The families hit hardest by recent rate rises can expect relief, on the tax front, from July 1.

 

That’s the message the Treasurer, Wayne Swan, is trying to sell to the Australian public.

He says Treasury modelling shows that the government’s tax cuts “are focused fairly and squarely on low and middle income earners.”

“That is the people on modest incomes who havee been left behind in recent years by previous governments,” Mr Swam said.

(It’s never too late to blame your predecessors).

Mr Swan also told the public, in his home state of Queensland, that this includes shop assistants, mechanics, people who are working in clerical occupations, childcare workers

.

“They will be the significant beneficiaries of these tax cuts,” Mr Swan said.

But he broadened his message to include all Australians.

” There are something like 1.8 million women who work part time and earn less than $20,000 a year,” Mr Swan said.

“They will receive significant tax cuts as a percentage of their income.”

Mr Swan said, too, that the tax cuts are “affordable.”

“We will only deliver tax cuts that are affordable,” he said.

Expect much more of this kind of talk, in the months ahead.

Mr Swan did not explain, though, just how some $30 billion worth of staged tax cuts, directed largely, as he said, to hard pressed low to middle income earners, will help to curb Australia’s now  troublesome inflationary pressures.

These people, after all, are also the most likely to spend any extra money that might come their way.

They have little choice, on that front.

But that must add to aggregate demand.

The Prime Minister Kevin Rudd wants more international financiers to base operations in Australia.

He made his pitch in a speech he delivered in New York yesterday.

“… the Australian financial sector has one of the soundest regulatory frameworks in the world,” he said.

Mr Rudd said, too, that much of the spadework had already been done.

“The development of Australia’s financial services sector shows that world-class industries can emerge given the right policy settings,” he said.
“And it is worth reflecting for a moment on the global comparative advantages Australia’s financial services sector exhibits,” Mr Rudd added.

He reminded the US financial community, too, that Australia is in the same time zone as the East Asian hemisphere.

“Australia has strong institutional – and, increasingly, linguistic – linkages to financial markets across our region,” Mr Rudd said.
He noted, too, that an increasing number of Australian professionals are already “capable of operating in the principal languages of Asia.”

Mr Rudd said, also, that the market capitalisation of the Australian Stock Exchange, which is now more than one trillion US dollars, is also “about three times bigger than Singapore and around half that of the Hang Seng.”

And he said Australia’s funds management industry is the fourth-largest in the world with $1.3 trillion under management.”

That had resulted from superannuation reforms that the previous Labor government had introduced in the 1990s.

Mr Rudd reminded US investors, too, that his government plans to halve the withholding tax on distributions to non-resident investors in Australian managed funds to 15 per cent.

He said this would make Australia’s tax system “much more competitive with comparable tax regimes elsewhere.”

Mr Rudd noted, too, that Australia expects to have an agreement for mutual recognition between Australian and US securities regulatory regimes “by year’s end.”
This would be ” a global first for both the SEC and its Australian equivalent ASIC,” he said.

Hedge funds and CDOs would be brought under Federal legislation if proposals by the US Treasury secretary, Henry Paulson are accepted.

The proposals, which will be made public Monday (US time) have been described as the broadest overhaul of Wall Street regulation since the Great Depression.

Virtually all market players, including hedge funds and private equity funds, would be drawn into the regulators’ nets, if the proposals are accepted.

However, they have already attracted criticism, with one academic noting that they would rely heavily on self regulation.

“This is the equivalent of the builders of the Maginot Line giving us lessons on defence,” law professor, Michael Greenberger said

And in an article published in the New York Times (www.nyt.com), reporters Nelson Schwartz and Floyd Norris confirm that the proposed legislation would have “a light touch.”

They say it would enable the government to do little beyond collecting information, except in times of crisis.

And even Paulson himself does not expect the proposed legislation to apply before the end of the year, when a new president would be in office.

Paulson, himself, had a long career on Wall Street.

And his proposals have been designed to ensure that US financiers would still be able to compete effectively with foreign rivals, once they are in place.

Even so, they are sweeping. Scwhartz and Norris the proposals would impose the first regulation on hedge funds and private equity funds overnight.

“The proposals would, for the first time, create a set of Federal regulators with authority over all players in the financial system, be they banks, insurance companies or other entities like hedge funds and private equity funds, which now operate virtually without regulation.”

They note, too, that as the full impact of the current US market crisis becomes evident, the political stakes are likely to grow.

That, almost certainly, will include demands for much tighter regulation than Paulson is proposing.

However Schwartz and Norris note that the initial response of influential Democrats to Paulson’s proposals has been positive.

The Reserve Bank chief, Glenn Stevens, is sanguine about the prospect of further rate rises.

Speaking at a seminar yesterday, Mr Stevens noted that Australia’s banks might raise their home loan interest rates even further, to recoup the higher borrowing costs they now face, as a result of the US credit crunch.

But he appeared comfortable and relaxed about this, saying simply “that’s life.”

That comment, coming immediately after 12 official rate rises – and some stiff unofficial ones as well – won’t endear Mr Stevens to young families, with big mortgages, in Australia’s outer suburbs.

Many, indeed, might regard his remark as callous.

Especially as the Reserve Bank also admitted, in assessment it made of the stability of Australia’s financial system yesterday, that it expects more foreclosures in future, as some, now overcomitted, homebuyers find that they cannot meet their monthly payments.

The bank did say that, statistically, the number of sub-prime mortgages in Australia is not large enough to threaten Australia’s financial system.

Australia’s politicians, undoubtedly, are now delighted with their decision to flick pass the decision to raise or lower the nation’s official interest rates to to the Reserve Bank.

It means that barely visible officials, like the Reserve Bank board members now cop much of the blame for raising rates.

Not the highly visible politicians.

This has genuine advantages, though,  in terms of risk management.

It means, for example, that rates will be raised, when necessary, even if an election is imminent.

Politicians, on any side, could never be trusted to do that.

But political – and economic – policies often have unintended consequences.

And that has, certainly, happened in this case.

At 3.6 per cent – and heading north – Australia’s inflation is higher than it has been for 16 years. Dangerously high, in fact.

For the good of the entire community, it has to be vigorously attacked.

That usually involves raising interest rates.  And that is quite right, when the circumstances demand it, as they do now.

What is clearly not right, though, is that the burden of steps taken for the common good should fall, quite disproportionately, on one section of the community.

That is the one third of the mostly young Australian families who are paying off their homes.

Other policies, too, can be used to fight inflation.  Tax rises, for example, also reduce demand.

Cuts in government spending, too, can be deflationary.

It would, of course, also be unfair to place too much of the blame, for all this, on the shoulders of Glenn Stevens and his board.

It was, after all,  the politicians who set up this system, not the Reserve Bank, which simply administers it.

Even good policies, though, can ultimately prove counterproductive, if they are applied callously.

And that is a point which sometimes seems to escape Mr Stevens.

Australia is “coping better” with the world financial crisis than many other countries, the Reserve Bank says.

In its review of the nation’s financial stability, released today, the bank also says that Australia is “well placed” to keep this advantage.

The Prime Minister, Kevin Rudd, presented a similar message, in a speech he gave on the eve of his departure on a trip to 17 other countries, to promote Australia’s advantages.

But he warned, too, that Australia’s now lagging productivity must increase in the years ahead.

The Reserve Bank’s review, also, makes sober reading.

The bank says, for example, that:-”The global financial system is currently under more strain than it has been at any time since at least the early 1990s.

“It is dealing with both a significant repricing of many financial assets and the unwinding of some of the leverage built up during the preceding boom.

“There has also been a marked rise in uncertainty about the economic outlook and the strength of financial institutions, particularly in the United States. While the strains originated in the US sub-prime residential mortgage market, they have become much more pervasive over recent months.”

The bank also says current repricing of assets reflects a sharp increase in risk aversion.

It says, too, that world is seeing a re-appraisal of the underlying risks of many investments.

That has included the sale of assets as some borrowers are required to reduce their leverage.

But it says these developments have been brewing for some time.

“These adjustments follow a prolonged period during which credit risk was widely perceived to be low, and during which investors were prepared to finance the purchase of assets with high levels of debt,” the bank said.

“It has also led to a number of the world’s major financial institutions announcing significant write-downs.

“In addition, conditions in many financial markets – particularly the asset-backed-paper markets – have been very unsettled, with issuance of new securities falling markedly.”

The bank has no illusions about what all this means.

“As a result of these developments, confidence in the global financial system is more brittle than it has been for some time,” it says.

“Bank share prices in many countries are down by around one third from their levels of a year ago, and spreads on bank debt have increased significantly.

“Investors have also exhibited a strong preference for short-term assets, requiring especially large premiums on long-term debt. Further, in the United States and Europe, changes of ownership have been required for a small number of financial institutions experiencing difficulties.”

It notes, too, that these strains have led to a tightening of credit conditions in many developed countries.

And it says interest rate margins over risk-free rates have also “increased significantly.”

“Many financial institutions have also had pressure on their funding and capital positions as they have provided financing to previously off-balance sheet vehicles that were unable to continue funding their illiquid assets in the short-term money markets.

“Against this general background, many central banks have modified their liquidity operations in domestic money markets, and monetary policy has been eased significantly in the United States.”

So why is Australia is currently doing better than many of its competitors, as the Reserve Bank says it is?

“In Australia, the financial system has coped better with the recent strains than have the financial systems of many other countries,” the Reserve bank says.

“The banking system remains highly profitable and well capitalised, with the banks having minimal direct exposure to the sub-prime problems in the United States,” it adds.

“The credit ratings of the larger banks remain high, with none of them having been put on negative credit watch or having their ratings downgraded.

“This strong standing of the banks has contributed to rapid growth in their deposits over the past six months and they continue to be able to raise significant volumes of funds in both domestic and international capital markets.

“The solid position of the Australian banking system partly reflects the high quality of its assets, with the banks having considerably less risky portfolios than banks in many other countries,” the Reserve adds.

“Ratios of non-performing loans to total loans remain at low levels, with arrears rates having declined over the past six months. While lending criteria were relaxed over recent years, credit standards in Australia did not fall by nearly as much as they did in the United States.

“The banks also typically take relatively small open positions in financial market instruments relative to the size of their balance sheets, and relative to many international banks.”

But the Reserve says Australia still has problems.

“Notwithstanding this favourable position, the changed credit environment has had a significant impact on the Australian financial system.

“As is the case in other countries, bank share prices are down considerably and funding costs have risen significantly.

“These higher funding costs have been largely passed through to business borrowers. Lenders have also increased their mortgage indicator rates by more than the rise in the cash rate, after these rates had moved together for the past decade.

“In addition, lenders have tightened credit standards, particularly to firms with complex and highly leveraged balance sheets.

“These changes in the cost and availability of funding are having a significant effect on the nature of competition within the system. In particular, the market for securities backed by housing loans has been disrupted, with new issuance drying up.

“As a result, lenders that rely on this market for their funding are finding conditions much more difficult than those that rely more heavily on deposit and other markets.

“The tighter financial conditions in Australia are having an impact on both household and business finances, although overall balance sheets remain in good shape.

“Recently, the household sector has benefited from favourable labour market conditions and strong income growth and, over the past decade, has experienced a significant increase in its net wealth relative to income.

“Reflecting these developments, the share of households not able to meet their debt obligations is low by both historical and international standards. There are, nonetheless, some pockets of stress, with higher interest rates and weaker asset markets putting more pressure on many households’ finances than has been the case in recent years, and loan arrears are likely to rise from the current low rates in the period ahead, the bank said.

It said the nation’s strong economy is also helping.

“The favourable macro-economic conditions of recent years have also meant that, at the aggregate level, business balance sheets are in a healthy shape: profitability is high, and both debt-servicing requirements and arrears rates are at relatively low levels.

“Notwithstanding this positive picture, the recent sharp increase in risk aversion and higher funding costs have created difficulties for some firms, particularly those with highly leveraged balance sheets, and those that have relied heavily on short-term funding.

“Despite the strains in global financial markets, the underlying resilience of the Australian financial system, together with the relatively favourable outlook for the domestic economy, means that the system is much better positioned than the financial systems of many other countries to cope with the current difficulties.”

Wall Street closed lower overnight, Australian time, amid fears set off by weak data and poor results from the software giant, Oracle.

The Dow Jones industrial index, which was almost 150 points down at one stage, closed 109.74 points down at 12,422.86 points.

The S&P 500 shed 11.86 points to close at 1,341.13 and the NASDAQ composite index fell 16.69 points to 2,324.36.

These were the first substantial falls on Wall Street in four sessions.

They showed, beyond all doubt, that volatility persists on world markets.

New data, confirming that business spending in the US is still weak, set off the falls.

That was followed by news that a proposed buyout of the Clear Channel is now in doubt.

Weaker than expected results, from the Software Giant Oracle also depressed the market.

Ignore the usual who got what, at the latest meeting of Australia’s political leaders in Adelaide.

The real story, from that meeting, is that Federal State account books were cleared.

And that should lead to real improvements, in some dark places, in future.

Things have been so grim at Australia’s hospitals, for example, that staff at some routinely cooked the books, to make outcomes look better than they actually were.

And that was while the situation at some country hospitals, in particular, were very bad indeed.

As one regular visitor to Australia’s hospitals put it:”Never go to a country hospital.”

So what has changed?

Perhaps the most important change is that health funding will be consolidated into one broad channel.

And new performance standards will be set.

And as those standards will be administered externally, failures should be much harder to disguise than they are now.

As the communique issued after the meeting of the Council of Australian Governments (COAG) explained, this will be done under a new health care agreement.

“COAG also agreed that in developing the new health care agreement there would be a review of the indexation formulas for the years ahead,” it said.

“COAG also agreed that the new Australian Health Agreement should move to a proper long-term share of Commonwealth funding for the public hospital system.

COAG agreed that the new health care agreement would be signed in December 2008 with a commencement date for the new funding arrangements of 1 July 2009.

“COAG also agreed for jurisdictions, as appropriate, to move to a more nationally-consistent approach to activity based funding for services provided in public hospitals.”

But, it said, this would be “one which also reflects the Community Service Obligations required for the maintenance of small and regional hospital services.”

“COAG also agreed to the introduction of a national registration and accreditation system for health professionals and steps to address health workforce skills shortages,” the communique said.

A severe recession in the United States would hurt Australia.

Investors with money in Allco or ABC Learning won’t need to be reminded of that.

Some analysts, though, have been arguing that Australia would escape the worst effects of a US recession, because we don’t sell all that much, at least directly, to the United States.

Demand from China and India would see us through it, the argument goes.

The Prime Minister, Kevin Rudd, reminded these sceptics last night just how important the US still is to us.

He was speaking on the eve of his departure on his first big overseas trip, on which he will visit 17 countries, including the United States.

“The United States is the biggest economy in the world,” Mr Rudd said.

“It is the largest trading nation in the world.

“The US dollar dominates global financial transactions.

“For Australia, too, the United States is a crucial economic partner.

“Our trade is robust – it was worth around $A47 billion last year, making the US our third-largest trading partner overall.

“The US also accounts for nearly 30 per cent of our incoming investment and for nearly 40 per cent of our outwards investment.”

Mr Rudd said, too, that the United States is more than a close economic partner of Australia.

“In many ways, it plays the most important role in sustaining global growth and sustaining the momentum underpinning open global markets.

“US leadership is crucial to getting a good outcome on the Doha Round of trade negotiations,” Mr Rudd said.

“An outcome that delivers immediate market access gains will give a much-needed confidence boost to business with a signal that the governments of the world are committed to ongoing trade liberalisation,” he added.

Mr Rudd admitted that the United States could not achieve this result on its own.

He said co-operation by all advanced countries would be needed.

Meanwhile economist Alan Langford, of HSBOS, warned that the volatility in US markets is not yet over, despite recent gains on financial markets.

He said, too,  that key risk premiums at the shorter end of the US debt market “remain contained” but “still well above normal.”

But, Langford adds:”…longer dated spreads are now approaching the highs they hit in the early part of the decade…”

That was when Enron and WorldCom sent B rates 10 year corporate bonds as much as 750 basis points above risk free US government paper of the same duration.

The implications, for a capital hungry country like Australia, should be obvious.

Traders struggled to bolster their confidence after bad news hit Wall Street in early trading overnight, Australian time.

Consumer confidence in the US hit a five year low yesterday and house prices in the US continued to fall sharply.

Consumer spending accounts for about 70 per cent of the US economy.

And the Dow Jones industrial index was more than 100 points down, at one time, early in the day.

However, confidence returned and the index closed just 16.04 points, or 0.13 per cent  down ay 12,532.60 points, at the close of trading.

High tech stocks helped.  Indeed the tech heavy NASDAQ index closed 14.3 points higher at 2,341.05.

The S&P 500 also rose – slightly – on the day. It closed 3.11 points higher at 1,352.99.

These developments followed a week of generally rising share prices.

Analysts said traders now seems eager to put a floor under the market.

The Rudd government is planning to overhaul Australia’s Federal finances today, to put  their focus directly on service delivery.

The Federal Treasurer, Wayne Swan, will explain the plan when he meets his State counterparts in Adelaide, for a meeting of the Council of Australian governments.

In a statement before the meeting, Mr Swan said that, if accepted, the Federal government’s plan would “substantially advance the modern federalism agenda.”

And modernisation Federal-State relations would underpin future growth and prosperity.

“After more than a hundred years, the governments of Australia are finally getting it right,” Mr Swan said.

“Today’s meeting in Adelaide will lay crucial new foundations for reform in key areas of federal-state financial relations in particular.”

Mr Swan said he expected the States to agree to a new architecture of cooperative funding arrangements that would replace the inefficient and complex system of grants that has plagued key areas of service delivery for decades.

“The new financial architecture will make roles and responsibilities much clearer – so that
Australians receive the level of service delivery they expect and deserve,” Mr Swan said.

Federal State relations in Australia have been in a mess, for years. The consequences have been serious. Many country hospitals, throughout Australia, for example, are operating well below acceptable levels.

Mr Swan’s task today might be made easier by the fact that Labor now controls all State governments in Australia, as well as the Federal government. However, that is not guaranteed. State and Federal interests can still differ.

However, the States are likely to find Mr Swan’s plan to simplify Federal State financial relations attractive.

Mr Swan said that under it, the terms on which the Commonwealth and the States engage with one another would change in several important ways:

First, the Commonwealth will dramatically reduce the number of specific purpose payments
to “just a handful.”

“Almost 90 existing agreements will be collapsed into just five,” Mr Swan said.

These would cover health, childhood education and schools, vocational education, disabilities and housing.

“Second, the States will get the flexibility they need to allocate resources to those areas where
they will produce the best results,” he said.

“The Commonwealth will move away from the cumbersome prescriptions of the past, and remove the input controls which inhibit State service delivery and priority-setting.

“Instead, the focus will be on the achievement of outcomes – that is, what the States and Territories deliver to the people of Australia – rather than how they deliver it.

“Third, the Commonwealth will provide greater funding certainty to the States.

There will be no more five-year agreements with take-it-or-leave-it offers when they expire,” Mr Swan said.

“The new Special Purpose Payments will be on-going payments, with the Commonwealth and the States meeting periodically to review funding levels to ensure they remain adequate into the future.

“This will mean policy objectives and service delivery — not money — will be front and centre of Commonwealth-State relations – just as it should be,” Mr Swan said.
He said the aims would be to:-

• deliver better services to working families wherever they live
• develop human capital;
• build national productivity;
• increase our international competitiveness;
• create more effective markets for resources; and
• end costly waste and duplication.

for more see www.treasurer.gov.au

Consumer confidence in the United States has slumped to a five year low.

And US house prices are still falling sharply.

This news hit early trading on Wall Street, although there were signs of a recovery later in the day.

A Conference Board report showed consumer confidence in the US falling to 64.5 this month from 76.4 in February.
A quarter of those surveyed expected businesses conditions to worsen in the next six months. And nearly a third said the economy would have fewer jobs.

Fewer consumers plan to purchase big-ticket items like refrigerators and television sets, and more than half said that employment was currently “not so plentiful.”

Home prices across America also continue to fall record rates.

The value of single-family homes plummeted 10.7 percent in January compared with a year earlier, according to the Case-Shiller index. This is  a closely watched survey of 20 major metropolitan regions.

This was the steepest year-over-year decline since the index began eight years ago.

Economists said the slump was probably worse than at the height of the last US housing recession in the early 1990s.

There is some hope that the sharp fall in house prices might help to lure buyers back into the market.

Right now, though, sellers are still struggling under a wave of foreclosures.

And a tight credit market that has made it more difficult for many Americans to take out mortgages.

US housing stocks have ballooned as purchases have dried up, while buyers waitecd for prices to fall even further.

The decline in housing prices has been compounded by a general sense of gloom about the economy.

However, there was one bright spot.

Sales of previously owned homes ticked up last month,according to the National Association of Realtors, ending a six-month streak of declines.

The positive sales figure led some analysts to suggest that the housing market is approaching its bottom.

But economists are sceptical.  They predict that prices will fall for several more months before sales pick up in earnest.

The Federal government is setting aside an extra $50 million for export market development grants, even though it is planning heavy spending cuts in other areas.

Trade Minister Simon Crean made the announcement today. He said the government recognises that it is necessary to improve Australia’s trade performance.

“The funding for Australia’s Export Market Development Grants (EMDG) scheme will be boosted by $50 million, bringing total funding available for grants on eligible business expenditure in 2008-09 to more than $200 million,” Mr Crean said.

“And the promotional expenses which attract EMDG grants to Australian exporters will be subject to more generous assessment criteria and a higher maximum grant during 2008-09,” he added.

The EMDG scheme provides financial assistance to both aspiring and current exporters.

Legislation to expand the scheme was introduced to Parliament last Thursday.

Mr Crean said the previous Government, which cut the real value of grants from their 1995-96 level by half .

“If we want to secure our future beyond the resources boom, we have to engage much better with the fastest-growing area of opportunity – world trade,” Mr Crean said.

“The Government went to the election with one of its major commitments to improve Australia’s trade performance.”

“This expansion represents a down payment on that commitment.”

The EMDG expansion follows the Government’s announcement of a renewed emphasis on the Doha Round of trade talks, and its commissioning of the Mortimer Review of trade policies and programs.

Mr Crean contrasted the Government’s funding with the performance of the previous Government.

“When two years ago the previous Government made changes to the EMDG scheme, they failed to provide adequate funding,” he said.

“They raised the benefits but didn’t fund them. And they abolished any ‘net benefit to Australia’ test.

“As a consequence, funding fell short, we now find, by $27 million.

“So around 900 businesses will this year receive much smaller EMDG cheques than they were expecting from the previous Government.

“The previous Government conned these businesses. It made promises to them that it knew it was not funding. Those businesses have paid the cost of the previous government’s deceit.

“Unlike the previous Government, we have funded our commitments.”

The changes to the EMDG scheme include: more generous thresholds; the inclusion of patenting costs in the scheme; access to the scheme for non-profit export development bodies; restored accountability through a ‘Net Benefit To Australia’ test; and allowing all services to be considered eligible unless otherwise specified.

The review of export policies and programs chaired by David Mortimer, announced last month, will examine how the Government can further improve the operation of the EMDG scheme and help ensure that the scheme provides the most effective support for Australian exporters.

The EMDG scheme is administered by Austrade.

Donations to the World Youth Day Trust will be tax deductible in future.

The trust is one of several organisations that the government is adding to its deductibility list.

This is being done under the Tax Laws Amendment (2008 MeasuresNo. 2) Bill 2008, which was introduced into parliament, just before the Easter break.

The bill also proposes several other small, but significant changes.
The government said it had two objectives.

It said the proposed changes are meant to:-

• improve Australia’s taxation system and
• extend deductible gift recipient (DGR) status to a number of community organisations.

The government  said bill would also amend the tax law to account for amounts misappropriated by an employee or agent.

“This recognises the loss taxpayers suffer when they dispose of a depreciating asset or capital gains tax (CGT) asset and an agent or an employee steals the proceeds,” the government’s explanatory statement said.

It said this would also ensure that the market value substitution rule does not apply
where CGT event C2 occurs in relation to a share in a widely held company or a unit in a widely held unit trust.

It would ensure that taxpayers are treated fairly by paying CGT on an amount they actually receive.

The Bill exempts from income tax the Endeavour Executive Award and
research fellowships under the Endeavour Awards. The measure ensures
consistency in taxation treatment of research fellowships.

It also establishes the means for State and Territory governments to
seek to exempt from income tax the first $1,000 of early completion
bonuses paid to eligible apprentices.

The Bill updates the list of deductible gift recipients (DGRs) to
include nine new entities and to extend the time period of DGR status of
four entities.

The following organisations are provided DGR status for the first time:

• World Youth Day 2008 Trust

• The Council for Jewish Community Security

• Wheelchairs For Kids Incorporated

• Memorials Development Committee Ltd

• AE 2 Commemorative Foundation Ltd

• Ian Thorpe’s Fountain for youth Limited

• Amy Gillett Foundation

• The Spirit of Australia Foundation

• Playgroup Australia Incorporated

America’s shadow banking system is likely to complicate efforts to resolve the US financial crisis.

That hugely complex system was erected to allow financiers to operate outside standard banking regulations.

This certainly had its advantages. These included unprecedented flexibility in global finance.

Developments, that would never have been possible before, simply became overnight realities.
But there were abuses, too.

And, as Humphrey Bogar’ts character, Rick, was reminded, in the film Casablanca, the fundamental things apply as time goes by. They still do. And that has never been more evident than it is now.

America’s bankers ignored more than external regulation when they accepted the bad loans that brought on the sub-prime mortgage crisis.

They also ignored the most basic rule of their own trade.

That is don’t lend to people who are not able to repay their loans. Predictably, their greed, ultimately, put the stability of the entire US financial system into jeopardy.

Once again US authorities have stepped in, to rescue the damaged system, just as they did in the 1930s.

US economist, Paul Krugman, recounted the history, in an article he wrote for the New York Times. www.nytimes.com.

Krugman recalled that American banks accepted regulation, as the price of the bail-out they needed, at the time of the Great Depression in the 1930s.

This time, though, the rescue will be trickier, because US financiers have still not accepted that discipline is needed.

New developments, in the Bear Stearns case, illustrate that.

The Fed is trying to secure a better deal in that case. The buyer, JP Morgan Chase, offered just $US2 a share. Many investors believed that short-changed them. They argued that it grossly undervalued the target company, which was, after all, America’s fifth biggest investment bank.

The Fed is now trying to clean up the mess, by urging the buyer to bump its offer up to something like $US10 a share. Ultimately, though, it has nothing stronger than the power of persuasion, to achieve its highly reasonable objective.

That might work. “Jawboning,” as it is known in the trade, has been effective in the past. And it will, be again, in the future.

The outcome of this case, though, is still unclear.

As already noted, deregulation, over the past two decades, has certainly had its advantages. It has given the world a much more flexible financial system, than would have been possible without it.

But there have been serious – and quite pervasive – abuses, too. And there is now a new imbalance in the system.

And hidden costs are now being exposed.

Public money is, once again, being pumped into the American system, to restore stability, just as it was in the 1930s.

But as Krugman also points out, though, there is an extra dimension to all this, now. And that is troubling.

This time though, there is no quid pro quo.

The gradual erection of hugely complex financial architecture, both in the US and Australia, that amounts to a shadow banking system, operating outside the discipline of all banking regulations, is making the situation worse.

The financiers, who caused the problem, are not yet accepting the disciplines that should be required to fix the present troubles. And that, unfortunately, might well make it much harder to restore stability.

The bulls returned to Wall Street overnight, restoring most of the previous day’s losses.

The Dow Jones industrial index rose 261.66 points, or 2.2 per cent, to 12,361.32 points.

The S&P 500 gained 31.09 points, or 2.4 per cent, to close at 2,258.11 points

And the tech heavy NASDAQ composite index rose 48.15 points, or 2.2 per cent, to 2,258.11 points.

However oil prices eased. Crude oil futures dropped 70US cents a barrel to $101.84.

Analysts, though, warned that markets remain volatile.
They accept that the US economy still has a long way to go, before it can be said to be experiencing a recovery.

This means that holding big stocks, of speculative oil or gold, might not be quite as good an idea as it first appeared to be.