NationStates Jolt Archive

http://money.cnn.com/2007/08/10/real_estate/mortgage_meltdown_crushing_other_markets/index.htm?postversion=2007081016
A grim forecast has economists more pessimistic over how far the collapse will spread to the rest of the economy.

As some of you will have heard, the whole subprime loan thing is blowing up in people's faces right now. And it's not just the agencies that handed over the loans in the first place, it's also other institutions which bought the loans (which are in effect just a series of cash flows, to be split up, repackaged and sold to the next guy) and so on and so forth. Major banks, hedge funds and the like, who normally wouldn't have been handing over subprime loans are in big trouble because they invested so heavily in securities based on them. The effects are felt internationally, from Macquarie Bank here in Australia to a bunch of banks in Germany - everyone is now frantically going through their books trying to establish how deep they're in this mess.

Next week the Fed is going to meet again, where Ben Bernanke will have the option of an emergency interest rate cut to make credit a bit cheaper and keep things running. Now, I know that Bernanke is a much more orthodox economist than Greenspan ever was, and I have a feeling that he's much more of a "we care about inflation and that's it"-type. So he'll be reluctant to cut rates unless the danger to inflation isn't too great (it probably isn't, considering the effect of the crisis on disposable income etc) and there are reasonable worries about serious effects to the "real" economy.

So how worried are you about those effects?

So how worried are you about those effects?
Just tell me: Will it have a positive effect on my overdrawn account?

Just tell me: Will it have a positive effect on my overdrawn account?
No, probably not.

No, probably not.
Dang!

I am not worried at all. In fact, I am happy about it. I love it when bad things happen because then the stock market goes down and I can buy more shares of my favorite market index fund for less cash.

I'll start really worrying when the Fed starts talking bailout a la the savings and Loan "crisis" in the 80s, because it'll be yet another example of corporate handouts and fuck the little guy. But if it's allowed to shake out like it needs to, I'll come out of it better in 2-3 years, because housing prices will recede and I can get into the market then--to buy a home, as opposed to an investment.

I'll start really worrying when the Fed starts talking bailout a la the savings and Loan "crisis" in the 80s, because it'll be yet another example of corporate handouts and fuck the little guy. But if it's allowed to shake out like it needs to, I'll come out of it better in 2-3 years, because housing prices will recede and I can get into the market then--to buy a home, as opposed to an investment.

You might come out of it better a bit sooner. It sounds like the central banks are going to ease up credit. This could help you get a house now because there may be lower interest rates.

Hehe, a few tips if your lender goes belly-up: http://money.cnn.com/2007/08/08/pf/saving/toptips/index.htm?postversion=2007080817

I am not worried at all. In fact, I am happy about it. I love it when bad things happen because then the stock market goes down and I can buy more shares of my favorite market index fund for less cash.
And if it goes down down down down until it crashes?

And if it goes down down down down until it crashes?

If you look at the market in long terms--which you should always do, if you're in it--then a crash early in an investment cycle is a good thing, because strong companies always get dragged down with the weak ones, and that means you're getting undervalued stock when you buy in. If a major crash, for instance, takes a hundred points (for the sake of argument--I don't know what it's trading at) out of Apple's ass, then you're a sucker if you don't buy it, because it's a solid company that will grow again, and you'll have bought low.

I have no clue what this is all about...

I'm confident that the central banks acted preemptively enough to stymie a 1989 or 1998-esque meltdown, but the negative economic effects caused simply by slowing growth due to the housing slowdown are yet to be seen.

Remember, though, the world economy is booming, growing at a rate nearly triple its 1950-2003 average...it still has a lot of kick, and the newly wealthy consumers in BRIC may be able to provide far more lift than they could have 10 years ago. However, at the same time, global liquidity and developed-world consumer spending are still the main engines for growth and are the main driver of growth in Chindia (Russia and Brazil are different), and the result is that they may falter and cascade in to a recession if developed-world growth collapses.

Americans in DEBT, how is this possible?!?

I have no clue what this is all about...
It's a bit of a long story.

For years now the Federal Reserve Bank has had very low interest rates. That meant you could borrow money cheaply and not have to worry about the interest as much.

Part of that caused an unprecedented spike in companies taking each other over. Usually a firm doesn't have enough money to buy another with cash, instead they take up a mortgage to do it. So the takeovers grew bigger and bigger, and specialised takeover companies made absolutely huge profits. Stock markets all over the world were benefitting too (combine the cheap credit with the solid growth of the international economy and the growing affluence in China etc and you get the picture), a lot of people made a lot of money. People started to not worry as much about risk, and the possibility of things turning out badly got a smaller and smaller number attached to it (it's all done with mathematical equations).

Meanwhile, "average Joe" was benefitting too, because he could get a cheaper mortgage for his house. House prices were exploding because everyone could now borrow more money to buy, but the number of houses available to be bought didn't grow as fast.

Even those who normally couldn't have afforded to own their own home got in on the action. Some lending companies started to specialise in "subprime" loans, ie loans for people who had little or no good credit history, lower incomes and no cash of their own. These people got mortgages for 90%+ of the value of their house, ie they bought their entire home on credit without spending a dollar of their savings (if they had any). For a while you could hardly be poor in America without constantly being offered cheap-interest loans that required virtually no credit history checks. And as if that wasn't enough, politicians all over the country were telling people how it is the great American dream to own their own home.

Once people had taken these loans and bought their houses, the lenders figured they had done a good deal. House prices kept going up, so if the people couldn't afford their payments anymore, the house could be sold and the lender got its money back. And because all a loan really is from a financial perspective is a series of payments made over time, the lenders could quickly turn the loans into cash by selling them off to someone else. Basically the name on the loan document that says "Average Joe will pay $100 every week to Lender Corp" is changed to say "Average Joe will pay $100 every week to Smith Investments", and in return Smith Investments pays a certain amount of money (and here's where the mathematical formulae come in again) to Lender Corp.

So the loan document becomes a "security", a series of future cash flows to be bought and sold on the market. The price can rise one day and fall the next, depending on things like risk associated with it (quite low, remember the price of the house is going up, so if payments stop the house can be sold at a profit) and the interest rate (set by the Fed and low as well).

So soon all the big financial companies, banks, hedge funds, private equity etc etc were deeply involved in trading and holding papers that were really just subprime loan documents.

But things started to crumble. Inflation was rising, so the Federal Reserve had to increase interest rates. Repayments got more difficult for Average Joe. People stopped borrowing as much and in some places people actually had difficulties finding buyers for their homes if they wanted to sell.

So what does that mean for our subprime loan document securities? It means that they suddenly look like a much less attractive thing to own: interest rates are higher meaning Average Joe is at a greater risk of failing to repay and house prices aren't going up as much (and even going down in places), so if Joe does default, you're not even guaranteed to get your money back because the house might be worth less than you lent in the first place.

This realisation has set in now. People don't know how the housing market will turn out, so the mathematical formulae that calculate how much the loan document is worth no longer return reliable values. There is too much uncertainty, and no one knows whether they're paying too much. That means it has become difficult to find buyers for these documents, and banks all over the world are sitting there with millions or billions of dollars in these papers and no one who wants to buy them, and the potential that too many of those loans default (which has already killed a few smaller investment firms).

This is most likely the hit over the head that brings investors back down to earth. There is a "repricing of risk" on the cards, ie finally bringing back higher numbers for risk into the equations. People will be less likely to get approved huge credits for risky ventures (like corporate takeovers), and you can bet your ass that if you don't have an A+ credit history you're gonna have a hard time finding someone to give you a mortgage for a while.

I've probably forgot a few things, but that's the gist of it.

In a few years, the banks around the world will find out that the Gulf States and places like Saudi have borrowed trillions of dollars on the oil reserve estimates that the borrowers themselves cooked up.

http://dieoff.org/page140.htm

Another source of systematic error in the commonly accepted statistics is that the definition of reserves varies widely from region to region. In the U.S., the Securities and Exchange Commission allows companies to call reserves "proved" only if the oil lies near a producing well and there is "reasonable certainty" that it can be recovered profitably at current oil prices, using existing technology. So a proved reserve estimate in the U.S. is roughly equal to a P90 estimate.

Regulators in most other countries do not enforce particular oil-reserve definitions. For many years, the former Soviet countries have routinely released wildly optimistic figures—essentially P10 reserves. Yet analysts have often misinterpreted these as estimates of "proved" reserves. World Oil reckoned reserves in the former Soviet Union amounted to 190 Gbo in 1996, whereas the Oil and Gas Journal put the number at 57 Gbo. This large discrepancy shows just how elastic these numbers can be.

Using only P90 estimates is not the answer, because adding what is 90 percent likely for each field, as is done in the U.S., does not in fact yield what is 90 percent likely for a country or the entire planet. On the contrary, summing many P90 reserve estimates always understates the amount of proved oil in a region. The only correct way to total up reserve numbers is to add the mean, or average, estimates of oil in each field. In practice, the median estimate, often called "proved and probable," or P50 reserves, is more widely used and is good enough. The P50 value is the number of barrels of oil that are as likely as not to come out of a well during its lifetime, assuming prices remain within a limited range. Errors in P50 estimates tend to cancel one another out.

They borrow money on the P90 estimates, which are really ideal.

So, it's likely that they won't be able to pay their debts - in fact, they will eventually default.

Think of it as a big glacier, moving your way, inexorably crushing everything in its path.

This will make the current instability seem irrelevant.

And, since our banking systems and economies are so intertwined, it will result in global depression.

That's why you don't get into debt, fools.

That's why you don't get into debt, fools.

Not all of us are lucky enough to be able to buy a house without a mortgage. However if you get a mortgage you cannot afford the repayments on, then yes you are an idiot.

It would be nice if house prices recede, so I can afford a place after I get out of uni, assuming I get my place.

And if it goes down down down down until it crashes?

I will buy all the way down. Even if you invested in a diversified fund right before the 1929 crash you would be beaucoup rich 30 years later. When you are a young investor, you should be hoping for bear markets for a decade or two if you buy in a highly diversified manner and do not need the money for a a long time.

That's why you don't get into debt, fools.

Although I am an American and hence have a ton of debt, I do not feel terribly foolish about it. I have a ton of tax deductible debt and a healthy bunch of non tax deductible but low interest debt. I have no high interest debt.

This debt has been very helpful for me financially because it enabled me to buy a bunch of stuff that I wanted.

Debt is something that needs to be entered into intelligently and as part of your well thought out strategy of wealth building. It is a powerful force that can be used for one's financial good or ill. It is not necessarily bad or good, just powerful.