans for new roads or public transport.

What is happening in the US might lift our house prices if investors running from that economy choose to buy in Australia instead, but the more substantial influence pushing house prices up is likely to be interest rates. Credit Suisse says an interest rate cut at the Reserve Bank's next meeting is almost certain.

The one overwhelming flow-on effect from the subprime mess is that money has become harder to get. If people can't borrow as much as they used to, they might not be able to offer as much for houses, pushing prices lower.

Through it all, it is important to take some heart. It's not as if the bank has just foreclosed on the whole neighbourhood, as has been happening in the US.

MY INVESTMENTS

IT DEPENDS on how smart you are. For US property investors, things are looking pretty lean. For investors holding structured finance products, the outlook is even bleaker.

But amid the fear, it is important to keep a level head. Cutting losses can be a gamble in itself. Investors with good quality stocks that are taking a hit are probably trying to hold on through the turmoil and waiting for their shares to recover. One of the hallmarks of a smart investor is the ability to make money in dog days.

INTEREST RATES

RATES are falling. They fell last month by 0.25 of a percentage point. Next month they are expected to fall again, perhaps by half a percentage point.

The Reserve Bank's focus has shifted radically from just a few months ago when inflation was the big black beast. These days, in spite of inflation pushing 5%, well above the 2-3% target band, the Reserve has chosen to worry more about the impact of teetering financial markets than about price rises. That means lower rates to come, but it could also mean prices for all kinds of things will rise unchecked for a while.

As world economy shakes, rattles and rolls, Marc Moncrief looks at what it means for jittery Australians concerned about their financial future.

THE DOLLAR

THE latest round of subprime jitters has not done much to the dollar, which has been hovering around 80 US cents since it fell from near parity with the US dollar last month.

That is a bit surprising, and it may change today. When the US Government demonstrates it is willing to hand over the equivalent of about half of the Australian economy in the space of a month - about $A230 billion between the bail-outs for Fannie Mae, Freddie Mac and AIG and another $A225 billion to the world's financial markets from freezing last night - it ought to hurt that currency. However, investors everywhere battening down and returning to safety. For most, that doesn't include the Australian dollar.

BUSINESS/BANKING

WHEN bankers are doing it tough, there aren't many others who are likely to have it much easier.

Businesses need to do business to grow and bankers need to arrange business to make their money. But these days all but the most aggressive professional investors are closing their purses.

Treasury bills in the US - an investment considered risk-free - have rocketed in price. That means investors in the world's largest economy are nervous and looking to take minimum risk.

Businesses want to know what's coming next. They want to know where the next collapse might come from and they want to know how the US Government is going to react to all the madness. Until those two things become clear, money is likely to stay tight.

THE US GOVERNMENT

RECENT events will have an impact on the US election, but no matter who wins the presidency in November, new regulation is coming for the finance sector.

Business remembers well the days of Sarbanes/Oxley (SOX) - a set of reforms rushed into effect after the terrorist attacks of September 11, 2001.

In the business community, SOX was considered clumsy and heavy-handed. The US will only hurt its economy further if it overshoots the regulatory reforms that both presidential candidates are promising and forces businesses to look for more welcoming economies.

MY GOVERNMENT

AUSTRALIA, as our leaders have been telling us, is in a much better position than our peers in the US and Britain. We have nothing like the US subprime market, unemployment remains low (so far) and our banks have plenty of money to be able to keep working.

As long as those pillars are in place, we are unlikely to see massive shifts in public policy. Deterioration - particularly to unemployment - will give the Opposition a weapon with barbs.

© 2008 The Age

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