Why the collapse of the US Government’s bailout package is bad news for Australian SMEs

It’s been an extremely dramatic night in the United States overnight, with Congress voting down US Treasury Secretary Henry Paulson’s $US700 million bailout that was designed to buy the bad debts of the big US banks and restore confidence in the US financ

It’s been an extremely dramatic night in the United States overnight, with Congress voting down US Treasury Secretary Henry Paulson’s $US700 million bailout that was designed to buy the bad debts of the big US banks and restore confidence in the US financial system.

The rejection of the bailout package has sent global financial markets into meltdown, with Wall Street shedding $US1.2 trillion overnight. Australian and Asian markets are also expected to dive today and keep diving this week.

So why does the failure of the bailout plan matter so much to Australian SMEs? What will be the fallout for our economy? How bad might things get?

Let’s have a look at some of the big questions.

Yesterday you told me this bailout deal was basically done. What happened?

It’s an amazing turnaround. On Monday morning Republicans and Democrats appeared to come to an agreement on the $US700 million rescue plan, keeping the guts of the package – that the US Government would buy the banks’ bad debts – while attaching some important conditions, such as limits on Wall Street salaries and strict oversight for the administration of the package.

But overnight, the American House of Representatives voted 228-to-205 against the plan, plunging global markets into panic.

Why didn’t the plan get up?

It seems many congressmen just couldn’t come at spending so much of taxpayer money bailing out the very Wall Street banks that got us into this mess. The Republicans are particularly being blamed this morning; Republican House members voted against it by more than a two-to-one margin. A majority of Democrats voted in favour.

Not wanting to spend taxpayers money is fair enough, isn’t it?

At any other time it would be, but this is an extraordinary situation. Across the globe, the credit market, which underpins the operations of banks, has frozen up. Banks just aren’t lending to each other any more. Already we’re seeing banks in the US collapse (the latest to fall last night was lender Wachovia) and banks in Europe under pressure, with governments in Britain, Belgium and the Netherlands forced to step in and rescue some financial institutions.

So a few fat cat banks fall over. What’s the big deal?

If banks won’t lend to each other, they certainly won’t lend to companies. So when big US employers next go to the market to borrow money to fund their operations (paying suppliers, paying workers), they’ll find that the well is dry. Pretty soon, they’ll have to start laying off workers.

Those unemployed people will be forced to cut their spending, which will mean companies see their sales dry up, which will in turn force those companies to sack workers. On top of this, sharemarkets are likely to continue to fall, which will wipe out investors’ savings and force them to cut back too.

Pretty soon the US economy is in recession or, as some pundits are predicting, in depression.

That sounds ugly. What impact will this have on Australia?

A recession in the US will undoubtedly cause a sharp slowdown in the economies across the globe. Australia’s economy is reasonably strong, but we’ll still take a hit. A global slowdown in growth will mean demand for Australian resources will fall, and given we are so reliant on mining exports right now, that’s bad news.

Australian banks are also extremely reliant on getting funding from overseas markets – about 30% of their money is borrowed offshore. If it gets even harder for our banks for access funding offshore, then they will cut back sharply on lending to businesses and individuals. If you can get money, it’s likely to be at very high interest rates.

So as an Australia SME, what should I do?

As bloggers Gail Geronimos and Colin Benjamin have been advising in the last few weeks, it’s time to really build that relationship with your bank manager. Gail’s recent posts on taking your banker to lunch and considering finding a second banker are particularly worth re-reading this morning.

Otherwise, it’s time to tighten the belt. Look to trim costs where possible and focus hard on cashflow – our story on the top 10 cashflow tips might help.

When we looked at what good companies did in the last recession, another thing that stood out was that companies with flexible balance sheets fared best, so look to trim debt where you can and ensure you’ve got a bit of emergency cash around for when things get really tight.

In the last few months, SmartCompany has looked at the downturn from a range of business angles. Today might be time a re-visit some of those issues.

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