Tuesday, September 16, 2008

Why Lehman's won't happen here.

If you have no interest in Economics, skip this one.

The collapse of Lehman Brothers - an investment firm exposed to the crisis in the US sub-prime market has hit the stock market - particularly the financial centres - this morning with a 2 to 4% average drop and a drop in the US against the Euro.

Basically, what we're seeing is the US market sending shivers through all financial markets.

But all is certainly not lost.

For a start, the US banking, financial systems and market are already under investigation - an investigation held off from completion at the current Administrations insistence until Bush leaves office, I might add - by the International Monetary Fund.

Bush has been resisting this push for seven years. And there's the first difference between the American market and the rest of the world - the ability and willingness to take short term hits for long term stability.

The American ethos seems to be that any sign of short-term weakness will be exploited, and must be avoided – no matter what the long term cost.

Alan Greenspan understood the market. And although I may not have agree with the policy of Fed bail-outs to the market (As apposed to the floating of currency, we’re talking buy-out of stock by the Fed to inflate market prices), Greenspan kept the economy on a remarkably even keel for the time he was in charge, considering he presided during not only September 11, but also the burst of the tech boom.

The American Fed Reserve is the equivalent of the Reserve Bank of Australia. And whilst the workings of the RBA look incomprehensible to the outsider (and sometimes the insider), the Fed can be alarmingly transparent (unless you want to investigate it, that is).

The Fed has been, for the last year, in my opinion, at the mercy of the stock market. If we're talking about "swerves" in policy responding to market conditions, Fed head Ben Bernanke is the perfect example. Up until August last year, Bernanke resisted calls for an interest rate cut, citing the risk of inflation as his reason for inaction.

Two weeks later, the Fed cut interest rates, but stated there would be none further -the risk was simply too high.

That position lasted for a month, until January. Bernanke cut rates by three quarters of a per cent. Days later, there was another cut.

Reactionary? Tick. A sign that policy was at the mercy of the market? Tick. Foolish? I think so.

The other big difference between America and the three markets I’m using as examples (Our own, Europe, and the UK), is regulation.

Australia has quite a high standard of regulation in regards to Authorised Deposit Taking Institutions (ADIs) and what their provisions are in regards to investment versus deposits and loans. In short, your bank or Credit Union must have a certain amount of cold, hard cash sitting around ready at a moments notice should something terrible happen to the share market. That way, your deposits are safe, and the institution is far less likely to call in your debt should something like the sub-prime crash occur, as you’ve got significantly more breathing room.

Also, second mortgages and unsecured lending practices in Australia are more heavily regulated, and banks themselves have tighter procedures than in the US.

Lastly, the face of the finance sector has changed since the introduction of FSRA regulations, which were the last phase of the reforms to the Financial Regulations introduced during the pyramid scheme debacle of the eighties.

The United Kingdom has also showed its willingness to regulate where necessary earlier this year during the furore surrounding the bailout of Northern Rock. The advantage the UK has over the American financial sector is that the current Prime Minister is the former Chancellor of the Exchequer – the man who engineered in large part some of the financial reforms in the UK is now the head of the government, whilst Ben Bernanke is finding himself more and more unpopular even within the Fed itself.

The legislation of the UK could still stand to be further tightened, however, if a repeat of Northern Rock is not to be seen. Gordon Brown has promised such.

As for the European Market, this is the one that most interests me. The market there is vastly different, as there are the competing interests of so many different countries and the far more prevalent practice (particularly in France) for companies – including Financial Institutions to be privately owned rather than public.

Regulation there is controlled through the European Central Bank (ECB), and their response to the Lehman crash mirrored our own – an injection of cash through the system, but no panic buttons pressed. What impresses me even more is the concerted effort of Europe as a whole to keep things on an even keel through modest management. This piece highlights what the difference between the Fed and the ECB (And Europe’s larger banks) in response to a crisis.

The Fed in the last sixteen months has reminded me of a hyperactive toddler on red cordial. I feel like grabbing it by the scruff of the neck and sticking it in a naughty chair to watch the action until it’s learnt its lesson. Bernanke doesn’t seem to understand that if you tie yourself to the market, you have to deal with the up and downs.

And with the sub-prime crisis already on the cards when he did so, you can only assume the man thought he had the magic touch Greenspan had. What he didn’t seem to grasp was that Greenspan’s biggest advantage was he knew when to go on the attack and when to go on the defence.

Bernanke doesn’t.

In the RBA, and through the tightened legislation in the last two decades, Australia is primed to ride out the crisis in the US, as are the UK and European markets.

Now, if AIG (American International Group) goes down* (I’m tipping it won’t – the Fed would have to be insane not to weigh in on this one), we’re in for one very interesting couple of quarters.

Oh, and America? This is why it's a good idea not to worship de-regulation of the Financial sector like a damn god. And when are you going to regulate your Insurance Sector? Australia's has at least been self-regulated for years.

*If you can't see this, do yourself a favour and sign up for a 14 day trial. Some call the AFR conservative. Yeah, well, so it should be. It's money, not a collection of Pogs, isn't it?


Michelle said...

Interesting post Keri.

If my economics lectures had been presented in an interesting manner, I may have done better in the subject.

It's a good subject, shame about the lecturers. And the textbooks.

Dam Buster of Preston said...

Correct me if I am wrong but hasn't the McCain/Palin ticket spoken about further reform (read de-institutionalisation) of the US banking sector if they get voted in?

Good points Keri. I heard an interview with one financial commentator who said that the issue would have been more serious 10 years ago but there has been a big change in the economic landscape away from the US and more towards asia and europe, especially since the EU has existed.

Australia is less reliant on the USA and the nation is a lot more stable now tha ten years ago due to surpluses and diversifying our market.

Tobias Ziegler said...


The McCain-Palin campaign tends to be a moving target with respect to its "policies". As of today, John McCain appears to be claiming that (i) he warned people that Fannie Mae and Freddie Mac were at risk (despite the fact that during the primaries last year he acknowledged that he didn't see it coming) and (ii) he wants to toughen up the regulatory framework (despite the fact that, as you noted, he has indicated the opposite previously).

Great post BTW, Keri. My economics lectures (I only studied it up to first-year in uni) were moderately interesting, but I still don't remember much of the detail.

Keri said...

Thanks, Guys. It took me ages to get the style right, and I still wasn't happy. It was really hard to chop it from business-like and parse to conversational.

Anonymous said...

"Alan Greenspan understood the market. And although I may not have agree with the policy of Fed bail-outs to the market (As apposed to the floating of currency, we’re talking buy-out of stock by the Fed to inflate market prices), Greenspan kept the economy on a remarkably even keel for the time he was in charge, considering he presided during not only September 11, but also the burst of the tech boom."

Have a read of the book, "Dot.con" and you might change your mind about the above. Greenspan's "do nothing" policy during the tech boom has left a lasting effect on the US economy.