sell your US bank stocks
See: this …
See: this …
I wrote a little bit about the subprime mortgage troubles a few months ago, and mostly we’ve all forgotten about it. Generally Canada has been well-insulated from the troubles, and probably most people have yet to be touched by the crisis directly.
But anyone who thinks we’ve heard the last of it is wrong, I’ll bet, and anyone who thinks Canada will be fine if the US economy takes a real hit is even wronger.
Chris Penn writes about his concerns for the overall financial health of the the US of A in an aptly titled post: We really are in trouble in this country. This is just the beginning of it.
The United States doesn’t -make- anything any more. For the last 5 years, our economy has been driven by increases in asset prices, namely housing. People cashed out equity and spent like crazy, driving the economy forward.
All good things must come to an end, and we’re seeing just the first inning of the housing bubble unwind in a game that’s going extra innings. As prices drop, equity vanishes, and mortgage owners owe more than the property is worth.
Anyone who promises a fix for this situation that isn’t “we have to ride this out” either has something to sell you or is running for office. Don’t believe them. This financial crisis took years to make and it will take years to unmake.
If you want to figure out what is all the fuss about subprime mortgages and the economic turmoil they seem to be inflicting, BBC’s Robert Preston has a good extensive summary.
Here’s the bottom line: for the past few years, Wall Street has operated a giant machine for turning mind-boggling amounts of US home loans – which are hugely vulnerable to losses from fraud and the inescapable cycles in interest rates and housing prices – into supposedly risk-free investments for risk-averse investors in Asia, the Middle East and (as it turns out) for Europe’s big banks.
He doesn’t explicitly mention hedge funds, but these are behind much of the complex debt restructuring, slicing & dicing mentioned here.
From the Pessimism file:
I’ve always been skeptical of hedge funds and sophisticated derivative products. In theory these financial instruments protect against risk, by playing potential movement of the market in one direction, off of movement in another. It’s high-powered math stuff, and it’s made many many people truckloads, billions of dollars. But I don’t really understand it – though I was tangentially involved in the derivative business for a while. And it’s always seemed to me that hedge funds, at their base, are about getting money for nothing. That is, getting money without accomplishing anything. Still the house that Enron helped build has gotten bigger and bigger, and has become to some extent the underpinning of the entire global economy. Basically, it’s flooded the world with lots of cheap money. That sort of thing, eventually causes problems, because the laws of physics will always beat out the laws of the market.
And, according to Steven Pearlstein in the WaPo, the whole thing might come tumbling down.
As it all unfolds, we are learning several painful truths about the new global financial system, which until recently was widely lauded for its ability to price and spread financial risk to investors willing to accept it.
One lesson is that the sophisticated strategies employed by bank and investment funds to “hedge” risk may not be as reliable as had been thought.
In recent years, for example, banks and hedge funds created elaborate investment strategies built around the presumption that Bond A would always go up when the price of Bond B went down, effectively limiting potential losses. But in recent weeks, many such strategies began to go awry as markets for mortgage securities dried up and fund managers began selling whatever they could to raise cash to pay lenders. As a result, Bond A and Bond B began moving in the same direction, creating losses on both.
Another popular way for sophisticated investors to hedge their bets is to buy insurance against the possibility that a particular company or set of mortgage holders will default on their loans. But in some cases, this insurance policy, known as a credit swap, has been issued by hedge funds that themselves had taken on similar risks. If things go bad, a hedge fund may not have the money to uphold its side of the insurance bargain.
Australian analyst Satyajit Das makes the point that the main achievement of the new financial architecture has not been to spread risk so much as it has been to expand risk by vastly increasing the amount of borrowed money. Making loans to buy bonds secured by packages of other loans makes for big fees and exciting work for bankers. But as Das predicted last year in his book, “Traders, Guns & Money” — and as we all discovered yesterday — if the supply of credit suddenly dries up anywhere in the system, the elaborate new structure they’ve created can come crashing down on itself.
And chances are you and I will get caught under that crashing system, one way or antother.