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Thursday, November 1, 2007
House of cards

The so-called ‘US Sub-prime’ market finally did what is was expected to do, starting mid-2007: bring good old-fashioned credit failure, coupled to stress-testing leveraged universes.
Comments Cees Bruggemans is Chief Economist of First National Bank, “Next year should be a lot quieter after such an impressive cleansing - unless something else intrudes.”
But what does ‘sub-prime’ mean? A little tongue-in-cheek, Mr Bruggemans puts the idea into perspective: “You mean, the borrower lies about his income (no job, no income, no hope) and the lender offers exceptionally low ‘teaser’ interest rates, with the proviso of these going up by half (!) within two years? And nobody screamed?
“And then they took such loans, bundled them with better loans, sliced and spliced the end result like so much rope, got rating agencies to apply the last rites, and sold them on to unsuspecting institutions looking for yield enhancement (a little extra margin, magnified sixteen times by leveraging, so that anything small really started to look impressively large)?”
And that house of cards was supposed to remain intact?
If you have never tasted snake-oil before, this was your golden opportunity, he say.
About a US $1 trillion of the stuff was written, first Fed estimates are that $100 billion will go bad, but add the misadventure of any misguided leveraging, and the final bill will be about $250 billion.
That would have sunk the US banking system. But because banks securitised and offloaded the stuff faster than they generated it, relatively little stuck to banks, except to the extent that their asset management funds invested in such stuff.
“Anyway, the $250 billion is spread around the world,” he explains, “at least 10% in Japan, a goodly portion in Europe and a fair amount in lower Manhattan. The losses will rest where they fall.” Rest in peace.
Meanwhile, financial markets in their entirety couldn’t quite figure where all the bodies were buried. A few hedge funds owned up (and folded). A few banks wrote off early and got mostly ignored. A few latecomers owned up and got clobbered. But by then the greater universe was on a witch hunt, while pulling away from leveraged corporate debt as well.
Banks became wary of counterparty banks. Are you still good? A rush for Treasury bonds ensued, sinking such bond yields. A flight to safety was in progress.
On 10th August it got so bad that European money market rates no longer reflected central bank targeted rates. Trust was out of the window and the willingness to deal getting thin indeed. Liquidity was drying up. The ECB, faced with banks being unable to get funds, injected $130 billion, followed shortly by Fed and BoJ.
Another week and US credit markets generally seized up, with heavy spill over into equity markets, as uncertainty bit and induced risk aversion, good assets were sold to cover bad credit losses, and basically everyone lost their nerve.
“Even Japanese housewives reversed positions, dumping Aussie and Kiwi and causing the Japanese Yen to shoot through the roof as the carry-trade got liquidated,” adds Mr Bruggemans.

Copyright © Insurance Times and Investments® Vol:20.10 1st November, 2007
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