Sunday, 16 March 2008

SUB PRIME is code for Stu-Pid

Bear with me but my high school economics is a bit rusty.

The Sub Prime Crisis (SPC)... I'm going to digress here and marvel at wonders of the English Language. My wife has asked me a couple of times what the Sub Prime "thing" is and I don't blame her. The name "Sub Prime" suggests something financially technical but in essence it is a
way to describe people with shit credit. It just made it easier to refer to them in business. Can you imagine people in the mortgage industry saying "Hey Bob, well done on last months results. How many of those contracts were WORTH SHIT?"

The way I understand it (and I welcome your corrections...of course no one reads this so I will forever remain oblivious) The SPC and subsequent downfall of Merrill Lynch, Bear Stearns and other investment banks is the result of relaxing lending standards to boost the economy.
Mortgage brokers who in essence are Sales people working on a commission. They don't actually care if the person who is borrowing the money has the capacity to pay because they get paid at the commencement of the mortgage. The payoff for having shit credit, is the mortgage has
a higher interest rate attached to it. ....

Ok, here's where you lose me. If you are lending to someone with bad credit. Why would you create a product that makes it hard for them pay it back?? Isn't that just inviting them to default on their loan? But anyway, it was what it was and nobody thought it was a BAD idea to lend to people without the capacity to pay back and the brokers went on a free for all.

Of course on the other side of the coin, If you have bad credit and someone offers you a loan, regardless of the interest rate you're gonna take it. Why? because your bad credit rating exists BECAUSE you have a history of borrowing money that you don't have the capacity to pay back!

ANYWAY, The mortgage originators therefore throw all this money at the folk who won't pay it back and of course the money ran out. So they take all these worthless high interest sub prime contracts, securitize them and sell them to the investment banks. High risk, High return right. So
the mortgage originator offloads the risk to the investment banks who in turn give them more cash to lend out. (Simplistic I know but I am a simple soul)

So this goes on for a couple of years, China becomes a threat, taking away heartland American manufacturing jobs. Mortgages are defaulted, the Mortgage Backed Securities turn to shit. And Bear Stearns gets bought out by JPMorgan. - Then we discover that throughout all this time of
loose lending the US was actually in a Recession. Thats like buying a vacant block of land, planning to build your own house and realising you have an advanced case of cancer.

Hmmm. So you artificially stimulated spending and you still went into recession you might think to leave the economy alone right? Let it heal a bit. Find that mythical equalibrium. I also realise that there are may other factors in play here, and my summary could probably be better illustrated in cartoon form but I ask the question now. What is lowering interest rates going to do?

Mr. Moore my High School Economics teacher taught me to memorise the effect certain monetary policy initiatives would have on the economy and if I recall correctly, lowering interest rates will reduce savings, increase lending, increase spending, boost the economy, lower the value
of the dollar and pretty much make the US economy think that it is an end of season sale..... Sounds like a happy ending except that relaxing lending criteria was also a policy to stimulate spending too, and look where that landed them.

This is where my economic understanding gets a bit blurry. If by artificially stimulating spending through relaxed lending criteria nobody foresaw that the MBS would default, what will the unforeseen ramifications of artificially lowering interest rates in a time when the greenback is experiencing already all time lows. Back in the 90's Australia in the PM Paul Keating years experienced the "Recession they had to had" when they relaxed controls of things like exchange rate to make the Australian economy more lean and reactive. Recent actions by the Fed & US Treasury seem in the opposite spirit. Years of economic over-management is going to cause the machine to break eventually and the recession that the US is now will pale in comparison to the
Depression that they will have in the future.

The only light at the end of tunnel though is that over the past 7 or so years, the Government has dumped billions into the war, creating employment & stimulating certain sectors of the economy. If that ends, then the US is going to really be SUB PRIME.

Good Luck Y'all, I'm off to buy some Gold.

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