Why shonky loans in Florida and Las Vegas now can affect you -
no matter where you are in the world!
Markets are far more determined by raw emotion and sentiment than the experts would have us believe.
Of these emotions the fear of loss, especially if money has already been lost, is actually stronger than the greed for gain. This human fact applies to the stock market, the property market and any other market.
Many supposedly highly sophisticated players have had their fingers very badly burnt by buying packaged US Subprime mortgages, which were graded as AAA investment grade and sold off around the world.
Many of these are now being re-rated as CCC or CCC-, a category that S&P (a major credit rating agency) defines as "currently vulnerable to non-payment".
The investment bankers assured the purchasers that risk had been minimized by computer modelling and fancy mathematics - AND THEY ARE WRONG .
The total bill for their mistakes is at least $100 billion and possibly $200 billion or more.
How does this all affect you?
Money has suddenly become tighter because the big players are now figuring out how much money has been lost. The banks were used to being able to 'on sell' the loans that they made and this has become harder and more expensive.
And where all these dud loans are is not yet known.
One German bank has needed to be bailed out and some hedge funds have closed their doors. But how many other financial bodies are still out there, trying to hide the extent of their involvement, (and possible insolvency) is unknown. This guessing game is one reason why the credit markets have been so paralysed. In short, no one knows who to trust.
And if the financial whiz kids got this one massively wrong - how many of the other complex financial products out there are also time-bombs?
UNCERTAINTY is leading to a credit crunch and marked risk aversion.
The reality is that many of the "stars" of the recent markets were not financial geniuses; they just borrowed big to magnify gains in a rising market. And if the market falls, they are likely to lose big-time as well!
To keep share or property prices rising, new buyers with new money have to enter the market. The "credit crunch" now apparent in many markets, means that caution rather than search for a return, is the main market psychology.
Individuals and organizations are in survival mode.
The banks both large and small are checking their exposures to risk: from the small borrowers to the hedge funds and private equity players. The hedge funds are very vulnerable to problems because most have magnified their returns, in the good times, by leverage. So if their underlying investments are unsound, any problem is rapidly magnified.
In the last couple of years, the hedge funds have become a far more common investment for ordinary people and pension funds; they are no longer the province of the rich. Your Pension or Superannuation fund may well have some hedge fund investments. The damage will thus affect many who are not high flyers. The extent of some of the losses on Wall Street will be seen in September, when the major investment banks will have to report earnings.
In the US Housing market where the mayhem started, contraction is forecast for the rest of 2007 at least. In some of the high flying markets such as Florida and California, prices have already dropped about 8% from their peak. Some forecasters are tipping up to 2,000,000 home foreclosures in the US.
At this stage it is uncertain if things will get this bad, but damage to American (and Global) economic growth is on the cards. In this situation, keeping abreast of developments and watching how they may affect you is essential.
August 15, 2007
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