The current slump in economic activity really frustrates politicians, whether they be from Australia, the US or Europe. Everyone is turning to the money pump to spurt money at consumers in the hope that they will spend and restore growth.
While this activity limits the impact of the downturn, it does not solve the problem because a lack of consumer confidence was not at the core of the 2008 crisis – it’s a by-product of the crisis.
At the core is the fact that banks lost huge sums by lending to people who couldn’t repay. As the losses mounted, banks found themselves short of capital and interbank trust evaporated, leading to the banks constraining credit. And as they constrained credit, consumer spending was affected.
There is no doubt that at least $2000 billion of bank/finance group capital has been lost, and the actual loss figure may be much higher. It is not until those losses have been recognised and a good measure of the capital restored that America will return to growth. At the moment, $700 billion to $800 billion has been recognised and the capital raised to cover the losses.
In the US, much of the capital has come from the various American bailout packages. But clearly we are less than half way in the global loss recognition process.
In Australia, our banks have not suffered the same loss of capital, but foreign banks have left a multiplying credit problem on our soil. The tightening of bank credit is beginning to affect commercial property values. As that happens, it lifts bank losses and further restricts bank lending.
There will be considerable grief to come among a vast array of businesses both large and small. Of course, Australian banks will have to raise more capital to cover any losses that are ahead of them. Most have already started the process, though the more recent capital raisings have been as a result of Australian banks being required to fill at least some of the void created by the withdrawal of so many international banking groups who simply no longer have the capital to maintain healthy Australian operations.
It is this lack of capital in the banking system that is going to hold back the world in 2009. The sharemarket already understands what is ahead and the groups that are most likely to be affected have had their share prices slashed. But it is important for all investors and business houses to understand the power of these forces.
The most important asset for most businesses today is a good relationship with their banker. Only with that relationship will businesses get the loan power that they need to prosper. Very few Australian companies understand the power that has been switched to the banks.
While the politicians scream for Australian banks to lower their interest rates on housing to match the Reserve Bank’s cuts, they forget that banks are recouping the extra costs of offshore borrowing by lifting loan rates to business. That means that a great many Australian businesses will have no choice but to reduce their staff levels.
This vicious circle is not well understood by Australian politicians who plead for banks to lower housing interest rates every time the Reserve Bank makes a cut. While this was good news initially, now it simply means higher bank charges for business borrowers and less jobs for the community. Banks, whether in the US, Europe or Australia, have to restore their capital positions before we can sustain a major recovery.
This article first appeared on Business Spectator
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