Gas Week

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Resolution of overnight global liquidity squeeze impossible to predict: numbed markets wait for direction

Posted by gasweek on 28 September, 2007

For the past 15 or so years, banks have grown by lending to people and businesses, then bundling those loans and selling them to investors in world capital markets, reported The Australian (8/9/2007, p. 20). Capital markets shut down: Most of the sub-prime loans involved in the recent liquidity event were bundled and sold that way. Nobody knew who bought them. “But,” The Australian reported, “there may be $100 billion in sub-prime loans that are never going to be repaid. Almost overnight, on August 9, those world capital markets seized up as investors decided that buying bonds supported by mortgages could result in losses, no matter where they came from. There is almost no market for new bundles of mortgages or other debt packaged into bonds. If you want to borrow money, the only place to get it is from a bank.”

Uncertain resolution: “The RBA is not alone,” the newspaper said. “The share market does not know which way to turn, either. It plummeted when the credit squeeze first hit in Europe but made up all its losses in the following weeks. There is a view (shared by the International Monetary Fund and the Organisation for Economic Co-operation and Development) that the events in financial markets will simply translate to slightly higher interest rates, which would not do much to dampen world growth, although the US may face more severe problems. This is a fair conclusion provided the shortage of liquidity does not worsen, but no one knows how it will end. It may be, as Australia’s leading banks expect, that the blanket refusal by capital markets to accept new debt will evolve into a more discriminat­ing approach that allows highly reputable borrowers to raise funds while lesser credits are excluded.”

Catastrophe possible: International Capital Markets Association chairman and Barclays Bank chief Hans-Jorg Rudloff darkly warned this week that the alternative would be catastrophic, the newspaper reported. “If we stay stuck, the patient is going to die,” he said. “Trading of assets has to be resumed.” A dead patient would translate into widespread bank failures and global recession, which would likely extend even to the far reaches of provincial China.

Reference: David Uren, Economics Correspondent

The Australian, 8/9/2007, p. 20

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