Macquarie's shares sink more than 10%

Australia's biggest investment bank revealed that two of its funds, together holding $220 million, had been hit with substantial losses related to the US sub-prime mortgage crisis.

There were also fears a global credit crunch triggered by the sub-prime market fallout could put an end to the infrastructure asset spending spree that has been so profitable for Macquarie.

By the close of trade Macquarie shares had tumbled $8.80, or 10.67 per cent, to $73.70 - the biggest single day sell-off in five and a half years, since the stock fell 10.8 per cent on February 6, 2002.

Other financial stocks followed suit, with number two investment house and fellow global infrastructure predator Babcock & Brown Ltd dropping $3.19, or 11.32 per cent, to $25.00.

Allco Finance Group Ltd fell 7.48 per cent and Challenger Financial Services Group Ltd, which has just followed Macquarie and Babcock into the global infrastructure market, lost over 6.64 per cent.

Falls among the big four banks ranged from about five per cent for St George and 2.5 per cent for Westpac.

Macquarie revealed on Tuesday that its $140 million listed Macquarie Fortress Notes fund, and the $80 million unlisted Macquarie Fortress Fund, stood to lose up to 25 per cent of their value.

Neither fund has direct exposure to US sub-prime mortgages, but both have been hit by price volatility in US credit markets triggered by the sub-prime crisis.

Macquarie received margin calls on the funds, which are highly geared at six to seven times.

Reynolds & Co director Markus Mueller said he doubted Wednesday's sell-off was "the end of Macquarie Bank".

"They've created complicated financial structures but I doubt it very much," he said.

"But you just don't know and that's why the market has reacted very strongly."

Mr Mueller said Macquarie was more likely to be coming back down to earth after its shares experienced a phenomenal run, and were most recently buoyed by chief executive Allan Moss forecasting another strong year of profitability.

Fat Prophets chief executive Angus Geddes said the global private equity boom could be drawing to a close.

"And Macquarie Bank, they really do thrive on a low interest rate environment," Mr Geddes said.

"They needed that private equity boom to get a lot of that stuff on their balance sheet, to buy it, to package it, to hive it off.

"And if anything I think this really puts the spot light on the vulnerability of a lot of these investment banks riding that train."

As for the rest of the finance sector, Mr Mueller said Macquarie's fall may have alerted investors to US Treasury bond yields, which have crept up over the last three months.

Higher bond yields push up the cost of borrowing, crimping merger activity or making bonds a more attractive investment option than equities.

"So maybe the retail banks were already trading at a bit of a premium, so that has been adjusted a bit," Mr Mueller said.

"And we still have to remind ourselves that the global economy is in fantastic shape, and we haven't had a correction for a while."

Federal Treasurer Peter Costello expressed his confidence in Australia's financial sector, saying it was essentially in good shape.

Speaking in Coolum at the APEC Finance Ministers Meeting, Mr Costello said noted there has been a very high level of defaults in some parts of the US sub-prime market.

"Players in that market will therefore will have to suffer the consequences of these defaults, but I have no doubt whatsoever that the consequences of that will not reflect back on to Australian institutions, nor undermine their very, very secure financial standing," he said.

The US sub-prime mortgage market has developed around housing loans given to borrowers who have a high credit risk.

Babcock & Brown was unavailable for comment on whether it had any exposure, direct or indirect, to the US sub-prime market.