Falling stockmarket: Iceberg ho!

The Australian Government is the band playing as the Titanic sinks.

This morning we read two stories that leave us thinking that we must be living in some Down Under parallel universe: European stocks fall 5.5% on the worst day since 9/11 in anticipation of a global recession; and Prime Minister Kevin Rudd declares that the Budget surplus for 2008/09 will be 1.5% of GDP, or $18 billion.

One of the reasons stocks collapsed last night was scepticism over President George Bush’s fiscal stimulus package. Meanwhile in Australia, the Opposition criticises the Rudd restraint package as “unambitious”.

If the Australian Treasury actually books a surplus of $18 billion in the year to June 30, 2009, as opposed to simply predicting one in May, it will be a miracle.

Equities are now officially in a bear market. European markets are 20% off their peaks, which is the dictionary definition of a bear market, and although Wall Street was closed last night, the March Dow Jones futures contract fell 522 points, suggesting a decline from peak of 18%. The Australian index has already fallen 18% and is set to whiz past 20% today before the courageous bargain hunters emerge.

The Baltic Dry index for bulk shipping freight has fallen 42% from its peak in November and is down 30% this year, which is clearly signalling global recession.

Markets are not always right about the economy, but any Government that is talking about big surpluses, as Australia’s is, and any central bank that is still talking about hiking interest rates to battle inflation, as Australia’s is, might want to think again.

Stockmarkets have now moved into Sub-prime Alarm Phase 2. It isn’t about the mortgage defaults any more, since they are more or less understood. It’s about the monoline bond insurers, Ambac and MBIA.

These companies are sitting in slightly different Titanic deck chairs – MBIA has raised capital and its AAA ratings have been confirmed for the moment, while Ambac didn’t find capital and had its rating cut – but both are at the teetering point of a colossal inverted pyramid of bond insurance that is threatening to topple.

Without the fig leaf of MBIA’s and Ambac’s AAA ratings, provided by an absurdly inadequate capital base, many bond investors would be forced to sell because they are required to hold only AAA securities.

This is a direct consequence of the sub-prime crisis, since neither firm has sufficient capital to meet the expected default claims, but as my colleagues, Robert Gottliebsen and Stephen Bartholomeusz have been clearly explaining here in recent weeks, the threatened collapse of the monoline bond insurers takes the crisis to a whole different level.

Last night in Europe the index of 125 top-rated corporate credit default swaps, which are instruments that are used to trade on a company’s ability to repay its debts, jumped 14% to its highest level since the index began in 1994 (the higher the price, the greater the chance of default).

Credit default swaps on Ambac have now soared in price such that they are predicting a 70% chance of default within five years.

“The major risk for credit markets remains forced selling on the back of downgrades of the insurers,” a fixed interest analyst for an Italian bank told Bloomberg this morning.

The other problem for Australia is that commodity prices are sinking as well. Zinc fell 5.2% last night and copper 4.5%. Combined copper stocks on the LME, Shanghai and Comex in New York now stand 20% higher than two years ago.

If the Australian Treasury and Reserve Bank are giving Prime Minister Rudd and Treasurer Wayne Swan optimistic briefings, they should start reading Business Spectator and find out what’s actually going on. 

This story first appeared on BusinessSpectator.com.au