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Leigh Sales talks to economics correspondent -

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Leigh Sales talks to economics correspondent Stephen Long

Broadcast: 08/09/2007

Reporter: Leigh Sales

ABC economics correspondent Stephen Long discusses the week in business and finance.

Transcript

LEIGH SALES: The Reserve Bank left the official cash rate on hold this week but that failed to stop
interest rates in the money markets soaring to their highest level in more than 10 years. In
response, the Reserve Bank announced unprecedented moves to calm the markets. To explain this, I'm
joined by economics correspondent Stephen Long. So, Stephen, what's behind these moves on the money
market?

STEPHEN LONG: Well, the short answer, Leigh, is that the credit crunch that began in early August
has never gone away. In fact, it's got worse. So banks are fearful of lending money to banks, the
market for long term bonds back by mortgages has all but dried up.

So there's a rush for short term cash and this week you saw the key short term money market rates,
the 30 day bank bill rate for example, soar above 7 per cent, that's about 40 basis points higher
than you would expect it to be with the prevailing interest rate at 6.5 per cent, the cash rate at
6.5. Now, in practice, it's these rates that ultimately determine the cost of finance for business
and households, so it's a pretty serious situation. That's almost the equivalent of two interest
rate rises above where the Reserve Bank had set the official cash rate. So what was the Reserve
Bank's response? Well, that happened on Wednesday. Thursday morning, it announced that it was
broadening the range of securities it accepted when it injected liquidity into the money markets,
including buying mortgage backed securities from banks, so now we have the situation where in
Australia and the United States, we have a crisis that's come out of dodgy home lend and central
banks are buying securities back by mortgages from banks to inject money into the markets.

Now, I would say this raises serious policy issues and possibly issues of moral hazards when you've
got central banks underwriting credit in the market. And it should be the subject of debate,
although participants in the market have been glad to see the banks intervene in this way, the
debate hasn't happened.

LEIGH SALES: Well, indeed, what would happen if the central banks weren't taking this action?

STEPHEN LONG: Well, I guess there's the rub. I mean, if these lending rates in the money markets
kept going at these high levels, ultimately it would feed back into the real economy and you'd have
a situation where home loan interest rates, for example, went up pretty much across the board.
Already this week we've seen some of the institutions such as Macquarie Bank, which rely on the
debt markets to fund their mortgages, put up rates. And you'd also see rates for corporate
borrowing go up. And that would hit the real economy and possibly cause a real crunch in the
economy. And we've have Alan Greenspan, the former chairman of the Federal Reserve, who some would
argue is partly responsible for the mess we're in now, but nonetheless, he's saying the situation
we're in now is identical in many respects to 1987 before the stock market crash. A serious
situation.

LEIGH SALES: We're out of time there, Stephen. Thank you for coming in.