SATURDAY INSIGHT: Tanner on governing

"The last time I looked I had more TCF companies in my electorate than any other in the country." The speaker is about as inner-Melbourne as could be. Lindsay Tanner represents Richmond, Collingwood, Fitzroy and Melbourne itself in the federal parliament - the heartland of Australia's clothing industry.

As an officer of Federated Clerks Union in the 1980s and early 1990s he used to regularly visit one of the northern suburbs factories that Pacific Brands this week closed down.

"It's terrible," he says. "But it isn't just the economic crisis. It's also the way this company has been run; its debt levels, its acquisition strategy, its large number of brands, many of them little impact, and what we now know about very large pay increases given to management."

Australia's Finance Minister isn't completely powerless to help - the day before Pacific Brands sacked 1,800 workers he and colleague Julia Gillard ditched the 3 month waiting period for retrenched workers seeking to use government services.

And he is talking tough about executive salaries. "They've gone through the roof, they're out of control," he says at the end of a week in which Telstra revealed plans to pay its outgoing chief executive $11 million.

But he believes the best way to help is one of the least direct...

"It will always be the case that a slowdown will tend to hurt first the companies that already have problems."

"The most important thing to do is to strengthen the economy generally; to spend money on infrastructure and associated activity that helps sustain growth."

If the prescription sounds boring, the reality isn't. Tanner is part of the small group of four (the others are Rudd, Swan and Gillard) that has nutted out each of Australia's multi billion dollar stimulus packages as well as each of the other emergency measures.

Since Lehman Brothers collapsed in late September it's been a white-knuckle ride.

"It's been like fighting a series of emergencies. There are huge sums of money involved and it's not an exact science," he says.

"You have to make judgement calls based on the best advice, from the Treasury and the Reserve Bank and other places, but we're not doing physics experiments - these are highly complex constantly changing circumstances where most of the factors that are involved are external and we often don't have all the information."

"People say, you know 'here's what happened in the Swedish banking system in the early 1990s and here's how they responded, so do what they did'. Well inevitably the Swedish banking system is different from the American banking system and in turn the British banking system and our banking system, and the differences can be critical."

Does he ever wish he could just "wait to see," rather than making emergency decisions that throw around billions of dollars on the basis of imperfect information, an idea infamously put forward by the Opposition's Treasury spokesman Julie Bishop shortly before she lost the job.

Tanner was, after all the Finance spokesman in opposition who derided his predecessor as "Santa Minchin" and on taking office promised to wield "Tanner's Axe."

"Our problem is that we can't sit around staring at our navels," he says. "We have to act quickly because of the lags involved. Even when we're making bonus payments, it takes time to get the money out of the door."

"These are in unprecedented circumstances. The responsibility that is weighing particularly on the four of us is pretty heavy, but that's what we spent a lifetime aiming for."

"One of my party colleagues straight after the famous meetings of that weekend in October when we announced the stimulus pacakge and the bank guarantee, said to me, 'I hope you're taking lots of notes in all these meetings mate, this is history being made,' and I looked at him and laughed and said, you've got to be kidding - who'se got time to take notes about anything?"

"In the middle of this you don't think about things like that."

Some of what were to be Tanners biggest tasks have been put on the back burner. The results of Razor Gang Mark II, his second go at shaving spending, were expected by Christmas.

They now won't be ready until the May Budget.

"We have been forced to move away from the serene steady roll out of policy. The wider context has become so turbulant that it has become clear it is going to be difficult to deal with these things sensibly. We've been literally spending so much time on the global economic situation."

"It's one of the interesting lessons I've learned in government, he confides. "When you are in Opposition you have virtually no resources and you are used to thinking of Government and its resources as infinite; its people, resources, its brain power, its capacity to dream up ideas, to get answers, provide briefing papers, get teams working on problems."

"One of the things you realise when you are in government is that they are not infinite. You need to allocate resources to where you want your effort, and not only with the public service."

"Because it's the same small group of people at the top who ultimately have to make the decisions - who have to be informed and make decisive calls - there's only so much capacity that those people have to absorb, to think, to toss around."

Do you mean that if you are fighting a fire, you can't redecorate?

"Yes, we were about to start a budget process, and had the world been vaguely normal in September and October, then things would have proceeded as they were going to. We had got one already got one thing out of the door with the Gershon report on information technology. We thought let's proceed with that, but lets fold the rest of the razor gang into the ordinary budget process."

As Tanner sees things, his first budget as Finance Minister was about making the easy cuts, "things that didn't require a huge amount of complex groundwork," what economists call low-hanging fruit.

The cuts in his second budget will be more difficult, and by themselves won't look like much.

"It's low-profile work and it doesn't excite much interest, except in Canberra," he says. "But I'm a devotee of that old saying, look after the pennies and the pounds will look after themselves. I'm the guy looking after the pennies."

Just because the budget is expanding, doesn't mean that the budget shouldn't be frugal in the way it spends money, Tanner says.

"I see a central part of my role being to liberate resources that can be dedicated to more valuable purposes - whether in the current climate it's sustaining jobs, sustaining economic activity or whatever."

But he is frustrated that there isn't yet a good way of measuring how good he will be at that job. Finance Ministers are normally judged on the toughness of their first few budgets. The cuts expected in Tanner's first budget were toned down at the request of the Treasurer Wayne Swan who was concerned about the looming economic downturn. The cuts in the second won't be seen in a bottom line that will swell well into deficit in order to keep fighting the downturn.

"The two things actually aren't in conflict. We are very clearly now in the domain of a very substantial deficit. My work is to ensure that whatever the quantity outcome, the quality keeps improving."

"There isn't a way of measuring this yet, but it is something about which I have had initial discussions with my department. The concept is simple: for a total amount of money that the government spend in a given year, how much is devoted to it merely functioning and how much ends up as outcomes?"

"For instance what percentage of tax receipts is used up just in the administering and collection of tax? It's very low, around half a per cent. I know it is difficult and I don't know whether it has been done overseas, but I want to develop a broader measure against which our budgets can be judged."

"A classic area where I think it would be hugely beneficial is in somewhere like the ABC, to get an understanding of what proportion of its resources actually end up directly providing content versus running the organisation. That kind of metric will give you a very good idea, even though it's not capable of being done absolutely scientifically, particularly over a number of years, of whether governments and their organisations are getting flabby or inefficient and whether citizens are getting value for money."

"I try to keep my partisan sledging down to a dull roar, but the Howard government was essentially uninterested in managing government. It tried a few things early in its term and then gave up. I was dimly aware of this in Opposition, but I only became fully aware of it on taking office.

"It essentially created the government as a giant holding company or conglomerate and got individual agencies to mimic private companies. Each had a CEO with very wide responsibility, and virtually all across-government functions, purchasing and so, were abandoned. The end result was massive inefficiency."

The Gershon report, prepared for Tanner by Tony Blair's British cost-cutter Sir Peter Gershon, is one the "consultants reports" that the Opposition bagged in Question Time this week. Tanner says Gershon donated his fee to charity.

"We adopted Gershon's recommendation in full. They give you a good idea of what we are trying to do. Here's just one small positive outcome: The Department of Defence has a history of being a very good purchaser of Microsoft products and getting good deals from Microsoft because they are a big purchaser. We have reached an arrangement with Defence to lead a collective buying effort between all agencies and departments and Microsoft. That is saving us $15 million a year across departments. Microsoft isn't complaining because although its price goes down the cost of dealing with us goes down as well."

"We've decided to allow departments and agencies to keep the savings from that one because they are thinly spread. That's just one small example of where across-government collaboration, provided you don't go too far to a centralist model and try to get an intelligent balance, produces better outcomes."

"It's just a start. We have 45 data centres outside the Defence department. That's 45, wholly devoted to different arms of the Australian government. Individual agencies have been doing their own thing with no attempt to aggregate and deal with sustainability, redundancy, power supplies and so on. It's massively inefficient."

"Gershon estimated that if we develop a whole of government strategy, over 15 years we can save $1 billion - just by being more intelligent in the way we do things."

"We are methodically working through all of these areas; travel, the purchasing of office equipment, property. At the moment individual agencies compete against each other to rent office space, pushing up the price. There is no common standard on how much space an individual employee needs, as there is in the US and the UK."

"What you have is this elegant private sector theory applied completely inappropriately to government and it has produced absolutely perverse outcomes; waste, inefficiency and poor performance."

The Finance Minister is warming to his topic. It may seem a long way from helping those who lost their jobs their jobs this week at Pacific Brands, but it isn't to him. The job he does matters to him, even if much of the work is unnoticed more broadly. The Member for Melbourne is applying himself to making sure government works.

He seems to be enjoying it.

Tanner's quiet revolution

. saving money while spending more

. adopting an all of government approach

. saving $1 billion on IT alone

. extending savings to travel, purchasing

. a "value for money" scorecard

. unveiling savings in the May budget

Read more >>

SATURDAY INSIGHT: Our problems are worse - much worse

Yes, it's the current account deficit. Remember that? It puts us at risk.

What if a weakened financial system and weaker than usual spending are the least of our problems?

What if there's more to worry about that keeping the money flowing and minimising the extent of the recession?

What if our real problems are deeper and have the potential to sink us?

What if we are only dimly aware of them or find it easier to deny them until it's too late?

What if we've been doing that for years?

It's hardly an unlikely scenario.

In the United States a problem which did have the potential to undo the economy was ignored or denied by everyone from the world's most important central banker down.

Investments that seemed too good to be true were investigated and found trouble-free right up to the day millionaire philanthropist and funds manager Bernie Madoff turned himself in.

Welcome to Australia in the first decade of the 21st century.

Welcome to where where we find ourselves at the end of The Howard years...

Back in 1997 when the Howard government was young, financial markets took a set against a a number of Asian countries including Indonesia. Its currency plunged 60 per cent. There was mass unemployment, rioting, regime change, austere medicine imposed by the International Monetary Fund which made things worse and the loss of 13 per cent of GDP.

And yet, as the winner of this year's Nobel Prize in economics Paul Krugman points out in the new edition of his book The Return of Depression Economics, Indonesia's current account deficit at the time was smaller than Australia's. Its standard of living was more sustainable than ours.

A country's current account deficit is the measure of the foreign dollars that it pays out to rest of the world each quarter over and above the foreign dollars that come in. It can only be sustained by ever-growing foreign borrowing.

Since the Asian economic crisis - the bullet that Australia missed - our current account deficit ratio has doubled. What we pay out over and above what we take in now amounts to roughly 6 per cent of our GDP. That's quite an achievement for a nation at the end of five years of an almost-unprecedented export boom. Our imports have climbed faster.

Much of the increased import spending has been on mining equipment and the like - a necessary counterpart to the resources boom.

But much of the rest has been on consumer goods: roughly 50 per cent more on consumer electrical imports such as plasma TVs, almost 70 per cent more on imported food - all within the space of five years.

The Howard government helped, announcing personal income tax cuts in each of 2003, 2004, 2005, 2006 and 2007. Tax breaks - either outright exemptions or concessions - soared from $50 billion to $73 billion. Government spending jumped by one third. At a time when employment generally climbed 15 per cent, the Commonwealth public service (excluding Defence) swelled 25 per cent.

Almost as the fast as each wave of mining-generated cash came in, the government pushed it out where it would be spent. In its dying days it formally adopted as a campaign slogan what by then had long been its unofficial guiding principle - go for growth.

The party that in opposition had hired a "debt truck" to drive around Melbourne streets bemoaning Labor's $200 billion foreign debt, left office with a foreign debt exceeding $600 billion. During its final year we were expanding that borrowing at the rate of $200 million per day.

Much of it was spent on the not-particularly-useful exercise of bidding up the price of Australian houses. After the government halved the headline rate of Capital Gains Tax at the turn of the century Australian house prices doubled. Investors who used to account for only 20 per cent of the loans to purchase housing took out 40 per cent as they swept owner-buyers aside and pushed up prices. It used to take three to four years of a typical household income to buy a Melbourne house. It now takes seven. The US website Demographia lists Melbourne, Sydney, Adelaide, Bundaberg, and Queensland's Gold Coast as among the world's 12 least affordable markets. It identifies Melbourne as being less affordable than New York.

This makes no obvious sense from an international point of view and bears all the signs of a bubble waiting to be pricked. It has also put housing beyond the reach of Melbournians who could have once afforded it, perhaps unsustainably. But it has kept the a larger number of constituents happy. One of John Howard's parliamentary secretaries is reported to have once quipped, “rising prices make for happy voters”.

That happiness fed into a feeling of wealth, and a feeling that (perhaps aided by dipping into housing equity) it was okay for Australians to spend more than they earned each year.

Extraordinarily in 2003 Australia's household saving ratio turned negative after being in positive territory ever since records had been collected. For the first time Australians households in aggregate were spending more than they earned each pay period. We began to literally live beyond our means as our mining boom was taking hold. (Our savings ratio has since returned to positive territory and is now climbing sharply as we shut their wallets ahead of a recession.)

We could have done things differently.

Norway stands alone in the rest of the world in having had as much wealth showered on it as has Australia in the last half decade. No other nation comes close. (Canada, which has experienced the third biggest boost to its terms of trade is a distant third.)

Instead of running up a growing current account deficit, Norway built a rapidly growing current account surplus and is perhaps the most protected nation in the world from attacks by financial markets.

Whereas Australia was blessed with natural gas, coal and iron one, Norway was blessed with North Sea oil. But it knew it wouldn't last. So it moved the windfall tax revenue to an untouchable Norwegian Petroleum Fund, later renamed the Norwegian Pension Fund. Not only could the massive inflow not be paid out in tax cuts or used to expand government programs beyond all reason, most of it couldn't even be brought onshore. (It also has to invest ethically.)

Because the Petroleum Fund invests its money in foreign currencies offshore it neither bids up the Norwegian currency, Norwegian real estate, Norwegian prices nor Norwegian imports.

Norwegians mightn't feel as wealthy as they might have had they gone down the Australian road. But in reality they are much wealthier, with a buffer of continuing earnings that will protect them whatever happens to China and the worldwide demand for resources.

Australia has no such buffer. Australia is in the same situation as a lottery winner who splurges the booty as it comes in spending even more than the winnings in the excitement. Norway is like a lottery winner who keeps the windfall away from the family and won't even let it in the house, banking if offshore as insurance against the day things turn nasty.

And Norway is not alone. Timor has also set up a petroleum fund.

As the globe enters its first co-ordinated recession in half a century, and as the providers of finance become more jittery than they've been in generations Australia finds itself absolutely dependent on the rest of the world to maintain its standard of living, more so than Indonesia was before its currency came under attack during the Asian economic crisis.

China's surge in economic growth - the one thing that bought Australia temporary immunity from attack by financial markets - has stalled, or perhaps stopped.

Marvin Goodfriend from Carnegie Mellon University describes China's boom as “a one-off in the history of the planet earth.”

“We have never had it before in thousands of years of planet earth and we are not going to have it again in a few thousand years,” he said during a visit to Australia.

What if China's boom doesn't restart? What if instead of being a blessing Australia's abundance of resources remains as irrelevant as it is now becoming.

In its recent economic update Access Economics reminded clients that it it has long said that, "if China's surge stumbles then Australia's trading balance will be buggered". It added, "buggered it will soon be."

Access sees Australia's current account deficit jumping to a "Godzilla-like" 9 per cent of GDP next financial year, in part because it believes our recession will be milder than those overseas and we'll continue to expand our imports without the export income to pay for them.

The result might be an orderly collapse in the Australian dollar (Access sees a collapse from US 65 cents to US 56 cents) or it might be an attack on the dollar.

Its easy to understand why foreign funds managers might feel we are good candidate for such an attack. Our current account deficit would be many times the level of the Asian countries caught up in last decade's economic crisis. Our developed legal and banking system need not save us. In 1992 funds manager George Soros successuflly took on the Bank of England, making his reputation and US$ 1.1 billion in the process. Our Reserve Bank carries only small reserves of foreign exchange. It couldn't last as long as did the Bank of England.

On the face of it the United States would be as vulnerable to a capital strike or currency attack as would Australia or Britain. But the US is different. It manufactures the world's currency. It could literally print money to buy itself time.

Earlier this week The Age spoke to seven of Australia's more thoughtful economic observers. They were asked for their thoughts on the best way to stimulate things. But some said that was the wrong question. Melbourne University's John Freebairn said instead we had to get prices, spending and saving back into balance. "I for one am not worried if Australians save any tax cuts," he said. "We've been spending too much."

"Some corrections are necessary. Our housing prices have to fall. These recessions - almost as Paul Keating said, sometimes we need them to get over our bad behaviour."

Cutting interest rates toward zero as the US has done would be a bad idea, Freebairn says. The US did a similar thing at the start of this century in order to escape its 2001 recession. It helped create the sub-prime mortgage boom whose unwinding led to the crisis that is now threatening the globe.

Freebairn wants our leaders to use the present crisis to set up things up for sustainable recovery in the decades that follow. Otherwise, he says, "it's a wasted opportunity".

The former head of the Competition Commission Allan Fels wants the government to do nothing that will make Australia less competitive for the recovery which is to follow. It's already approved the gobbling up of two middle size banks by the majors and is showing signs of handing out money to whatever interest group asks for it first. "The should plan as if the recession will last for three years," he says. "And keep their eye on the sort of Australia that will emerge from it."

Gerry Harvey of the retailer Harvey Norman says he's not that fussed about getting people back into his stores in the short-term. He'd rather the government concentrated on making Australia productive.

With surprisingly little to protect us from what the future has in store after a half decade of riches we will need to work our way out of our problems carefully.

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SATURDAY INSIGHT: Landslide piled upon upon landslide

Ruth Williams and Peter Martin in the Insight section of Saturday's Age

"In a landslide, each time the earth moves and settles, people imagine the worst is over - until it happens again."

Think back almost a week ago. On Sunday afternoon, as Melburnians enjoyed a few hours of sunshine before the inevitable evening clouds, the financial world order was about to change in the most dramatic fashion. By Monday morning, as the Australian stockmarket reacted violently to the news from New York, the damage was clear. And throughout the week, it got progressively worse, leaving investors reeling and Australians concerned about what it meant for them.

It was a week that broke records as well as banks, and prompted intense soul-searching on how the subprime mortgage crisis in the US could cause so much pain...

The bad news came thick and fast. Venerable Wall Street investment bank Lehman Brothers collapsed. Rival Merrill Lynch was sold off at bargain basement prices. American International Group, the world's biggest insurer, survived only after being given an $US85 billion ($A105 billion) lifeline from the US Federal Reserve. There was a shotgun merger between HBOS and Lloyds TSB in Britain, and $US180 billion was heaved into markets after a terrifying pause in global commerce on Thursday evening. That funds injection sparked yesterday's dramatic turnaround.

In Australia, news of the impending crisis spread quickly, and had fast and evident results. On Monday, as Australian shares fell almost 2%, Treasurer Wayne Swan and Prime Minister Kevin Rudd spoke to Glenn Stevens and Ken Henry, heads of the Reserve Bank and Treasury, then briefed cabinet later that day.

On Tuesday, the benchmark index sank another 1.4%, its lowest since Christmas 2005, and ANZ chief executive Mike Smith cut his holiday short, arriving back in Melbourne on Tuesday night. On Wednesday and Thursday markets fell still further. Before yesterday's rally, Australian shares were worth 6% less than they were at the start of the week. Super returns have been hit, share portfolios of investors big and small substantially deflated.

And the global flow of money, which keeps the world's economy going and upon which our banks rely for access to wholesale funds, sits almost as stagnant as parts of the Murray-Darling basin.

Last Sunday evening, as Victorians drifted off to sleep, events taking place in New York were to radically alter the world's financial system, and with it, Australia's. The implications - financial, economic and even political - will be far-reaching.

"From a historical perspective, there has been nothing like this since the Great Depression," says Patrick de Fontenay, adjunct professor at Australian National University's Crawford School of Economics and Government. "The problem is that all financial institutions that rely on debt for their operations are having trouble rolling over their debt. And whenever a financial institution gets in trouble, there's contagion."

What we are seeing is contagion on a huge scale, and it has terrified investors. AIG was, to use the cliche, "too big to fail". But Lehman, which the US Federal Reserve allowed to fall into bankruptcy, was not. Investors are now fearing - indeed, expecting - more collapses of financial institutions that are also not too big to fail. What investors do not know is how far the contagion will spread. That makes them scared, which makes them panic.

And nowhere was panic more evident this week than on global sharemarkets. Wall Street fell 4% in one day, and Australian shares, despite a 4.3% rally yesterday, will finish the week at levels last seen 2½ years ago. Yesterday's bounce was more evidence of raw emotion at work as panic selling gave way to panic buying.

Even those who have been in the market for a long time - who worked through the 1987 stockmarket crash - are stunned. "The events of this week have been extraordinary," says David Evans, managing partner of stockbrokers Evans & Partners.

"It has been a historic week. It could be that all of the major American investment banks as they stood a week ago, by the end of next week or next month will have different letterheads."

The sell-off in Australia, as elsewhere, has been most dramatic in financial stocks - traditionally a haven for investors. Macquarie Group, which once traded for $97, lost almost a quarter of its value in one day on Thursday, falling to $26.05 before an extraordinary rebound yesterday. This week, the S&P-ASX financial index dropped 1.4%, with the big four banks all hit.

In Australia, the biggest sharemarket victims during the week would have been those who borrowed to invest, who found their share portfolios were worth less than the debt outstanding on them.

"People who are highly geared have more to be concerned about," Evans says.

Thousands are facing margin calls - a demand to pump more money into their loan accounts. These forced sellers drive prices down further, building, and building, on the downward momentum.

The Australian Securities Exchange's latest information, from late 2006, shows that about 7.3 million people - about 46% of the adult population - owned shares directly or indirectly through a managed fund or self-managed super. But the survey doesn't track how many of those people borrowed to buy their portfolios. Just how many people out there are sweating on a margin loan, frantically clutching for cash to meet their obligations, is not known.

But while the threat of a margin call may hang over the heads of a minority of Australians, every working Australian is exposed to the market through their superannuation. And here is another local consequence of these global events.

Headlines this week warned of more negative super returns, coming after last year's average return of minus 6.4%. For the June quarter, super returns were the worst since compulsory super began in 1992.

Back in June, that negative symbol came as a shock to many investors, accustomed to their super funds delivering double-digit returns. Superannuation Minister Nick Sherry was moved to reassure super investors that despite last year's negative returns, super remained a sound investment.

It was a pre-emptive move, aimed at shoring up people's faith in super before it faltered too much. But he may well have to say it again in a few weeks' time when the September quarter statements go out, bearing once again a number with a negative symbol in front of it.

His central message has been that, even though returns are lower now, long-term averages remain strong. "Australians overwhelmingly do not access their superannuation at a single point in time; it is a long-term saving," Sherry told Parliament this week. "The most important rate of return to focus on is the five to seven-year rate at least, if not longer."

If it fell, in part, to Sherry this week to reassure super investors, it was also up to the super industry itself. Richard Gilbert, chief executive of the Investment and Financial Services Association, urged super investors not to be "like lemmings running off a cliff", advising them to call their super funds, or even get paid advice. "Don't make decisions based on your instinct alone," he said.

One group of people will face significant implications from the market slide - those about to retire. There are about 1.4 million Australians aged between 55 and 60, many of whom are considering retiring and accessing their super. Another 1.3 million are in their early 50s.

"If you are 55, or approaching 60, and thought you were going to retire next year, well perhaps you can't," Gilbert says. "It's going to affect a lot of people."

But for the rest of us, with a decade or more left on our super investments, the eventual super damage is unlikely to be severe. Super accounts are still buoyed by a decade of strong returns. Assuming markets eventually recover (and they always have in the past), everything that goes into super accounts now is buying at what may be close to the bottom.

But even those who escape relatively unharmed on their super are likely to feel a further consequence of this week's events - more pressure on bank mortgage rates.

Once upon a time, Australians who took out a mortgage might have been reassured that it had the words ANZ or National Australia Bank written on it. But these days, that doesn't mean that the money behind that loan came from ANZ or NAB depositors, or even that it came from Australia.

Roughly half of the money lent by the big four Australian banks comes from overseas. Almost all the money once put up by non-bank lenders such as Aussie and RAMS did. And although it looks the same to an Australian borrower, the price of that money to a lender - such as a bank - is beyond Australian control. Whenever the Reserve Bank cuts interest rates (which is likely at its next board meeting on October 7) it is only able to cut the price of the Australian money. The price of the other half is set in China or Europe or Japan, or wherever the ultimate lender lives - and it's soaring.

UNTIL the credit crunch began in August last year and foreign investors got nervous, they were happy to demand little more than the Australian wholesale interest rate to invest in Australian mortgages. But after August, when it became apparent that many of their loans to US borrowers were worthless, they started demanding a lot more to fund mortgages - even good quality Australian ones, if they would fund them at all.

RAMS folded, other non-bank lenders became shells of themselves and Australia's big banks aggressively pushed up their rates well beyond the rate rises sanctioned by the Reserve Bank. The Government could only look on helplessly as mortgage rates pushed through 8% into the nines - despite the official cash rate peaking at 7.25%.

In recent months, foreign lenders had relaxed, cutting the premium they demanded to fund Australian home loans to about 1 percentage point. But this situation ended late last week. So horrified were the lenders at what happened to even top-notch, AAA-rated US institutions, their asking prices to lend to Australian institutions are surely set to go through the roof.

What does all this mean? When the Reserve next cuts Australian interest rates, mortgage holders should not expect Australia's banks to pass all of it on. Too many of their other costs will be going up.

So, Australians will feel the impact of this week on their share portfolios, their super funds and their mortgages. It all amounts to a lot of bad news - and a delicate balancing act for the Government.

In the political world, if there is to be a winner of any sort from the market fallout, it may well be Malcolm Turnbull. As investors waited anxiously on Tuesday morning to see how much our sharemarket would fall, Turnbull emerged victorious from a Liberal leadership ballot. A former merchant banker, his economic and business credentials tower above those of his predecessor, Brendan Nelson. His first question to the Government as Leader of the Opposition?

"What concrete action is the Prime Minister now taking to further strengthen the Australian economy, in particular the financial sector, in response to the bankruptcy of Lehman Brothers investment bank?"

Rudd soon fronted the media to reassure the public of a capable Government, briskly dealing with the unfolding crisis.

"On a daily basis the Treasurer and myself have been in active conversation with both the secretary of the Treasury, the governor of the Reserve Bank, and … the head of APRA (the Australian Prudential Regulatory Authority). That close collaboration continues," he said.

One can only hope the politicians comprehend the magnitude of the crisis facing Australia and the world, because the immediate woes facing super funds, mortgages and share portfolios fade compared to what could really go wrong.

In a landslide, each time the earth moves and settles, people imagine the worst is over - until it happens again. In March there were five big investment banks in the US. Then Bear Stearns collapsed, sold in a forced rescue to a bank for a mere fraction of its value.

Then there were four - Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley. Like Bear Stearns, each had survived the Depression. But not all would survive this week - Lehman collapsed after its shares plunged 92% and the US authorities declined to intervene. Merrill Lynch sold to the Bank of America for one-third of its previous value on the same day.

And then there were two. A day later US authorities took over the world's biggest insurance company, American International Group, rather than allow it to collapse.

Every time another one falls, the other institutions with which it does business hurt too. They become less willing to lend or invest money, and the global flow of money dries up further.

And the next weakened institution, frantically trying to save itself by borrowing more money, finds that no one will lend to it. It topples, and the landslide resumes. No one can say when the landslide will end.

The direct effects are bad enough. Lehman used to employ 26,000 people - 140 of them in Australia. Merrill used to employ 60,000. The indirect effects are worse. US firms and US consumers are winding back spending and may well bring on a recession.

In normal times the US Federal Reserve would try to buoy things by cutting rates (it resisted temptation to cut this week), but with its official interest rate at 2%, it can't cut much further. Of course, a recession in the US needn't mean one in Australia. For five years Australia's prosperity has been underwritten by the extraordinary growth of China and its demand for raw materials. The big question now is whether that growth will continue without rising demand for Chinese goods from US consumers. China exports roughly half of everything it produces - mostly to the US and Europe, so a recession in the US would be expected to have an effect on Chinese economic growth.

But in July two economists from ANU reported that a US recession might not hurt China deeply, because the money that would have been invested in the US would instead be pumped into China, accelerating its development. The jury is out.

However, a recession, even one that does spread to Australia, is not the biggest threat concentrating the minds of those in Australia's Reserve Bank. Australia has, after all, survived recessions in the past.

On Thursday, after Kevin Rudd had tried to reassure Australians of the soundness of our banking system, of the Government's busyness as it managed the crisis, investors got a taste of the biggest threat to economies all over the globe.

For an hour or two on Thursday afternoon, an entity called the forward exchange foreign market in Asia stalled, and the heart of the world's financial system stopped beating.

No financial system can work unless the people and businesses that need access to money can get it. For a few hours on Thursday, the US dollar became completely unavailable for some purposes. No one who wanted to enter into a so-called forward contract - a commonplace and crucial part of international commerce - could do so using US dollars.

So frightened about the future had people with US dollars become that for a few hours they were unwilling to agree to part with them in the future at any cost.

British, European and other central banks couldn't wait for the US financial system to open at 11pm east Australian time, instead taking action at 5pm - which was 3am in New York.

They poured $US180 billion into global markets - almost enough to buy the entire output of Victoria for a year. They spent it in minutes.

It is possible to think of the financial system as the lubricant on the wheels of trade. Without that lubricant ("liquidity" in the economists' language) the wheels seize up.

If people with money become so worried about the future that they refuse to part with it, then commerce itself will seize up.

Regarded as a remote possibility throughout the US financial crisis, this scenario has become more real this week. And, as Australians ponder their super returns, their portfolios and their mortgages, this bigger threat looms.

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