The market cheers on naked Bernanke

Today the big sums on the sidelines that had been waiting to buy decided it was time to move because the weaker holders had been forced out earlier in the week. The buyers reasoned that there was now less chance of a US recession, so the commodity outlook was better and Australian banks, unlike so many in Europe and the US, have good assets. 

Today’s buyers are punting that the US Federal Reserve can solve the massive monoline/sub-prime problems affecting the banking system. Let’s hope they are right, but last night’s US central bank statement frightened me because the Federal Reserve did not really grasp the problem.

Australia must hope that our Reserve Bank chief Glenn Stevens gains a better understanding of the problem than his counterpart in the US, Ben Bernanke, because this crisis has the potential to really hit Australia and bring on a recession. Stevens is a good operator, but his speech in London last week showed that he has a lot of work to do to catch up with what is happening.

Bernanke says that the main reason to reduce US interest rates was “a weakening of the economic outlook and increasing downside risks to growth”. Rubbish. The problem is not the US recession or US growth – that’s merely a symptom. The problem is the staggering potential losses that are faced by the $2300 billion in global lenders who relied on AAA-ratings that turned out to be false (the monoline insurance disaster).

The nearest the US Federal Reserve gets to addressing this crisis is: “The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.”

The way to instil long-term confidence in a market is first to show that you understand the problem. Last night, European markets were recovering and wanted to feel bullish when the respected market strategist at Royal Bank of Scotland, Neil Parker, said what most people knew but would not say – that Emperor Bernanke had no clothes.

Parker did not use those words, but embraced the sentiment by describing Bernanke’s actions this way: “Rather than instilling confidence into the markets I think it will just throw in more panic, so we’ll get a short-term rally, [after which] most of the equity markets are going to get an absolute hosing again.”

Here in Australia, the potential problem facing us is how to fund our banking system if our sources of overseas borrowing are battered by the monoline insurance disaster. It’s too early to know exactly how monoline will affect our banks. Today’s market set their fears aside but in my view, to maintain confidence Stevens must recognise the potential problem and say that he is closely monitoring it.

As we saw in 1987 and with previous big crashes, a huge sharemarket fall reduces the value of most asset classes including commodities and property. But the extent of the looming asset value fall will depend on how our banks (and global banks) fare in the monoline crisis.

They may need to raise interest rates to attract local deposits.

Stevens’s problem is that all his data says we have an inflation problem. Before the 5 February Reserve Bank board meeting, Stevens has two obvious tasks. The first is to really study the lending crisis fear that is driving global share markets and determine its effect on Australia. Secondly, he should go and see Gary Morgan or other pollsters who study Australian consumers. Consumer sentiment has changed and they don’t need an official interest rate rise to curb their spending.

I am an admirer of Stevens and I think he will address the problem.

This story first appeared in BusinessSpectator.com.au