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Economy
Saturday, November 1, 2008
More to come

Alan Greenspan has been quoted as saying that the US (and therefore the world) is experiencing a once-in-a-century financial crisis. Paul Hansen, Group Director, Retail Investing, notes a few of the contributory factors for the record.
Lehman Bros was 158 years old and survived the Great Depression of the 1930’s, yet has fallen on its sword during this crisis, partly because it was a major underwriter of mortgage-backed securities and was hard hit by the sub-prime crisis.
“A long period of rapid economic growth, low inflation, low interest rates and general economic stability bred complacency and increased the willingness of both individuals (property) and financial companies to take risk,” he explains. “Rising interest rates in the US burst the residential property bubble two years ago and since then the problems have largely come from this area. An end to the fall in US house prices remains a key to ending the crisis. This has not yet occurred. The sub-prime crisis may not end until the US housing market reaches a more affordable level.”
Hansen notes that AIG, one of the biggest insurance companies in the world, is a prime example of the heightened risk-taking. “It has many excellent businesses, but in the late 1980s it formed a new financial business which subsequently wrote billions of dollars of derivatives, which are now at the heart of its woes and are far removed from its core insurance business.”


In particular, it began insuring investors against defaults on collateralized debt obligations (CDOs), or pools of securities. This and other similar securities accounted for the bulk of the $41 billion dollars written off recently and has led to the US Fed buying almost 80% of its shares and extending a loan facility of $85 billion to the company, thereby throwing it a strong life-line.
“It is gratifying to see that not all of these American investment banks have been poorly managed.”  Although Goldman Sachs’ third quarter profit fell 70% from last year, it still made a net profit of $845 million in possibly one of the worst quarters in modern history.
Clearly, the crisis is not over as long as property prices continue to fall.  “This means that uncertainty/risks remain high.  How many other financial companies will fail?  This is impossible to predict, but the probability is fairly high of further failures,” observes Hansen.
Developed market economies are slowing and recessions in the US, UK, Europe and Japan are distinct possibilities. This puts pressure on company earnings. Global stock markets are in strong down-trends (bear markets).  As yet, there is no evidence that these are ending, although sentiment is extremely negative and in most instances shares look good value, for example in Asia (excluding Japan).
With the MSCI World Index down 27% (in dollars) at 2005 levels and the JSE All Share Index down 25%, “we don’t think this is a time to be selling, even though there may well be more downside to come.
“Rather, partly because of the uncertainties which are reflected in low prices, we think it makes sense to be gradually accumulating (perhaps on a monthly basis) both offshore and local equities.
“Stick to your investment plan within your risk profile.  Remember that over the past few months in SA, three of the four asset classes have done well (listed property, bonds and cash).

Copyright © Insurance Times and Investments® Vol:21.10 1st November, 2008
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