A year ago, the house of cards on which the US mortgage industry was built on began to collapse with the demise of New Century Financial, the second largest mortgage originator in the US. Today as we look across the financial landscape in the global financial market, we find some of the top names in the banking industry have already become patrons of the corporate graveyard. Northern Rock (UK), IndyMac (US), the Lehman Brothers, a century old US investment banking tradition has all but crumbled into oblivion as the magnitude of the subprime leading crisis unfolds. Even the largest savings and loans bank, Washington Mutual, was not spared from the fallout. On 25 September 2008, the Federal Office of Thrift Supervision seized and placed WaMu under receivership in an effort to bring some semblances of sanity to the US financial market.
The US government, urged by some of the major developed countries in the world at the United Nation meeting in New York, proposed a $700 billion bailout plan for the troubled financial market. Due to its huge price tag, members of the US Congress have balked at giving their seal of approval. Even now as the members of congress debate over the nitty gritty details of the bailout plan, the world’s financial markets watched and wait in anxieties. No one really knows whether the bailout plan will work but the atmosphere around Washington DC is that of a somber nature. Everyone agrees that something needs to be done and that the plan was “too big to fail“.
Though we are at the opposite end of the globe, the Australian Stock Exchange (ASX) took a serious pounding as the banking industry shares resume their decline wiping out any gains made earlier in the week. The S&P/ASX index dropped nearly 130 points as a result of doubts whether the US bailout plan will work. The scene at the ASX was like a drama of epic proportion unfolding. At 00.57 GMT on September 24, shares of the mining giants’ BHP and Rio Tinto declined at an average of 0.85%. By 04.56 GMT, the banking sector was hit next by worries of the bailout plan. The Macquarie group shares and Westpac Banking Corp by dropped by 5.6% and 2.8% respectively. The National Australia Bank (NAB) was not spared either as worries of the bank’s exposure to the collateralised debts (CDO) resurfaced again. Shares of NAB declined 2.6%. According to the analysts at MM&E Capital, the deterioration in the shares prices has nothing to do with short selling but rather everything to do with bad debts.
A week ago, Kevin Rudd, our esteemed Prime Minister, assured the Australian people on The 7.30 report that Australia is very much protected from the cascading effects of the subprime leading crisis in the US. If that was true, the Australian economy would be the only developed economy in the world which could survive on international trade in isolation. The truth is that our Prime Minister is as in touch with the Australian economy as the US Republican presidential nominee John McCain, who made the comment that the US economy is “fundamentally sound”.
Experts are warning that as the process of “deleveraging” continues further, the impact of the crisis will get worse especially for those on ‘Main street” and not just Wall street. The reality is clear and brutal. Already there are signs of how we will be affected. The layoffs by Ford, and Mitsubishi are the initial ominous signs of what’s to come.
To make mattersworse, the credit crunch had made it next to impossible to get a mortgage nowadays. The irony is that while banks are lending less, their profits are still soaring! As the income from loans declined due to the credit squeeze, banks in order to make up for the loss of revenue from the lending sector, have to seek alternate means to improve their balance sheets. To do this, they have adjusted their fees upwards. Unless you own substantial holdings in Westpac or the Commonwealth Bank, there is no cause for rejoicing.
The Governor of the RAB, Glen Stevens, reaffirmed this situation by saying that due to higher costs in funding; the Australian financial intermediaries are passing on the added costs to the customers. In this respect, the market is working efficiently. For any financial market to perform efficiently, it must also be informational efficient. The subprime lending crisis is a perfect example of what happened when the market becomes informational inefficient. The lack of transparency resulted in investors making ill informed investment decisions when the exotic financial instruments like the CDOs, MBS were rated triple “A” by the rating agencies. In other words, the investors didn’t know what they were buying. The same goes for all of us at Main Street. It is so typical of us to follow whatever the financial planners or mortgage broker tells us because they are the so called experts. And today, in lieu of properties, financial planners are telling us to invest in shares.
This is where people like Warren Buffett and George Soros distinguish themselves when it comes to investing. The truly successful investors think along very different lines from the rest of the pack. They follow a definitive plan when it comes to investments. While everybody was loading up with CDOs and MBS, Buffett’s Berkshire Hathaway Inc was regarding them as “financial weapon of mass destructions” and a “time bomb” waiting to go off. Investors like George Soros who invest in the currencies markets hedge his bets when making investments decisions. This way regardless of whether the market is going or down, he makes a profit. By using a system of statistical arbitrage, the investor is able to capitalize on price differentials of an asset in different markets.
The mechanism to go about this is very clearly explained in a book by a former London city trader, Rajeev Shah. (To know more read, Sports-Arbitrage – How To Place Riskless Bets & Create Tax-Free Investments). This system of “fail safe” trading was pioneered by Morgan Stanley’s Equity trading division during the 1980s as a method to avoid losses due to price differentials. Since then, the system of trading has advanced tremendously to using softwares like the ArbAlarm to locate price differentials in the market. The fact of the matter is that, the successful investors do not let “control” out of their hands. Using different forms of investment vehicles, they are able to capitalize on any situations when everyone else is running for cover.
For some of us, the best years of our lives is supposed to be our retirement. But with the current financial crisis, this situation is becoming next to impossible. The slide in superannuation returns has forced some of our seniors to be on the aged pension. One can hardly call living near the poverty line an enjoyable situation. Even those who had a “nest” tucked away are starting to feel the pinch which shares prices drops and with it the dividends. The market might recover but you would hardly call yourself recovering when the majority of your assets are down the tube because all your investments are linked directly or indirectly to the globalised economy. Perhaps it’s time to rethink one’s investment strategy before time runs out like many of the retirees in the US now.