Banks act on stock rout
August 11, 2007 07:39am
WORLD central banks have poured almost $200 billion into financial markets in less than 24 hours in a bid to stem a global financial panic.
The Reserve Bank of Australia had to pump almost $5 billion into the local market, about double the normal daily injection, to ensure that the cash interest rate did not spiral higher than the new 6.5per cent set only on Wednesday.Financial meltdown fears
The fear of a financial meltdown stripped 3.9per cent, or about $58 billion, from the value of the top 200 shares listed on the Australian sharemarket, with the All Ordinaries index closing at 5965.2points.
It was the biggest plunge in markets, both in Australia and around the world, since the aftermath of September 11, 2001.
Central banks also provided emergency support to markets then. However, the scale of yesterday's bail-out in Europe was E26 billion ($41 billion) larger.
The markets were last night nervously awaiting the start of trading in the US after London opened down 2 per cent.
Anxiety
Peter Costello tried to calm anxiety, saying Australia's financial institutions were sound, with none of the problems of the US mortgage market.
"People will start pricing risk higher and those people that have lower credit ratings may well have to pay a bit more of a premium for risk in bond markets," the Treasurer said.
"But it will not affect Australian financial institutions, nor will it affect Australian governments."
Deposits frozen
The panic was sparked by France's biggest private bank, BNP Paribas, freezing deposits in two hedge funds which had E1.6 billion invested in sub-prime mortgage loans dollars.
Only days previously, the bank's chief executive had declared it had no exposure to the US mortgage market.
The Reserve Bank's efforts were dwarfed by the European Central Bank, which offered to provide as much money as any bank wanted at its official cash rate of 4 per cent and ended up advancing E95 billion.
Dollar dives
The Australian dollar dived 2.9 per cent to US84.1c, as it suddenly became impossible for Japanese speculators to finance what is known as the carry trade, in which they borrow money at low rates of interest in Japan and invest them here.
The global panic extended to Japan, where the central bank injected Y1trillion ($10billion) to stop interest rates rising.
Economy strong, says Bush
The Federal Reserve Bank, in the US, advanced about $US24billion ($28billion) to get its cash rate back from 5.25per cent to its target of 5per cent.
George W.Bush said the US Government did not need to provide further funds to the market.
"The fundamentals of our economy are strong," the President said. "And I am told there is enough liquidity in the system to enable markets to correct."
RBA
Financial market analysts said yesterday's turmoil raised a question about whether Reserve Bank governor Glenn Stevens was correct in his assessment, when lifting interest rates on Wednesday, that the US mortgage crisis did "not appear to have changed significantly the broader global outlook".
ANZ chief markets economist Warren Hogan said the bank was clearly aware of the volatility when it raised rates.
"But there does seem to have been a substantial deterioration in liquidity in the system, and the key is whether the actions taken by the central banks, including the Reserve Bank, will settle the situation or will there be further instability ahead."
Hedge funds
Although a number of hedge funds around the world, including in Australia, have closed their doors as a result of the US mortgage crisis, the actions of the French bank suggest it may allow bonds to default. This made financial institutions wary about lending to the financial markets, and suddenly there was not enough money available in the money market for everyone who needed it, forcing up interest rates.
The OECD's financial markets deputy director Adrian Blundell-Wignall told The Weekend Australian there was now a concern that there might be a run on hedge funds.
Although investors have to give a month's notice to withdraw funds from a hedge fund, if there were a rush it would cause widespread problems in financial markets, he said. "If there is a run on hedge funds, then it is like a run on banks," he said.
Dr Blundell-Wignall said hedge funds often borrowed as much as 20 times the amount of their investment so their plight represented a threat to banks.
Mr Costello said Australia could not expect to shrug off a downturn in the US economy or in world markets.
"The only effect in relation to Australia is, as you would expect, if the world's largest economy experiences downturn, or if the equity markets in the world's largest economy have a decrease, that has knock-on effects to other capital markets," he said.