Effects of the U.S. sub-prime crisis
It has been five months since the onset of the financial crisis in the
To know why it is taking so long and what are the effects, we have to understand the nature and magnitude of the problem. As to magnitude: recent estimates have put the sub-prime mortgage size at $450 billion, with Citibank and HSBC each taking a $40 billion hit. In relation to the total size of the
The nature of this sub-prime crisis is a little more complicated and involves more active participants than the Asian debt crisis. In the latter case, the defaulting borrowers were mostly governments and large corporations, while in the former, the borrowers are individual American homeowners. There is certainly more emotional dimension in the case of the sub-prime borrowers. We have to remember that most of the sub-prime borrowers were enticed by mortgage brokers or the banks to borrow with very little equity on the houses, with the expectation that with the low interest and the prospect of rising house prices, they will eventually have enough rental income to pay the amortization, or sell the house at a higher price. Then the bright guys in Wall Street and in the banks, had this idea packaging all these mortgage loans into a debt instrument, the Collateralized Debt Obligation (CDO), and selling these as securities backed by mortgages, to other banks, financial institutions, and other investors all over the world at very good yields which made them very attractive, supposedly safe investments. Then the household borrowers started defaulting and the whole thing unraveled. These securities are now worth less than 40 percent of what was paid for them.
The effect on the banks over and above the losses that they have to recognize as the value of these mortgage loans that are devalued, is that they have become stricter in lending or acquiring mortgage loans. So, even if they can source cheap funds from the Federal Reserve Banks, they would not be able to deploy enough of these funds at yields that will be profitable. The alternative of putting them in sovereign Bonds of countries will also drive the yields down, so they will have to look for Bonds of countries with less than prime credit ratings, which they are wont to do after getting burned in the sub-prime mortgages. The Philippine banks, due to the limits on foreign currency investments, have very little CDO investments, and significant amounts are with guarantees so that very small losses were recognized by Philippine banks.
The macro-effect of this sub-prime crisis is the weakening of the U.S. dollar against almost all currencies. The dollar has lost 20 percent in value against the peso in eight months, 10 percent against the Renminbi in 12 months, and at various percentages against the oil countries currencies. So, the OPEC members are complaining and increasing the oil prices to what the market can bear to compensate for their exchange losses. The
No doubt the
There are many lessons to be learned from this debacle, but what immediately came to mind is that those hotshot/bright boys in Wall Street and in the world’s biggest banks are as fallible and as susceptible to error like everybody else. When they lose money, they lose big, and most of the time it is other people’s money. Expert opinion is valuable and is needed. You just have to be sure to have the right expert. Most of all, financial literacy and understanding is important to anyone with substantial investment funds to be able to evaluate investment options or even just to evaluate the experts.
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