By Stephen Bartholomeusz
13 August 2008
Over the course of thirty-odd years of journalism you ask a lot of questions. It is very rare, however, to receive an answer that shocks you.
Recently Alan Kohler, Robert Gottliebsen and I interviewed Mirvac Group's outgoing chief executive, Greg Paramor, himself a 30-year-plus veteran of the property market.
I opened the interview with what I thought was a fairly innocuous question. Given that he had lived through a lot of cycles and crises in the sector, how did he rate the severity of this one?
This one, he said, was probably going to turn out to be the worst. What's more, he said that he believed we were only one year into what might be a three to five-year period of depressed activity.
Anyone who remembers the early 1990s and the "recession we had to have" would blanch at even the faintest prospect of anything worse than that. Yet one only has to look at the listed property trust sector, whose value has halved since last November, or the financials sector, which has fallen about 40 per cent over the same period, to conclude that the sharemarket is signalling some very unpleasant times ahead.
There is a temptation, or at least there was, to see the sub-prime crisis, and even the more general credit crisis that it evolved into, as something happening at a distance from Australia's financial system and our economy. It was something to do with US housing markets and reckless lending by US and European banks, plus their willingness to invest trillions of dollars in exotic securities that no-one really understood.
Sure, there were some initial adverse impacts. A few over-leveraged companies with the misfortune of having short term funding needs at the very moment credit markets closed were immediately in strife - Centro, Allco, MFS and the like.
Then the falling market triggered waves of margin calls and revealed the extent to which margin loans had become the funding source of choice for company executives and corporate investors. It turned out, much to the surprise of the investors, that many of these margin loans were something other than what they purported to be.
Still, those were financial market issues, not real economy issues. The Reserve Bank seemed relatively unconcerned, raising official rates again in March while citing its concerns about the rate of growth in domestic demand. The commodity and associated investment booms were, of course, still gathering pace. There was a disconnect, and some insulation, between what was happening offshore and what we were experiencing here.
Except, of course, there wasn't.
A quarter of a century ago the Hawke government floated the dollar, removed exchange controls and deregulated the financial system. Over the past 25 years our financial system and institutions have become inextricably locked into an increasingly global financial system. A crisis in offshore credit and equity markets is instantly imported into our system regardless of how well-behaved our banks and larger companies might have been.
The cost of debt has soared and the availability of credit, to the extent that it is available, has shrunk dramatically. The same is true of equity.
Our major banks raise, or at least used to, about $100 billion of funding from wholesale markets, most of it offshore. Those funds are now scarcer and a lot more expensive, with obvious consequences for borrowers.
Non-bank lenders have virtually no access to any funding at all, pushing demand back into the banking system. In the capital-constrained environment they are experiencing, the banks are now controlling their balance sheet growth by rationing increasingly expensive credit.
Given the absence of alternative funding sources for all but the largest and most creditworthy of borrowers, that has unpleasant implications for the real economy, or at least those parts of it that aren't directly exposed to the commodities boom and the investment and activity it has ignited.
Coupled with soaring fuel and food prices, the increased cost and reduced availability of credit is already showing up in an increase in defaults on credit cards and personal loans and a rise in mortgage arrears. After a decade and a half of improving credit quality and decreasing loan loss provisions, the credit cycle is turning rapidly on the banks.
There is a risk that the interaction of increased losses and provisions for loss will create a self-reinforcing cycle of capital erosion that forces bank balance sheets to actually shrink, reducing access to affordable credit - or, indeed, any credit at all - for an increasing number of customers. That is what happened in the early 1990s but a serious credit crunch today could, because of the degree of household leverage, be even more unpleasant.
There is no early or easy relief in prospect. Globally, sub-prime credit losses have been estimated by the IMF at about $US1 trillion. The global system will effectively have to raise a very substantial proportion of that number in new capital (whether from shareholders or taxpayers) to restore stability to its workings. It will have to do so in the context of a slowing global economy.
For our economy, the commodities boom, the strong fiscal position of the state and federal governments and the now-considerable scope the Reserve Bank has to cut rates provides some cushioning and flexibility to respond if it is deemed necessary. It looks increasingly likely that it will be.
This article was written by Stephen Bartholomeusz for D&B Insight.
About D&B
D&B is the world's leading provider of business-to-business credit, marketing and purchasing information and receivables management services. D&B manages the world's most valuable commercial database with information on more than 130 million companies.
Information is gathered in 193 countries, in 95 languages or dialects, covering 186 monetary currencies. The database is refreshed more than one million times daily as part of D&B's commitment to provide accurate, comprehensive information for its more than 150,000 customers.
The Australasian operations were bought out by the senior management group in August 2001. It was the first MBO of a wholly owned subsidiary in D&B's history worldwide.
Today Lazard Carnegie Wylie owns an approximate 90% stake in DBA and the local management team a 10% stake.
Strategies for future growth include developing DBA's commercial and consumer credit referencing business; expanding its receivables management outsourcing business; maintaining its lead in the development of unique credit and risk scoring products; and developing new products specifically tailored to the Australasian market. DBA currently employs over 500 people in Australia and New Zealand.
