The subprime leading crisis came about because of the development of reckless lending policies and sometimes-questionable predatory tactics adopted by the mortgage brokers. The other factor indentified as one of the leading cause is the collapse in value of the mortgage back securities. After the dotcom bubble burst, the Federal Reserve Bank in attempts to ward off a recession set the prime leading rate unusually low. This prompted the an expansion of the housing market as more and more people decided to invest in bricks and mortars to ride the wave of escalating housing prices. In order to cash in on the housing boom, the lending institutions relaxed their lending policies and created innovative new products to entice more customers. This lead to the proliferations of sub prime leading by the mortgage originators. The predominant type of loans originated was the Adjustable Rate Mortgages (ARM). As the interest rates went up, the repayment amount of the ARM also shot up resulting in increased delinquencies of the subprime mortgages. Thus, investors who bought houses that they could ill afford hoping to cash in on profitability ended up facing foreclosures.
The whole scenario is similarly observed in every developed country with the exception of Japan. Spain enjoying a housing boom lead on by low interest rates was impacted significantly. Ireland was also affected, with housing prices increasing several times over the last decade. The current trend of slowing prices is leading to a slowdown in the construction industry. As for France and Germany, these two countries suffered less severely as these two countries have different market circumstances. Germans are more inclined to rent rather than own and this had put a brake on spiraling housing prices. With respect to France, the French government has strict regulations regarding the numbers of house that could be built. This helps to dampen an oversupply in the market. Furthermore fixed rate interest loans spared the French from the effects of rising interest rates.
In the latest attempts by the Federal Reserve Bank, to restore confidences in the market had extended a loan of $85 billion to help American International Group to help it tide over the credit crunch crisis. However, the financial market still reacted negatively to the general climatic surrounding the credit crunch crisis in the US. Shares prices all over the world fell as investor liquidated their share holdings and switch to holding more tangible assets like Gold. Generally, investors are losing confidences in the US economy as no one knows for sure how much exposure are linked to the subprime mortgages. Analysts are calling these securities, which had been tainted with sub prime mortgages as “toxic assets”. Although foreign banks are not partial to subprime securities, their exposures have somewhat been limited. But with the collapse of Lehman Brothers, No one really knows for sure just what they have in their assets portfolio. Among the foreign financial markets, Moscow had been faring the worse. Trading on the Russian Stock Exchange was halted when the Micex Index dropped tremendously.
As the world scrambled around to halt the slide in the credit crunch situation, the Reserve Bank of Australia is contemplating options to help contains the effects to the fallout from the US. Measures’ being discussed involves putting a limit on the expansion of bank lending and the use of Interest rates to control excessive speculative investment in the property market. Another measure being contemplated is for the banking regulators to arrest the “Financial Accelerator”. This is the situation where increased investors confidences resulted in increased prices, which the investors used to leverage for additional borrowings. It is argued that by doing so, this will force prudential regulators to divert their attention from stabilising individual institution to stabilising the financial system.
Although the Central bank is of the opinion that the Australian economy is fundamentally sound, it still seeks to reassure the public that the Australian housing sector does not have any of the problems associated with the US housing sector. The Australian Prime Minster also seeks to reinforce the Central bank outlook by reassuring the Australian people that the country is protected from much of the fallout from the credit crunch crisis. He told The 7.30 Report that the Central bank. APRA and the Treasury are performing well and is up to the task of looking after the Australian economy in “uncharted waters”.
From an academic point of view, the efficient market hypothesis regards financial markets as “informationally efficient”. This means the prices of traded assets will reflect all KNOWN information at all times. This is not so as when can see prices varies daily in the financial market and as mentioned earlier, the securities traded by Banking institutions are tainted with “toxic assets”. The underlying reason for the price movements is because of liquidity. When investors feel at risk, they will hedge or seek to liquidate their investment holdings and this drives the prices down. This actually forms the foundation of a system call statistical arbitrage or sports arbitrage.
Statistical arbitrage seeks to take advantage of the relationship between price and liquidity. It works by capitalising on the statistical mispricing of an asset. (To know more read; Sports-Arbitrage – How To Place Riskless Bets & Create Tax-Free Investments). This model of trading was created by Morgan Stanley’s equity block trading desk operations during the 1980s. The brokerage house was able to avoid losses by buying stocks in related market as a hedge bet against its own position. Today such form of trading has even become more efficient as technology helps to improve the gathering of information relating to situation of arbitrages, using software like the ArbAlarm, an investors can locate market opportunities within seconds.
As with all investment, to make any financial investment decision, you will need access to quality information and a clear understanding of all your options. Such understanding can only come from having an open mind of the recourse that you have before you. Investing in bricks and mortars used to be one of the best investment decisions that one can make for one’s future. However, with the current market situation and cases like the collapse of the Australian Capital Reserve (ACR), one can’t help to think if it is as safe as it used to be. Furthermore, the instabilities that are facing the credit market only seek to highlight how insecure and the lack of control that we have over any situation. At the end of the day, whether the decision is good or bad, it is we ourselves who will reap the fruits or bear the pain of losses. No government or financial planners nor mortgages brokers will bear the risk for us.
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