By: DAVID JOHNSON
financial@portugalresident.com
Last time I wrote about concerns over increasing levels of default in the US mortgage market, especially those loans where the borrower has a less than rosy credit rating.
At the time, the level of concern was more of a nervous twitch than a full scale rout but the middle of August brought a very significant change in the mood and we saw what newspapers were delighted to call “Black Thursday” on August 17. We will soon have a black day for every day of the week if they carry on with this!
Nevertheless, the movements in the financial markets were almost unprecedented. Share markets lost four per cent in one day, the Pound moved three cents against the US Dollar, the Japanese Yen gained seven per cent against the US Dollar in three days, the New Zealand Dollar lost 13 per cent against the US Dollar in just one week and monstrous amounts of liquidity were injected into the markets by central banks from Europe, America and the Far East, in an attempt to stem the tide of panic.
Even the Reserve Bank of Australia threw money at the credit markets as the “credit crunch” took its toll.
The reason for the initial volatility is fairly well reported and quite obvious. However, following the cause and effect, through its twists and turns within the financial markets, is a bit of a rat run so bear with me as I guide you through just one portion of the current market’s complexity.
US mortgage companies have been lending to anyone who could sign their name, say please and promise to repay the loan, but lenders haven’t been actually checking that the borrower was capable of doing so. That was fine while house prices were rising and interest rates were down at one per cent but US interest rates are now at 5.25 per cent and house prices are sliding (actually they are plummeting in some areas).
So, mortgage companies are seeing rising default levels and cannot recover the value of their loans against rapidly depreciating assets, which means they are less able to repay the people they borrowed from (banks and other institutions) and the shares in these companies are falling dramatically as other investors “get the hell outta there”.
The lack of available credit also means banks are less able to fund company mergers and acquisitions, which so often rely on highly geared borrowing and that added to the slide in share prices. Falling share prices mean the majority of investors are losing money and many of those whose equity portfolios are being hammered are selling out of other investments to fund the losses.
Carry trade
One of the most common forms of global investment in recent years has been the oft-mentioned ‘carry trade’ where money borrowed in Japan at 0.5 per cent is invested in places like Australasia, South Africa and the UK where the interest rate yield is so much higher. So it is no surprise that many of these ‘carry traders’ are unwinding their investments to recoup losses and the consequence of this is that the Pound sterling, the Australian Dollar, New Zealand Dollar and South African Rand are all losing value.
The great irony of this situation is that the US Dollar is actually strengthening despite America being the source of the crisis. This is because, as investors seek safer places to lodge their funds until all the turmoil dies down, the safest haven of all is the US Treasury certificate; debt supported by the US government and with a guaranteed interest rate return based on a 5.25 per cent base rate.
If you think I forgot the Euro in all this, well so did everyone else in the markets because the Euro has only moved significantly against the US Dollar and Japanese Yen, both of which are central to the unfolding drama melee.
So, after one of the most turbulent weeks in recent times, traders will be very nervous of becoming too long or short of any aspect of the market other than the US ‘sub-prime’ lending arena and who can blame them?
What is not certain is just how deep and extensive the exposure to this market is in other countries and other financial institutions. And there is still the question of whether this trouble could feed into a similar mortgage market tumult in the UK and Europe.
With so many holidays taken in August and the virtual shot down of large swathes of Europe, August is generally considered one of the quietest months in the financial market calendar. So such a monumental change of sentiment and the lack of traders at their desks have combined to make life rather exciting for those who worked through.
It is an excitement many could do without and we may, in the coming days, see a rush by traders to book next August as a holiday period.
David Johnson can be contacted by email on david.johnson@halofinancial.com or by phone on 0044 207 350 5474.
David is a Currency Dealer with Halo Financial Ltd, delivering competitive exchange rates and a personalised service to help property investors, holiday home buyers and migrants throughout Europe save time, money and hassle on their foreign exchange transactions.
