Bickering and dithering rather than a plan for Greek debt spells big trouble

As pessimism continues to take hold, there is a growing band of traders punting the local bourse will again fall below 4000 points and possibly push as low as 3500 if European leaders cannot contain the Continent's debt crisis.

While far less damaging than the bruising encounters of a fortnight ago, yesterday's falls unwound the timid gains notched up last week as European leaders continued to bicker and dither over how to prop up Greece and save the euro zone.

Rather than take the running, and put Greece into a controlled or orderly default, European politicians and the European Central Bank are at odds about exactly what to do.

As US Treasury Secretary Timothy Geithner commented: "What is very damaging from the outside is not the divisiveness about the broader debate, about strategy, but about the ongoing conflict between governments and the central bank, and you need both to work together to do what is essential to the resolution of any crisis."

So, why should any of this worry us? As we keep hearing from our politicians, our corporate leaders and the nation's economic pointy heads, we're hooked into China, a nation in the throes of perhaps the greatest economic miracle in history.

It matters because of the possible impact an unruly Greek default would have on international banking. Exactly what the impact will be is still too difficult to tell. And it is that fear of the unknown the extent to which the shock waves will reverberate through global banking that is spooking investors.

As we learned three years ago, global banking is interconnected in ways that even those running the banks seem incapable of fully comprehending.

European banks not only have extended trillions of euros in loans to the stricken PIIGS (Portugal, Ireland, Italy, Greece and Spain) but they have traded and exchanged an unknown amount of derivatives with each other and banks around the world, based on those debts.

Derivatives such as credit default swaps designed to spread risk have done exactly that. Originally intended to minimise risk, these unregulated trades instead have added to the uncertainty plaguing markets and hammering investor confidence.

A default could trigger insolvencies among European banks. That may then affect other banks with exposure to European banks.

That fear of the unknown explains why Australian banks, with little direct exposure to European sovereign debt, again came under pressure yesterday. Westpac led falls among financial stocks across the Asian region with a slide of 2 per cent, and the other three of the big four were hot on its heels.

Perplexed Australian investors are now staring at what should be, theoretically at least, absolute bargains on the local bourse.

Blue-chip companies that four years ago were trading on an average of 12 or even 14 times future earnings now can be bought for nine times next year's projected profit.

Even BHP Billiton, Australia's biggest company and the world's leading miner, is trading at just 9.5 times next year's projected earnings.

Although resource companies traditionally have traded at a discount to industrials, given the once fleeting nature of resource booms, this time there is general agreement that things are different, and that the current boom has years to run.

At yesterday's $37.60 close, a 1.7 per cent drop, company insiders reckon BHP is priced for global recession despite every indication that demand from China will continue at current levels for at least the medium term.

Dividend yields are also incredibly attractive. The average yield across the S&P/ASX 200 is now sitting at a whopping 5.28 per cent. One of the highest average yields in the developed world, it is outdone only by the French bourse, at 5.38 per cent, and is way ahead of Wall Street, where the average yield on the S&P 500 is just 2.18 per cent.

For the past two years, the Australian market has laboured under the weight of the strong Australian dollar, which has crimped offshore earnings from our bigger companies.

This time around, the dollar stubbornly has refused to go below parity despite the fears affecting global finance, which in previous times would have sent the Aussie plummeting.

So, are stockmarkets out of touch with reality? Are the lemmings running too hard with the bears and sending stocks to unreasonably low levels?

The answer would have to be "no". There is a perceived threat to the stability of global banking which politicians either are unwilling or unable to confront. As each day passes without resolution, that perception moves closer to reality.

And while stocks seem to be attractively priced, the wildcard in both key ratios is "projected earnings". If the forecasts are overly optimistic, current share prices may be just right. And if earnings are lower than expected, dividends will be lower.

Those concerns about a repeat crisis in global finance have consumers eschew debt and restore their balance sheets, much to the alarm of bankers who have had to rein in forecasts on lending growth.

It has been repeated in the corporate world as well. After being bitten three years ago, US companies are holding 7.1 per cent of their assets in cash, the highest level since 1963. And it doesn't include the cash reserves many US companies' foreign offshoots hold.