Here’s One For The History Books

Don’t panic, Kevin’s got it under control – our banks are as safe as houses he reckons (pardon the pun).

There’s no escaping the fact that this week has been a week from hell and will probably go down in the history books as exactly that.

Australian shares had their worst day since the crash of 1987, losing more than 8%, as mounting recession fears sent equity markets tumbling around the world.

The benchmark S&P/ASX-200 stock index recorded its biggest one-day loss in its 16-year history, dragging the value of the main share index below $1 trillion. The broader All Ordinaries recorded its worst day since the October 1987 crash.

– ASX-200 loses 8.3%
– Stocks plummet 16% for the week, worst since 1987
– Value of ASX-200 falls below $1 trillion
– European markets plunge on opening

It gets me back to people like John K. Galbraith, who, as far back as 1998 issued a stern warning that was all but ignored:

“This is the warning of the present time. We had a slight indication of that in August and September [ Long Term Capital Management crisis in 1998] . It’s a warning that everybody should have in the back of her or his head. The effect of the speculative collapse is something which economists have not yet, even to this day, fully appreciated, because it is not the collapse that causes the trouble, but the further effect on investment, and also the further effect on consumer spending.”

A very large part of our present consumer spending is based on debt creation, credit cards, or the impression given by stock market gains or real estate gains.

If and when the end comes, the economic effect will be the drying up, the slump, in consumer expenditure and, of course, the economic effects of that.”

I guess now we are likely to learn what he meant by ‘if and when’

Malcolm Maiden expressed his astonishment today:

“The continuing sharemarket crisis is like nothing I have reported on, and I have witnessed some doozies: the long, painful market slump in the seventies that followed the 1973 OPEC oil price shock, the October 1987 market crash, the Long Term Capital Management crisis in 1998, the 2001 meltdown and the World-com-Enron crisis that followed, and 9-11, to name some of the highlights, or lowlights.”

This is one is different because it is more than a year old, and there is still no clear picture about how it is going to be fixed.

The slump induced by the OPEC oil shock was also a slow burn, but Fed boss Paul Volcker eventually sterilised inflation by controlling money supply. The market slumps in 1987 and 1998 were much shorter in duration, and were solved essentially by liquidity injections.

The crisis was self-inflicted, and allowed to run its course, and the World-Com-Enron crises were also allowed to work their way through the markets ahead of accounting reform.

Already in this crisis we have seen liquidity injection of unprecedented magnitude, a raft of bank rescues, unprecedented co-ordinated central bank rate cuts this week, and the nationalisation of failed operators in the US, Britain and Europe, including Fannie Mae and Freddie Mac, the groups which between them finance half of America’s $US12 trillion mortgage market. None of it has so far unblocked what are, in essence, crucial global financing arteries

I’ve got to admit, as someone whose been expecting the worst for some time now, even I’m a little stunned at the sheer ferocity and magnitude this crisis.

It makes me wonder how politicians and business leaders can claim that they never saw this coming. I guess Galbraith’s observations of the 1929 Crash , in part, answers that question”… “Long-run salvation by men of business has never been highly regarded if it means disturbance of orderly life and convenience in the present. So inaction will be advocated in the present even though it means deep trouble in the future. Here, at least equally with communism, lies the threat to capitalism. It is what causes men who know that things are going quite wrong to say that things are fundamentally sound.”

11 Responses

  1. Above all else what we’re seeing is a crisis in confidence and sadly the damage done now could and probably will drag on for years to come. Trust in fundamentals that are supposed to underpin financial markets and economies are no longer viewed as trustworthy. Once trust is lost it’s extremely hard to regain.

    We can only pray that world leaders can start getting something right. It will require a coordinated effort just to halt the carnage,.

    NEW YORK ( — The Federal Reserve and Treasury Department haven’t been able to stop the panic gripping U.S. financial markets.

    Neither have finance ministers and central bankers across the globe – from powers such as Britain and China to smaller countries such as Iceland.

    In the face of the growing global crisis, can the Group of Seven and International Monetary Fund make a difference?

    That’s what the world is hoping. But even those calling for coordinated action on a global scale aren’t sure they can.

  2. Robert Shiller always provides interesting insights as well as offering thoughtful solutions. His previous book Irrational Exuberance was released on the eve of the 2000 stock market crash. His proposed solution is similar to that of people like George Soros. There’s no avoiding the pain of this fallout however. The more leaders who are willing to put on their thinking caps the better I’d have to say.

    Recommended Reading: The Subprime Solution:
    How Today’s Global Financial Crisis Happened, and What to Do about It
    Robert J. Shiller

    The subprime mortgage crisis has already wreaked havoc on the lives of millions of people and now it threatens to derail the U.S. economy and economies around the world. In this trenchant book, best-selling economist Robert Shiller reveals the origins of this crisis and puts forward bold measures to solve it. He calls for an aggressive response–a restructuring of the institutional foundations of the financial system that will not only allow people once again to buy and sell homes with confidence, but will create the conditions for greater prosperity in America and throughout the deeply interconnected world economy.

    Shiller blames the subprime crisis on the irrational exuberance that drove the economy’s two most recent bubbles–in stocks in the 1990s and in housing between 2000 and 2007. He shows how these bubbles led to the dangerous overextension of credit now resulting in foreclosures, bankruptcies, and write-offs, as well as a global credit crunch. To restore confidence in the markets, Shiller argues, bailouts are needed in the short run. But he insists that these bailouts must be targeted at low-income victims of subprime deals. In the longer term, the subprime solution will require leaders to revamp the financial framework by deploying an ambitious package of initiatives to inhibit the formation of bubbles and limit risks, including better financial information; simplified legal contracts and regulations; expanded markets for managing risks; home equity insurance policies; income-linked home loans; and new measures to protect consumers against hidden inflationary effects.

    This powerful book is essential reading for anyone who wants to understand how we got into the subprime mess–and how we can get out.

    Robert J. Shiller is the best-selling author of Irrational Exuberance and The New Financial Order (both Princeton), among other books. He is the Stanley B. Resor Professor of Economics at Yale University.


    “With The Subprime Solution, Robert J. Shiller offers his formula to protect us from repeating such disasters: more financial engineering. It would be easy to sneer at this idea, but Mr. Shiller, an economics professor at Yale University, always deserves a hearing. . . . In what he describes as a ‘brief manifesto,’ Mr. Shiller argues that bailouts of distressed borrowers are inevitable to avoid wrecking our economy and shredding our social fabric–even though bailouts may punish the prudent (say, through higher taxes) while comforting those who gambled on real estate and lost.”–James R. Hagerty, Wall Street Journal

    “[The Subprime Solution is] a lucid primer on how we slipped into this money pit and what it might take to clamber out of it. . . . Shiller is sometimes called a Cassandra, and his prophesies about the dot-com and housing bubbles did come true. Yet in these pages he sounds more like a visionary optimist who considers today’s emergency to be a grand opportunity.”–James Pressley, Bloomberg News

    “In The Subprime Solution, [Shiller] briskly sketches out his views on both short-term and long-term strategies for dealing with a housing meltdown that’s left millions of Americans a lot less wealthy—and an unfortunate number at risk for losing their homes. . . . The book’s most compelling discussion centers on the long-term opportunities that lie in this crisis. Shiller describes how key parts of America’s financial system–the Federal Reserve, the Securities and Exchange Commission, and the FDIC, to name only three–were created in the reforms after earlier bank crises or the Great Depression. . . . Shiller suggests that political leaders should look at the current crisis as an opportunity to rethink the homebuying process and add new protections to keep homeowners from getting in over their heads during a future bubble.”–Daniel McGinn,

  3. But, but, politicians all over the world keep telling us that things are “fundamentally sound”.

    Thank goodness for that.

    I was beginning to get a bit worried yesterday, but will sleep easy tonight secure in the knowledge that things are “fundamentally sound”.

    Hey, has anyone seen my Super…?

  4. I guess it is not so super anymore, more likely it is ordinary.

  5. I, for one, would like Rudd and Swan to turn it down. Simply because they don’t really know what the future holds and the level of supposed confidence they appear to be showing is more likely the result of their own political anxiety.

    Fundamentally sound is something all politicians should refrain from saying. Richard Gluyas sheds some much needed light on a dark subject.

    Despite Rudd’s rhetoric, banks not immune to world woes
    Richard Gluyas | October 11, 2008

    AUSTRALIAN banks are different, right?

    Our lenders, according to the well-worn spiel from Kevin Rudd and Wayne Swan, are strongly capitalised and well-regulated, with little exposure to toxic sub-prime assets. So far, moreover, they have been mere observers of the government-sponsored mergers, bailouts and general mayhem that has enveloped global markets.

    And as Bank of America — one of the remaining pillars of the US financial system — struggled this week to bed down a $US10 billion stock offering, Commonwealth Bank managed to scoop up $2 billion from an institutional placement to buy Perth-based BankWest. The argument about the relative strength of our institutions does carry some weight.

    However, the truth is that, in a global financial system where liquidity depends on inter-bank lending and increasingly fraught assessments of counterparty risk, the margin between comfort and chaos for any bank is disconcertingly thin. That is why no banking sector, including our own, has been spared in an extraordinary, $US3 trillion implosion in the value of global banks since the onset of the sub-prime lending crisis in the middle of last year. “

  6. My boss, of whom I have come to know as a dependable source of opinion, mentioned yesterday that is very likely that one of our ‘big four’ banks is likely to bought out, or merge with one of the others, as a consequence of events yesterday.

  7. Reb

    Fairfax’s Michael West has the same idea: “Don’t be surprised to find the big bank chiefs have beaten a path to the Treasurer’s door this week to pave the way for the jettisoning of the Four Pillars policy.

    And don’t be surprised to learn that ANZ and National Australia have been chewing over a merger.”

  8. Simon Hoyle offers a very simple explanation for why markets are now behaving the way they are. It comes back to the excesses generated by easy money, namely debt, which is a point many of us have raised time and again.

    “Everyone has a theory why the world’s financial markets have gone belly-up. Some blame short selling. Some think it’s the stupidity of home buyers who borrowed more than they could afford to repay. Some blame the bankers and people who sold the mortgages.

    Some blame a cabal of greedy Wall Street executives, many of whom weren’t nearly as smart as they thought they were. Some even blame al-Qaeda (truly).

    But the real explanation may be somewhat more prosaic – and understanding what’s at the root of it might give us a few clues on how we can stop our own financial systems from suffering the same fate.

    It seems to come down to two things: too much debt, and poor quality assets. Paying too much (and borrowing money to do it), and buying assets that are unlikely to either generate enough income to cover the interest cost, nor enough of a capital gain, are pretty nearly dead-certain recipes for disaster.

    Buying things, paying too much for them and then hoping they’re going to rise in value isn’t investing at all – it’s speculation.”

  9. “If you have to feed it”… (horses, dogs {sorry Shane}, cats, or any other animal {no we don’t include teenagers! Well yes we do actually}, cars, boats {fuel – yer – fool!}, or hobbies – oh! the cost of hobbies!). … “or paint it” (houses {of any kind!}, cars, boats {again!} etc!


    …and… If your outgo is greater than your income then your downfall will be your upkeep …how easy is that Mr Bank Manager and Financial Advisor!

  10. “It seems to come down to two things: too much debt, and poor quality assets. ”

    Hmm. The problem is that you only know that they’re turn out to be “poor quality assets” with the benefit of hindsight.

    Have you ever heard a real estate agent say “now is not a good time to buy?”

  11. Reb

    The trouble with bubbles is that most people don’t realise they’re in one until it bursts. Nasty.

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