Is it possible that no-one in the Government, Treasury or the Reserve Bank of Australia has any idea about risk?
That seems to be the case. Perhaps we could show them a very simple diagram from the Australian Bankers’ Association (ABA) website:
It’s the sort of thing that any young finance professional will learn in Investing 101. You don’t even need to be in the finance industry to understand how risk/return works. It is common sense.
During the bull market the risk/return chart became blurred. Almost every financial product was touted as being low risk even when it wasn’t.
Take another look at the chart above. It has cash and then three separate asset classes: fixed interest, property and shares. Yet it doesn’t show an asset class for products that were constructed using a combination of property, debt and leverage. Products that were priced as though they were only slightly more risky than cash yet were infinitely more risky and should have appeared on the chart as we have it below:
These were considered to be low risk as it was never expected that anything could go quite as wrong as it has.
But the inability of government, Treasury and the RBA to understand the public’s changing attitude towards risk is amazing. It should have occurred to them that as soon as bank deposits guaranteed people would start to put more of their money into the bank.
As we mentioned on Wednesday, no-one in their right mind would keep their cash in a 7.32% non-guaranteed investment when they can switch to a 7.25% guaranteed investment.
So now we have the spectacle of AMP, AXA and Challenger freezing all withdrawals on about $7 billion of assets as investors fly to safety.
It is even more amazing because the ‘flight to safety’ has been taking place in the US for at least the last month. There, big investors aren’t putting money in US bank accounts. That is because only the first USD$100,000 of bank deposits are guaranteed. Instead investors are investing in the safety of US treasuries.
They do so – even at yields below the inflation rate – in the belief that the investment is secure and that the US government will not default on its debt obligations. That is also why US government bond prices climbed so high recently and yields fell.
Obviously the policy makers here did not understand this, otherwise they would not have decided that a coverall bank guarantee was a good idea.
What is the next step? The freezing of mortgage trust redemptions means that funds have used up their short term lending limits with the banks. So they cannot pay out cash without first disposing of underlying assets.
Therefore we would not be surprised to hear from the RBA stating that it will either buy mortgage assets directly from the funds, or that it will lend cash to the funds using the mortgage assets as security.
Of course neither may happen. But it highlights that once a government starts to interfere it just leads to even more confusion.
Cheers.
Kris.