Sunday, September 9, 2007

Only the birds are coming home!

Have you heard of the crisis in the US sub-prime market? If not, you're about to.

American banks have been lending shed loads of money to the sub-prime market, simply put – lending money to people who have a bad credit history.

This business is high risk, so the banks charge higher rates of interest and secure the risk by a charge on the property. Which is all fine and dandy in a booming housing market.

This banking debt then becomes commercial paper and a financial commodity, to be bought and sold. The banks start trading in this paper to take the capital off their balance sheets and increase their liquidity. This brings in more cash and the whole lending cycle starts over again with a batch of new high risk customers and the deadly game of financial musical chairs is in play.

By the way, the music in this high risk game is the regular siren of increasing property prices.

Now for the fun bit, but its not funny at all. It hurts everyone - industry, business and our pensions. Surprise surprise - the risky customers in what is laughingly called the “sub prime market” are in over their heads with personal debt and decide not to pay their mortgages and so the banks begin fore closure proceedings.

This in fine until a trickle of bad debt, turns into a river and then a deep sea of debt and properties begin to flood onto the market. This glut of houses outstrips demand in the US and house prices fall sharply which consequently undermines the value of the huge commercial paper in the banking system.

The music in our game of financial chairs has now become deafening in its silence.

But in our game there isn't a chair left - just bewilderment as the key players stand around, scratching their heads and asking, “whose sitting with the debt-ridden commercial paper?

While everyone is waiting to find out who is holding the baby, sales of commercial paper dries up, there is a squeeze on credit and there is a serious loss of confidence in our financial institutions and the world markets.

You might imagine, this is a problem for the US banks and not ours - you would be wrong - we live and work in a global economy and when the US sneezes, we get the flu.

The birds are coming home to roost, but not the sub-prime customers - their homes have already been repossessed.

No comments: