6 October 2008

An Australian Primer to the Financial Mess

I have been speaking to many people about the unfolding financial mess and there is widespread confusion about what it's all about.  Also, many Australians do not realise how different the financial and government situation is in the US, so I thought it was time for a primer on the situation.

Differences in Financial Structures
1. There are LOTS of banks in the US, some so small they only have between 2 and 5 branches and some very large ones.  Australia has four main banks and a few smaller ones, but all banks have LOTS of branches.  The bank we used when we were in Georgia only covered a couple of counties.  If I wanted to transfer funds or access funds elsewhere in the country complex deals had been arranged to manage this.  In Australia you can access your funds anywhere in Australia.

2. The government enforced rules requiring the banks to make bad loans.  Initially the Carter administration passed laws encouraging banks to provide funds for disadvantaged people to own their own homes.  The Clinton administration decided to enforce the laws so that if any bank wanted to merge or acquire other banks they had to show they made loans to these disadvantaged people.  By disadvantaged you can read "unable to pay" or "bad credit risk".  There is no benefit in making bad loans in Australia.

3. Bankruptcy is relatively easy in the US.  Having bad credit will result in expensive credit, insurance and lots of other penalties, but if it is bad already, it is hard to get worse.  If you had bad credit, and a fellow in a suit said here is a bundle of money to buy your own home, and I'll even fiddle the application so you qualify, this meant free rent.  When the repayments became impossible, the common response was to send the keys to the mortgage owner and walk away.  In Australia, the debt stays with the person and is difficult to recover from a bankruptcy.

4. When the bank had lots of these doubtful debts, the government started bodies - oddly named Freddie and Fannie Mac.  These organisations worked book keeping magic and arranged to buy the doubtful debts and then mix them in all sorts of combinations and resell them.  Somehow this made horrible grade debt into A grade debt.  There is no mechanism for this here.

5. Australia's banking system is pretty solid.  Our main problem is our size and reliance on international finds and markets.  When the US and China sneeze, we get a cold too.

6. US Land taxes/council rates fund the local school system.  These can be many thousands of dollars.  These taxes remain with the property, so if a home is abandoned for two years, the selling price will keep dropping to take into account the back taxes.  That is one reason why Walmart finds it cheaper to build a new store outside the city limits rather than purchase a distressed downtown property.  Sometimes town councils will sell a property for $1 PLUS back taxes, and it will still find no buyers.  In Australia, local rates only pay for Council activities.  Schools are funded by State taxes.

The impact
1. Note how the US government has encouraged the banks to make bad debts and then provided a way to keep the whole thing going.  Now the government has bought up Feddie and Fannie and with the bailout/rescue will buy up the other mortgages at great prices.  Voila! The US government now owns a HUGE portion of the mortgage market in the US.  And all it took was some manipulation and banker's greed and we have a very effective transfer of property ownership.

2.  This will lead to a massive consolidation of US financial institutions.  Until that all shakes out, the money will flow sporadically which means credit will be tight.  Tight credit normally means higher interest rates and reduced consumer confidence.  So businesses with lots of debt will have to pay more to service that debt and earn less from sales.  The result is business failures, unemployment and tougher times for all.

3.  This is not like the 1929/30 depression.  It is closer to the 1873 depression.  Then a similar reckless financial expansion led to a 4 to 8 year depression.

4. The European banks are not in any better position than the US banks.  They are also collapsing all over the place as they did similar "imprudent" lending and also investing in US financial institutions.

5.  China and India are very reliant on the US economy.  When it slows down, all the underlying landmines in China - demographic, economic and social - will begin exploding resulting in depression there too.

6.  Australia's markets are overseas, so we will also feel the effects.

What now?
1. Brace yourselves.  Cut your expenses and live within (and hopefully below) your means.  You know you should have been doing this anyway, but now you have no choice.

2. Concentrate on the important things - family, faith and community.  These three things do not require money to be fulfilling.  Investments in Family, faith and community result in huge returns over many years.

Further Reading: 

1 comment:

Anonymous said...

thanks for this.
settled a few things in my mind!