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US banks fear the next crisis

SO the US economy “only” grew at the rate of 2.7 per cent in the third quarter of this year. That added the trifling sum of US$63.3 billion to the US$9.4 trillion GDP of that amazing country.

If it only boogies along at the same speed in 2001, the US will continue to suck in enough imported goods to prop up the world.

It is sometimes hard to get to grips with the wealth of America Inc. According to the National Retail Federation, recent sales of Halloween costumes, decorations and candy soared to US$6.8 billion from the US$5 billion recorded last year.

To put that in some sort of perspective, party goers splashed out more money for one night of revels than WA earns from its exports in six months.

An American Express survey projects that US shoppers will spend eight per cent more this Christmas, or an average of US$1,600 per household. Market economists wring their hands over the credit card crescendo and worry that people are not saving.

Well, up to the end of August, US equity mutual funds had pulled in US$255 billion, more than twice the comparable year earlier total of US$112 billion. And still the money comes, despite eye-popping gyrations on the markets.

Piggy banks are old hat on Main Street. More than half of the population rely on buying and holding shares for wealth creation. Severe warnings do not deter them. They just point to the score board.

The great bull run began in 1990. And It is probably no accident that coincided with the first peace dividends from the end of the cold war. Since then, the Dow Jones Index has climbed from around 2360 to 10,800.

The total valuation of stocks has ballooned five-fold to $15 trillion. About half way up, Federal Reserve chief Alan Greenspan made an uncharacteristic bad call when he warned of “excessive exuberance”. Exuberance is exactly the characteristic that does it for Americans. It is what floats their boat.

Anyone who has visited Wall Street, or watched the action on CNBC, can see that making money is fun.

One morning what appeared to be a polar bear pressed the market opening bell.

The CEOs of companies going public routinely hurl baseball caps to the crowd below. It is difficult to imagine similar scenes in the grey markets of Frankfurt or Sydney.

What bothers me though, is that US investors no longer seem to react to crisis. In the past two years, we have had the Russian debt crisis, the Asian crisis, the US hedge fund crisis, the Brazilian crisis, the Y2K crisis, the oil price crisis, and the Middle East crisis.

The scariest problem came when John Meriwether, a former top bond dealer at Salomon Brothers in New York, established a hedge fund called Long Term Cash Management (LTCM) and set out to borrow all the money in the world.

With the help of Robert Mertons and Myron Scholes – who shared the Nobel Prize for Economics for their understanding of financial risk – LTCM embarked on some gigantic currency and bond bets.

When LTCM imploded in September 1998, it almost took half the US banking system with it. A life boat was launched to rescue lenders, and the Federal Reserve slashed interest rates, and cranked up the money supply to head off a terrible credit crunch.

The world narrowly averted the real possibility of a collapse in the banks payments system or what is known as “systemic risk”.

Those two chilling words have come back to haunt us in recent weeks, and the threat is more real than Halloween ghosts.

The problem this time is the awesome sums lent by banks to telecom companies to pay what now look like very ritzy prices for telephone licences. Some bankers are starting to panic.

They are pulling up the drawbridge against more lending to stricken giants. Junk bonds have become just that. William Gross, who runs the worlds’ biggest bond fund, has advised clients to avoid corporate bonds at all costs.

A flight to quality has seen the gap between the yield on US 10-year Treasuries and the return on US corporate paper blow out to 200 basis points, by some measures the highest since the 1920s.

HSBC economist Ian Morris says: “Fears of systemic risk in the financial system have once again appeared on the horizon. Disaster scenarios are hard to predict, but conceivably we have not yet reached the apex of fear.”

Naturally, the exuberants on Wall Street say, if the worst comes to the worst, Alan Greenspan will simply cut interest rates sooner rather than later, and ignite the next bull market. Perhaps we should sit out that dance.

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