Investment World Hangs On The Brink

The Age

Saturday September 27, 2008

Vanessa O'Shaughnessy, Investment Reporter

THE investment world is holding its breath, waiting for news of the US Government's $US700billion ($A840 billion) bail-out plan. But while it was waiting, there was another casualty - Washington Mutual became the biggest US bank to fail.

Markets took the news badly. Erasing early gains, the S&P/ASX 200 Index plunged, before closing 22.6 points, or 0.5%, lower at 4904.8. European markets fell on opening and the futures market suggested Wall Street would too.

"Equity markets started strongly because they thought the bail-out was a goer," said HBOS Australia chief economist Alan Langford. "But everybody was rattled by the news that the deal wasn't done."

In Australia, Treasurer Wayne Swan chose the moment to announce the Government's plan to boost competition in the mortgage market. Using a model suggested by Opposition Leader Malcolm Turnbull just days ago, the Government will invest in $4billion of mortgages through the Australian Office of Financial Management.

It will target smaller banks and non-bank lenders that have had trouble attracting affordable long-term funding, such as Bank of Queensland and industry super fund-owned Members Equity Bank.

"This is definitely not a bail-out," said Joshua Gans, professor of economics at Melbourne Business School. "No one is talking about giving this money away - this is essentially the Government investing in the Australian housing market to make housing finance more affordable."

Short-term funding rates remain high, at up to 1.25 percentage points above the official cash rate, making it difficult - and expensive - for banks and other lenders to fund loans.

ANZ chief economist Saul Eslake said, according to the Reserve Bank's Financial Stability Review, banks had increased their standard variable rates by about 55 basis points above the official cash rate since the middle of last year. Mortgage originators had increased rates by an average of 85 basis points and more risky loans had risen by an average of 135 basis points.

The Government's initiative should make funds available for non-bank lenders, he said, although banks would also be allowed to tender for the money.

The Reserve Bank has continued to inject liquidity into the system. It accepted a relatively modest $876 million in collateral yesterday, to offset a deficit of $658 million. But TD Securities senior strategist Joshua Williamson said the RBA had a record $7.634 billion out in the financial markets.

Last night, as part of a collaborative central bank plan announced last week, the Bank of England said it would inject $US10 billion ($A11.9 billion) into financial markets overnight and $US30billion for one week.

On Monday, it will conduct an auction for +pound+40 billion ($A88.5 billion) against securities, including mortgage-backed securities. The funds will be available until mid-January.

Lack of funds was one reason behind the collapse of Washington Mutual, which will merge with banking giant JPMorgan Chase. The bank, which acquired ailing investment bank Bear Stearns this year, will conduct an $US8 billion capital raising.

"These are the guys that can do that because, along with Bank of America and ... Goldman Sachs, these are the ones that are deemed to be the relative cleanskins," said Tolhurst strategist Tony Farnham. "They are the ones that are armed and ready to access increased market share at pretty cheap prices."

But the market is becoming nervous because of speculation the US Congress will reduce the potency of the bail-out plan, which would involve the purchase of non-performing assets from banks using taxpayers' money.

Westpac senior international economist Huw McKay said there was a conflict between the need to protect the US economy and the need to allow markets to operate without intervention.

"Markets are consenting adults that take risks," he said. "While there are implications for the rest of us ... (a bail-out would mean) a lot of people are going to get away scot free."

Meanwhile, market participants were still figuring out the Australian Securities and Investments Commission's new rules on short-selling. Initially, issuers of contracts for difference (CFDs) had ceased offering the products when clients wished to take out a short position, or one where they expected the price of an individual stock to fall.

But IG Markets yesterday issued a statement saying it would allow "short position" CFDs again, in some circumstances.

Company director and chief operating officer Tamas Szabo said people who were using CFDs to hedge their risk on stocks they owned would now be allowed to do so. But GFT, another company that issues CFDs, said it retained its initial freeze on CFDs with a "short" position.

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