Credit Crunch Puts Aussie Banks in Tricky Position

The U.S. market was down overnight as the genius analyst community finally downgraded American banks. Thanks for the hot tip boys. "We probably have not seen the end of the bad news,'" said Craig Hester of Hester Capital Management told Bloomberg. "The first wave has come through the residential mortgage market, and now we're beginning to see credit card delinquencies on the increase."

There are still a few rogue credit waves out there. Yesterday Bloomberg reported that, "Moody's Investors Service may cut the ratings on A$83 billion of Australian mortgage- backed bonds linked to PMI Group Inc. on concern the U.S. home- loan insurer will find it harder to pay claims."

The Australian mortgage-backed bond market is about $180 billion. A downgrade on some of the debt will affect investors for sure (and just who are those investors?) But the most obvious affect is that non-bank lenders will have more trouble financing new loans. Banks will have to make up the difference, if they are willing.

But there's a reason banks weren't in the market for making high-risk loans in the first place. And with the credit crunch putting up the price of money in the whole sale market. Aussie banks have to pay more to borrow globally too. The banks would like to pass that cost on directly to the Aussie lender, and have pretty much done so in raising rates ahead of the Reserve Bank's decision later today.

It puts the banks in a tricky position. Raise rates too much and you choke of business and personal borrowing. Granted, this seems unlikely given the figures for credit growth the RBA published last week. But new data from the Federal Reserve show that U.S. banks have already tightened lending standards, and not just for consumers but businesses too.

In its most recent survey of senior loan officers at major U.S. banks, the Fed found that 80% of U.S. banks had tightened their lending commercial real estate lending (see figure below). This is an ill omen for the American economy. So far the housing bust has been confined to residential lending. But if banks stop loaning money to businesses for commercial property, the American economy suffers yet another body blow.

Source: http://www.federalreserve.gov/boarddocs/snloansurvey/200801/fullreport.pdf

The news was a little less bleak for American households. The Fed survey reported that, "In the January survey, significant numbers of domestic respondents reported that they had tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the past three months."

"About 55 percent of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40 percent in the October survey. Of the thirty-nine banks that originated nontraditional residential mortgage loans, about 85 percent reported a tightening of their lending standards on such loans over the past three months, compared with about 60 percent in the October survey."

Well, what did you expect? The Fed's recent rate cute hasn't helped stocks. And it has not encouraged banks to be more permissive in their lending. Perhaps the adults are in charge again. And perhaps Bernanke and company panicked when they cut rates last week.

Australia's banking sector is different from America. But even though rates are headed up here (and down in America) the net effect may be the same: reduced lending activity and slower growth. Of course in Australia, business spending is still strong and wage growth is in the pipeline. Look for another rate rise from the RBA if the February 21st wage data is strong. And look at U.S. dollar. Parity may be reality by the end of 2008.

Dan Denning
The Daily Reckoning Australia

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