By the time you’re reading this, the rally that Australian markets had been waiting for will be on in earnest.
As I file this article, trading has only just begun on the ASX but already the Australian stock market is rebounding after one of its most dramatic weeks in modern history. With US stocks finally hitting bottom and roller-coastering back upwards nearly 400 points on Thursday night, the short-term crisis in world financial markets looks to be over – for now.
The financial panic of this week will surely rank as one of the most severe in history.
After more than a year of instability, the US stock exchange succumbed to irrational terror on Monday after the weekend collapse of merchant bank Lehman Brothers. Despite desperate efforts from United States policy makers, including Chairman of the Federal Reserve Ben Bernanke and Treasury Secretary Hank Paulson, stock prices went into freefall on Tuesday, Wednesday and especially Thursday as hedge funds made massive bets (called "short selling") that banks and financial institutions would go under. World markets followed, including in Australia, where Macquarie Bank came under sustained pressure.
But overnight, investors rushed back in to the US stock market, buoyed by massive injections of liquidity from international central banks and perhaps reassured that the worst may be over. The US Federal Reserve, in conjunction with key European central banks, has announced that yet another massive line of credit will be made available to money markets, amounting to nearly $US200 billion. The scale of the crisis was evident simply by the timing of the announcement, which was released at 3:00am on the 18th September, Washington time, just as European markets were about to open.
The liquidity was made available from the Federal Reserve to central banks in Europe, Japan and Canada in an attempt to get short-term money markets moving again. By Thursday, most banks globally were refusing to lend to each other, seizing up the short term money supply internationally and blowing out interest rate spreads on overnight lending to levels not seen since 1941. At one stage, Asian currency exchange had all but shut down, with no US dollars available as panicked banks all over the world refused to lend even for the purposes of exchanging currency.
In Australia, the Reserve Bank of Australia also injected nearly $2 billion.
The massive cash injection calmed investor fear, which had reached hysteria after a week which brought down several global financial institutions and forced others to merge or seek government bailouts. After refusing to intervene to prevent the demise of Lehman Brothers, the US Government was then forced to bail out AIG, the country’s biggest insurer, and the UK Government encouraged a forced merger of large British consumer bank HBOS with Lloyds TSB.
Even with the market bounce likely today, analysts everywhere are warning that the crisis is far from over. US policy-makers are discussing the possibility of setting up a new fund which would buy distressed financial assets from ailing banks and institutions. New York Attorney General Andrew Cuomo is investigating whether short-sellers may have acted illegally in a concerted raid on Lehman Brothers, Merrill Lynch and Morgan Stanley, while in Australia the corporate regulator ASIC has reportedly interviewed Wilson HTM banking analyst Brett Le Mesurier about the source of rumours that Macquarie Bank is under-capitalised.
The question everyone will now be asking over the weekend is: is this a suckers rally? The markets have seen several rallies like this after similar bailouts in recent months, for instance after the forced buy-out of Bear Sterns by JP Morgan in March, only to plunge into new rounds of panicked selling in subsequent days and weeks.
The economic fundamentals driving the bear market remain. The collapse in the banking sector will further hurt a US economy which seems likely to slip into official recession, while the UK and Japan may already be in one. Finance institutions are big employers in cities like New York and London, and the fat salaries of merchant bankers and traders have a big flow-on effect to these local economies. Nor is the crisis in financial derivatives which begun in sub-prime mortgages over yet.
Perhaps most importantly, consumers in much of the rich world remain heavily indebted from decades of low savings and speculative housing investment. As companies fail and consumers tighten their belts, this process of de-leveraging will cause pain right across the world economy. The Lehman Brothers bankruptcy alone was worth $US660 billion – or ten times the size of Enron. Much of this figure is debt that will need to be written down by loss-making investors. Other companies, including AIG, will now be looking to offload distressed assets in a desperate attempt to shore up wobbly balance sheets. US economist Kenneth Rogoff thinks that the size of the US public bailout may stretch to $US1 trillion.
Shareholder wealth has also been hammered. In Australia, this will be felt most keenly by self-funded retirees and those who depend on their superannuation payouts – but also by municipal and state governments, non-profit organisations and charities, many of which rely on investments to fund their ordinary activities.
But for today, at least, the bottom has been found and the panic-driven selling has abated. The market has gained enough breathing space for the next round of accusations and finger-pointing to begin.
Short-sellers? Hedge funds? Regulators? The irrational emotions of fear and greed? All must share some responsibility. Next week, newmatilda.com will look at the policy and regulation failures that contributed to this crisis.
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