Australia | Oct 13 2008
By Greg Peel
As we speak, the Australian stock market is up a little under 5% having fallen 8% on Friday. Australian bonds are being sold down as well following a huge “flight to quality” on Friday. One can look at lower bond prices (higher yields) and say it is good news that money is now flowing out of the safe haven and back into the market. What cannot be determined exactly is as to whether bonds are being sold as a response to the government’s announced measures. In theory, such a commitment should undermine the value Australia’s sovereign credit.
But Australia acted reactively not proactively. In isolation and despite current financial market turmoil there was no real need for the government to guarantee retail deposits any further than they previously were ($20,000). Australian bank shares may have been trashed, but fundamentally their balance sheets are sufficiently sound. The Australian government made its decision based on what Europe in particular had announced earlier, and in a general response to announced G7 measures. If the rest of the world guarantees its bank deposits and Australia doesn’t, then the risk is money would flow out of Australia and Australian banks would have even more difficulty in raising wholesale funding.
The government is now fully guaranteeing retail deposits with official Australian deposit-taking institutions (ADIs) which include banks, building societies and credit unions, and deposits in local branches of offshore banks. It is not guaranteeing deposits in non-ADIs. There are other various inclusions, and any reader with a concern should contact their own relevant institution for details.
More importantly, the government is also guaranteeing wholesale (non-deposit) funding of Australian financial institutions. Australian banks have struggled recently with a much higher cost of funding in the face of financial turmoil, which is why they have not passed on all of the recent RBA rate cut into lending rates. There has since been a move by banks to pass on the full amount into fixed-rate mortgages. There was no point in the government guaranteeing this funding and not guaranteeing deposits at the same time for the world would have been reluctant to lend to Australian banks if no such guarantee existed, making an already difficult situation even worse.
It is important to note that the Australian government has not taken this step because it holds specific fear for Australian bank deposits.
It is also important to appreciate that such globally coordinated measures do not suddenly signify an end to the global credit crisis. However, it is a very positive step. The bank bill swap rate, which is a measure of the cost of wholesale funds to Australian banks, has slipped lower today following its panic explosion on Friday. There had been similar tentative moves in US credit markets late last week. Credit is the crux of the whole financial disaster – the stock market is merely a sideshow. If banks feel safe to begin lending to counterparties, which they haven’t felt for over twelve months, then we are on our way to at least halting the market’s slide.
It was rumoured on Friday that the RBA might make a further, emergency rate cut. While the need is not as critical now it would not be surprising to see the RBA do just that anyway, thus assisting in getting the money flowing. This would be good news for homeowners, but don’t believe that Australia’s chances of recession are in any way diminished at this point.
The Australian government also announced it would invest another $4bn into the non-bank lending market. This will help, but in the bigger picture is not a very good idea. The non-bank lending model will likely not survive the global financial crisis. That does not mean the government will blow its $4bn though. It is only buying quality mortgages.
We have a bounce. As to whether it can be sustained is not yet clear, and the response of overseas markets will be critical tonight. One can rest assured that the local stock market has the capacity to run very hard to the upside if global panic can abate. A return to previous highs, however, could take years.