Party like it’s 1929

I’m not particularly literate when it comes to the financial markets, I understand what the stock market and futures markets are and how they operate, but if you asked me to pick a stock I’d pretty much throw a dart at the prices from the day’s paper. Despite this, I feel qualified enough to categorically state that the global economy is just about screwed.

The big news at the moment is that Bank of America are buying out failed investment bank Merrill Lynch, backed by taxpayers funds of course, and another high profile bank, Lehman Brothers, is filing for bankruptcy. This is just a continuation of the collapses that we’ve been seeing over the past year and there’s no sign that it’s likely to stop any time soon. At the moment the US government, which isn’t particularly solvent itself considering it’s continued spending in Iraq, is quietly throwing cash at the financial sector to maintain ‘confidence’ in the economy.

Why does any of that concern me? Well, apart from the fact that I work for a US owned company at the pointy end of the Fortune 500, I have no doubt that when the USA crashes it’s going to cause a lot of pain here too. In the 1920s the level of global trade and financial interconnectedness was tiny compared with what we have today, yet even then the Great Depression was a world wide problem. My guess is that the only country that won’t be devastated by the collapse of the US financial system is Cuba, I guess those trade sanctions weren’t so bad after all. For example, today the ASX is warning investors not to deal with the local arm of Lehman Brothers and I suspect that a lot of other US owned financial houses in Australia will be feeling nervous about their future.

As well as the financial pain, we will no doubt also have to suffer the dimwits in the Federal Opposition gleefully crowing about how Labor has ruined the economy, despite the fact that this crisis has been precipitated by the same type of free market chicanery that the ilLiberals are so fond of. Sadly, I have no doubt that there will be plenty of people left hurting when their superannuation loses even more value than it has this year who will be looking for someone to blame, and Kevin07 will be firmly in their sights. Unfortunately, if the worst does come to pass, you can forget Brendoc’s extra $30 a week for pensioners, because worthless super funds will mean that there’ll be a lot of extra Baby Boomers lining up for their cheques.

22 thoughts on “Party like it’s 1929

  1. I don’t buy it, Dave. You can’t compare eras 80 years apart. I actually believe the collapse (if there is one) will be more confined to the US than it has been in the past.

    Real capital comes from outside the US nowadays – unlike back in the 20s when America was expanding its own head off – and those sources will remain intact. They just won’t invest in US companies and the US market for a while, that’s all.

    It’s not all ‘doom & gloom’ and our underlying fundamentals are still strong and driven by real forces such as real demand for housing. We’re safe, I’d say.

  2. I don’t believe that our economy will be able to withstand a large scale crash in the USA. If the US goes bust then it will take a big chunk out of the China bubble as well, which will affect Australia dramatically.

    The problem, as I see it, is the likelihood of the US government being left holding a lot of private debt on top of the obscene foreign debt that it has racked up all by itself, it’s simply not sustainable. It’s already going down that path, with the Fed accepting junk assets from Lehman Brothers

    the Federal Reserve has agreed to accept lower-quality assets in return for loans from the government.

    However you want to spin it it’s a taxpayer funded bail out, which programs will be cut to pay for the greed of the financial sector?

  3. The last bastion of the US government is Social Security, which Bush and Co tried to ‘privatise’ (ie. invest in the stock-market) over the last few years. If Social Security failed, the spread of poverty throughout the US would be unimaginable.

    It won’t be about fat Ray, if the US government keeps trying to save the financial companies who have been screwing with the market it’ll soon find that it can’t raise any more money. They are running a frighteningly large deficit and if foreign investors refuse to buy any more US bonds there’s a risk that their entire financial system could implode. A nation built on consumption will find itself in serious trouble when its currency is worthless.

  4. Well economics is a very inexact science and I don’t put much trust in what economists say. But I still think we are much better insulated from the US economy that what we used to be. Even the stock market crash of 87 actually led to a property boom in 88 & 89 here, which ultimately collapsed too but not for long.

    I’m staying positive on this Dave because I think our fundamentals and banking sectors are super-strong and we’ll withstand any implosion in the US. They’re the ones who have isolated themselves from the world with their incestuous dealings and free-for-all in the sub-prime market etc. But over here I’d say the worst is behind us and interest rates will continue to come down and investment in our real driver (housing) will return.

  5. I agree that our financial sector appears to have missed most of the really ugly stuff from the sub-prime crisis, and that’s not really what I’m worried about. What I fear is the storm in the US disrupting so much global trade that our economy shrinks due to a lack of overseas demand for our natural resources, if that happens we’re in a lot of trouble.

  6. I agree, Dave, but our forward contracts with China should overcome that and I still believe that our internal economy rides on the back of housing, which has a massive amount of pent-up demand that WILL be met once investors start investing again. In a way, a stock market ‘crash’ (or correction) would be a good thing here in that it would mean investors would jump back into real estate.

    But you’re certainly right about the US economy and it’s going to be one hell of a spectacle. Let’s just HOPE we avoid the fallout.

  7. Have a look at today’s ASX; down, down, down…. The real impact that the American crisis will have on Australia, as pointed out above, is the effect on our super funds. The consequences for the drop and the every increasing numbers of pensioners should not be underestimated.

    This will affect our housing market as the retirees won’t be able to gift monies to first home buyers as they have done in the past.

    The only real light on the horizon is that there are people out there with money who are too wary to dive back into to stock so they will seek to get into the safer property market over the next 12 months.

  8. I don’t think that we’re anywhere near the end of this unravelling of the US economy. I don’t think that we’ll see a single day crash, rather it’ll be financial institutions falling away one at a time.

    Is Bank of America really strong enough to take on Merrill’s bad debt? I don’t know, but I do know that there appears to have been SFA due diligence on the deal. The vultures waiting to pick over the bones of Lehman’s, can they really succeed with the same portfolio of crappy debt and assets that sunk a 180 year old firm?

    If someone says the worst is over, there’s probably worse to come. When the worst comes, no-one will be willing to say anything.

  9. The comment I read about Lehman was it was a “great business with a shitty balance sheet”. Merrill Lynch is a bit of a bargain and must not be in that bad state if the Bank of America bought it – they really took it on for prestige (they go from a B-Grade Investment Bank to the top of the class in one swoop) and now there is essentially two investment banks left – and there will no doubt be further consolidation in the foreseeable future.

    The thing is that the US is not the be-all-and-end-all it once was. We are no longer dependent on the USA – India, China, Japan, Europe…that is why we haven’t seen a 300+ point crash today like what was being forecasted. There is far too much doom and gloom cast upon the ASX. Things here are nowhere near as bad as it is over there (with the exception of Babcock & Brown – they are goners…).

    AIG are almost certainly the next ones to go – the government has said they wont bail them out and suggested the two last standing Institutional Banks (Morgan Stanley and Goldman Sachs) to set up some bridging lending for them – given they are battling to save themselves I can’t see that happening…

  10. Don’t forget the state of Macquarie’s shares. They are a big player in the Aus market and have invested similarly to Lehmans.

    Merrill Lynch was only a bargain because the government practically begged B of A to have them. They didn’t want another Bear Stearns on their hands.

    The big problem for Australia is not an immediate down turn of the ASX but a more gradual one. You will probably see many of our major investors making large quarterly write downs as their foreign investments turn sour. ANZ did this over the last quarter and it will only get worse.

    I agree that the US is no longer the end of our world but there can be no ignoring how significant a player they still are. Many other asian countries, particularly China, have invested in US bonds. Any downturn affects their budget. Also, places like India rely upon sales to US markets like no other. Europe is probably the most secure but even England is facing a recession. Everyone will get hit and everyone will get hurt. Time to start buying gold and property.

  11. I have to agree with Dave and disagree with Ray, the fallout from a (seemingly inevitable) US crash will have a negative effect on the rest of the world including us, though exactly how bad I wouldn’t like to speculate. Apart from anything else the US is a significant consumer of Chinese consumer goods so an absence of demand there will in turn ease their voracious appetite for our resources. If it wasn’t for Western Australia our economy wouldn’t be looking too rosy currently.

    Housing in this country is in crisis, not availability but affordability. There must be what the economists like to call a “correction” to bring house prices into line with earnings. Investors forking out $400,000 for 2 bedroom units then renting them out at equally ridiculous prices in a feeble attempt to get something approaching a decent ROI are in no small part to blame.

  12. Looks like the Fed just took a large chunk of AIG in return for an $85 Billion loan. With things that bad over there, there has to be some pain everywhere else.

  13. The Fed were trying to convince Goldman Sachs and JP Morgan to buy the chunk they bought this morning. In a time where 5 Investment Banks turned in to 2 it probably isn’t the wisest investment to buy a sinking insurance business.

    Lee – your comments about the model that MacBank and B&B operate is dead right – but it has been a poor model for a while now. It was always going to tank when times turned bad. At least MacBank has time and assets to bail themselves out (have at least until March to restructure the nervy debt). B&B are in the shit and wont get out of it…

  14. Sorry to interupt the ‘doom & gloom’ talk folks with a positive outlook, but I reckon you’re all reading too much into America’s self-inflicted problems.

    This is over-simplyfing things but if 10 of you invested $1million each in my company and I fiddled the books and took off with the $10 million, YOU would all be broke but I’d be rich and investing elsewhere.

    The fact is that capital doesn’t disappear, it just re-emerges elsewhere.

  15. The problem is, Ray, that an enormous amount of the money was loaned to people who couldn’t afford it, who bought overpriced houses in the middle of a bubble and are now being foreclosed on. The capital has disappeared, it’s not coming back.

    To modify your idea a bit, if we all bought a share of Grevillea Garden for $1million and defaulted on our loan but the bank could only sell the asset for half of what we paid then the capital is gone. Sure, you still have your $10 million, but the bank is down $5 million as well as the interest they were expecting to receive over the next 25 years. Therefore the bank tightens its credit policy and there is less money in the system to invest.

    At the moment there are 9800 housing foreclosures a day and property prices are continuing to fall, it’s not getting any better soon.

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