ADAM CREIGHTON

The Weekend Australian - - BUSINESS REVIEW - ADAM CREIGHTON

The most re­mark­able thing about the spec­tac­u­lar share­mar­ket crash of 1987 was how lit­tle ac­tu­ally broke. The eco­nomic im­pact of the colos­sal 25 per cent one-day fall in the share­mar­ket — much big­ger than the 1929 crash, which wreaked havoc — had lit­tle im­pact on the Aus­tralian econ­omy.

“With ben­e­fit of hind­sight it was a much smaller event than it ap­peared at the time,” says for­mer Re­serve Bank gover­nor Ian Macfar­lane. “The Re­serve Bank didn’t re­act much at all,” he adds, dis­pelling the mis­con­cep­tion the econ­omy pow­ered on be­cause of RBA in­ter­est rate cuts.

In the space of a few weeks in late 1987 the bench­mark All Ordinaries in­dex col­lapsed 50 per cent — al­most unimag­in­able now, when a 3 per cent drop is front page news — re­vers­ing the surge ear­lier in the year.

“The mar­ket has gone beyond all rea­son,” said the flam­boy­ant late stock picker Rene Rivkin in March 1987.

Yet the econ­omy grew a whop­ping 2 per cent in the fi­nal three months of that year, slow­ing a lit­tle into the bi­cen­ten­nial year be­fore ac­cel­er­at­ing in 1989.

The crash was the end, or at least the be­gin­ning of the end, for a colour­ful ar­ray of en­trepreneurs like Bond and Skase, but more Aus­tralians got jobs: between Oc­to­ber and Fe­bru­ary 1988 the un­em­ploy­ment rate steadily fell from 8.1 per cent to 7.4 per cent.

Why? The 1987 crash, un­like those in 1929 and 2008, didn’t im­pli­cate or re­flect problems in the bank­ing sys­tem, which is typ­i­cally ex­posed to real es­tate, not cor­po­ra­tions.

The real econ­omy was in­su­lated. “No one was forced to sell to re­pay loans; forced sell­ing is the prob­lem,” Macfar­lane says. “If we had a big fall to­day, which could eas­ily hap­pen, say 5 per cent or 10 per cent, in­vestors would just grin and bear it.”

The han­ker­ing for “fi­nan­cial sta­bil­ity” that has mo­ti­vated of­fi­cials in the wake of the global fi­nan­cial cri­sis — a strange goal for a sup­pos­edly cap­i­tal­ist so­ci­ety? — is at odds with the main les­son of the 1987 crash. That is, fi­nan­cial volatil­ity is tol­er­a­ble, even ben­e­fi­cial, as long as it’s an­i­mated by in­di­vid­u­als us­ing their own money. Few peo­ple or in­sti­tu­tions bor­row to buy shares; so when they lose money, oth­ers aren’t po­ten­tially sent broke too.

Fi­nan­cial dereg­u­la­tion in the 1980s fu­elled ir­ra­tional ex­u­ber­ance in Aus­tralia’s board­rooms late in the decade. Loans to busi­nesses as a share of GDP surged from a lit­tle over 30 per cent in 1983 to more than 55 per cent by 1987. Cor­po­rate gear­ing, the ra­tio of debt to eq­uity of non-fi­nan­cial firms, roughly dou­bled to 100 per cent by 1988.

But even that level of gear­ing — about $1 of debt for ev­ery $1 of eq­uity — still pro­vided a buf­fer to ab­sorb losses and in­su­late lenders, apart from a few spec­tac­u­lar ex­am­ples. As for the share­hold­ers, they were typ­i­cally bet­ter off and could af­ford to lose with­out cut­ting their spend­ing.

The 87 crash also maimed the so-called “ef­fi­cient mar­kets hy­poth­e­sis”, the then-new idea that mar­kets only re­spond to new in­for­ma­tion and then in­cor­po­rate it ra­tio­nally into prices.

“The EMH says as­set prices only move in re­ceipt of new info, but here we had pos­si­bly the big­gest sin­gle move­ment ever that oc­curred ab­sent of any ob­vi­ous event,” Macfar­lane says.

To keen con­tem­po­rary ob­servers, the 1987 crash re­vealed the fun­da­men­tal rea­son for the much larger GFC 25 years later. (Cu­ri­ously, the West Aus­tralian govern­ment sought to res­cue the rel­a­tively small in­vest­ment bank, Roth­wells — a cu­ri­ous use of pub­lic funds.) The readi­ness of gov­ern­ments to bail out fi­nan­cial in­sti­tu­tions was the fun­da­men­tal rea­son why the fi­nan­cial cri­sis oc­curred.

A 1987-style crash is less likely to­day. The worst one-day drop in the ASX 200 was about 8 per cent in late 2008. The mar­ket has be­come broader, big­ger and more sta­ble. “In parts of the 1980s, over half of the mar­ket by value was re­sources, com­pared to less than a fifth now,” says Tim Baker, an eq­uity an­a­lyst at Deutsche Bank. Share prices, at about 15 times earn­ings, aren’t too stretched ei­ther, based on tra­di­tional ra­tios of price to earn­ings, he says.

Re­sources stocks swing wildly with com­mod­ity prices and dis­cov­er­ies. The por­tion of the mar­ket owned by house­holds has halved to about 12 per cent. Mean­while the share owned by su­per funds, which hold shares for the long term, has dou­bled to 27 per cent.

Listed com­pa­nies’ gear­ing ra­tios are about 50 per cent to­day on av­er­age, while their debt ser­vic­ing costs have fallen to about 8 per cent, down from above 30 per cent in the late 1980s.

While the share­mar­ket crash it­self was rel­a­tively harm­less, the col­lapse in com­mer­cial prop­erty prices a few years later — val­ues in Syd­ney, Mel­bourne and Perth roughly halved — was dev­as­tat­ing, al­most caus­ing the col­lapse of one of Aus­tralia’s largest banks and cul­mi­nat­ing in the 1991 re­ces­sion.

An eco­nomic cri­sis to­day is more likely to be pre­cip­i­tated by a slump in hous­ing, not share prices. Aus­tralian house­holds, and through them the banks, are very ex­posed to prop­erty val­ues. Home own­ers and (es­pe­cially) banks are highly lever­aged, too, which makes any fall in prices po­ten­tially more dam­ag­ing.

Scott Mor­ri­son is con­fi­dent the fun­da­men­tals are strong. “While Aus­tralia’s hous­ing mar­kets, es­pe­cially in our largest cities, have ex­pe­ri­enced strong growth over the past decade, this of it­self is not ev­i­dence of an un­der­ly­ing weak­ness in hous­ing as­set val­ues nor that a hard land­ing for our hous­ing mar­kets is ahead,” the Trea­surer said this week. “On av­er­age, Aus­tralian house­holds have five times as­sets cov­er­age over the value of their debts.”

We have to hope he’s right.

Ian Macfar­lane

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