Over the past few days, the US financial markets has been like a scene relived from the Asian financial crisis in 1997.Even with the Federal Reserve Bank injecting $85 billions into AIG, the world largest insurer, the US stock market suffer its biggest decline since the 9/11 attacks. Apparently the move was not enough to reassure the investors that the financial market in the US was still sound. Within a single day, $700 billion of shares’ values were lost. The ailing Washington Mutual Inc shares also took a beating. The event was the fourth day of financial chaos in the US financial market, which came about when the Lehman brothers filed for bankruptcy on Monday15th September 2008.
As shares prices drop, the price of Gold and Bonds shot up indicating the shift of money to something considered less risky. Global markets were also not excused from the turmoil. As investors show their lack of confidence in the US economy and the Federal Reserve ability to stem the tide of chaos, Stock markets around the world suffered from tumbling stocks prices. Brazil’s saw a 7 % drop in its market index within a single day. Mortgages rates, which had dropped since the Government’s nationalisation of Fannie Mae and Freddie Mac, rose again removing hope that the financial crisis was almost over. The US treasury department also for the first time in history undertook to sell Bonds for the Federal Reserve in the effort to help the Federal Reserve raise funds to cope with liquidity crisis.
Because of the chaos, which continues to ensue after the bailout of AIG, the Federal Reserve committed another $180 billion in the effort to boost market confidence. Even as this article is being written, Morgan Stanley in the US and in the UK, Halifax Bank of Scotland (HBOS) are looking for potential merger partners in order to prop up their shaky situation. Central Banks around the world also conducted a joint coordinated operation to control the panic in the financial markets through out the world. The Bank of England committed 50 billions pounds into the market while the bank of Japan injected over $23.9 billion into the credit markets. The Swiss Banks, the Bank of Canada and the European Central bank also conducted similar operations. Interest Rates on US treasury Bonds dropped to a historic low while the gold price shot up in Hong Kong.
By Thursday, news of the Federal Reserve willingness to buy up the “Toxic Assets” from the financial institutions helped to rally shares prices. The Asian markets were the biggest beneficiary of the news of a possible Federal Reserve rescue package for ailing banks. The Hong Kong’s Hang Seng index shot up by 6.5% while the Nikkei when up an average of 3.8% indicating the return of Investors confidences in the market. The Chinese market fared even more impressively as the Shanghai index rocketed by 9.5% after the announcement by the Chinese Government that it will buy state owned banks shares. The Australian share market (ASX) also saw some gains after a turbulent week. The ASX 200 made a gain of 4.3% to reach 4,804. Australia’s biggest investment bank, Macquarie Group Ltd also saw a 35% rebound in its share value after taking a beating throughout the week.
The volatile movements of the financial markets have prompted behavioral experts to come up with reasons to explain the boom and crash of the market. It has been argued that hormonal factors are behind the drivers for the surge in investments as well as the flight from investments. One of the underlying foundations of economic studies is that it assumed that investors makes rationally decisions based on information gathered to evaluate the level of risks. However, this belief is now strongly being criticised as inadequate to explain the series of irrational behavior in the US financial market.
Proponents of an alternative concept argue that herd-like mentality, hormones and primitive emotions are the driving forces behind the recent volatile swings experienced by the financial markets. For example, initial investors are extremely cautious about what to invest. However, when they see their neighbor doing well from buying an asset, they will be encouraged to invest in that asset too. As the value of the asset goes up, so too will their confidence. This will fuel the conviction that this is an easy way to accumulated wealth. The reverse becomes true when the value of the asset goes down. As much as we wish to deny it, we have seen this too often around us. The recent collapse of the Australian Capital Reserve(ACR) only seek to highlight how much we are driven by animalistic instinct towards our investment decision. The lure of an additional 2% return had caused many to lose their life savings.
There is actually no such thing as easy money. The wealthy became rich because they followed a strategic plan towards investments. They have patience and they evaluate all risks and considered all sort of investment vehicles and never handling over control of their investment decision to others. Warren Buffet once said, unless you could stand watching your stock depreciating by 50% without flinching, then you are advised to stay away from the stock market. People like George Soros can remain extremely calm in turbulent markets because he uses a mathematical system call statistical arbitrage to hedge his bets against any currencies movements. This form of investment is also called “Riskless Investments”. (To know more, read “Sports Arbitrage – How to place riskless bets & create Tax free investments”).This system was developed by Morgan Stanley’s equity block trading operations during the 1980s. By exploiting the price differential of an asset behind two different market, an investor can profit whichever direction the price of an asset takes.
Technology advancement like the internet and the powerful personal computer has made statistical arbitrage an easy system to adopt using softwares like the ArbAlarm to calculate the price differential of an asset within mere seconds. People say life would be very easy of what the financial planners says is true. Follow everything what they say and in “5 steps”, you are on your way to financial freedom. They chose to ignore those external factors that are beyond your control, which can wipe out your savings with a single stroke. A good example will be the decline of returns in superannuation funds. Thousand of pensioners will not be living near the poverty line if the world works perfectly. Moreover, it is very true that your own future lies in your own hands, not in the Government nor in the hands of the so-called financial experts, which caused the credit crunch in the first place
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