Is the Sub-Prime Crisis in US going to affect IPs in Australia ?

[mortgageman]

Hi Kenneth,

The legislations being rushed through currently are being put in place as an emergency measure to prevent the US housing market from total implosion, and are reasonable given the current situation. However, they would not have prevented the current situation from occurring had they been in place a few years ago. Every state in the United States has extensive predatory lending laws. However, the issue has arisen because of the demand for high yielding mortgage securities, which are sold on to the secondary mortgage note market and have somehow found their way into large, supposedly safe hedge funds. In order to satisfy that demand, lending restrictions became way too relaxed with some lenders and brokers were of course pushing some dangerous products (in particular the option arm product) to gullible home buyers who have over leveraged themselves and not been prepared for rate rises. I think at the end of the day, with the demand for high yielding securities being so high and the due diligence from the institutional investors being so poor, no amount of legislation could have prevented lending policies straying. When this is combined with a public hooked on personal debt a situation has existed that could not be regulated against short of bringing in lending laws that would strangle the market in the way that the current credit crunch is doing.

Kind Regards,

Cameron Perry
Perry Financial Strategies

 

[Kennethkohsg]

Dear Cameron,

1. I think I do not truly understand the American Capitalism and the way the US Govt operates in its context, at this point in time.

2. Likewise, I suspect that I am also still lacking in true understanding regarding how the Australian Economy and its Govt actually operates and go about doing its own forward economic planning for Australia and ground management of the Australian Economy on the real time basis, at this point in time.

3. I see different things being operated in Singapore and in HK with respect to the way the economic planning and management of their respective country's economy are actually being carried out.

4. I will go and do more reading up on my own first before further discussing this topic with you in due course.

5. Thank you.

Cheers,
Kenneth KOH

 

[alexlee]

You assume more government influence and control over the broader economy, especially in terms of where resources are focused, than there actually is in places like the US and Australia. It's pretty wild west in that people are basically free to put resources wherever they want, instead of having the government 'steer' them to places where the government thinks resources 'should' be focused.

The US and Australian governments try to allow as much freedom as possible, and that includes making mistakes. In short, they try to treat them like adults (though currently the US is caving and trying to clean up the mess - I think that's very much motivated by the presidential elections) instead of treating them like children who don't know better (as Singapore does). As to which is better? Who knows.
Alex

 

[Kennethkohsg]

Dear all,

1. In reply to this thread topic, it seems to me that the Sub-Prime Crisis in US, is "unlikely" to affect the IPs in Australia, at this point in time. This is as far as I can infer from the present RBA's (tentative) views as reflected by Glenn Steven's speech, as follows:

"Yet these events have been absorbed thus far with little disruption in the broader economy. The availability of credit to sound borrowers has not been impaired. It costs a bit more, but that is in the context of a fully employed economy struggling to meet demand. The key banking institutions are strongly capitalised, have adequate liquidity and relatively little exposure to the problems in the US housing market. Business and consumer confidence both remain high. In the local housing market over the past year, we have seen prices accelerate in several cities in the eastern states. The economy grew significantly faster than trend over the same period. As a central bank, while we have been careful to ensure ample liquidity in the money market at a time of international uncertainty and re‑pricing of risk, we have remained concerned about the outlook for inflation, which is likely to be uncomfortably high in the near term."

http://www.rba.gov.au/Speeches/2008/sp_gov_190108.html


2. This is despite the Australian stock market having reportedly lost some $147bn during the first 18 days in January 2008. From its peak on November 1, the ASX200 has now fallen down by 15.8 per cent to 5747.3.

3. This is further not withstanding that RBA's own research having shown that the number of margin calls on highly leverage investors during the September quarter (the most recent for which figures are available) had increased fourfold.

http://www.theaustralian.news.com.au/story/0,25197,23073892-20142,00.html


4.For your further update and comments/discussion, please.

5. Thank you.

Cheers,
Kenneth KOH

 

[alexlee]

It might just be a time lag, you realise. Any effect on Australia is likely to pass through China first. So by the time US (and European) demand falls enough to affect China, which will then affect Chinese demand for our resources... it may well take months. In my opinion, we're nowhere near the endgame in the US yet. Wait until you see cracks in different debt products: credit cards, auto loans, commercial, and derivatives such as CDS's.
Alex

 

[bernly]

In my opinion, we're nowhere near the endgame in the US yet. Wait until you see cracks in different debt products: credit cards, auto loans, commercial, and derivatives such as CDS's.

Hello Alex

Do I detect a mood of pessimism here? You've been pretty philosophical and upbeat about the whole subprime thing, I've thought, until now and wonder if you've changed your thinking about acquiring more IP's in the near future and your general investing strategy.

Cheers

 

[alexlee]

Hello Alex

Do I detect a mood of pessimism here? You've been pretty philosophical and upbeat about the whole subprime thing, I've thought, until now and wonder if you've changed your thinking about acquiring more IP's in the near future and your general investing strategy.

Cheers

On the contrary. I've been consistently pessimistic about the short term. I'm upbeat about the long term. The short term is looking uglier.

I'm still planning to buy more IPs in the near future (as soon as I get a refinance through, in fact). But that will be a smaller % of my total portfolio. I think there is more pain ahead, but I don't think the whole system is going to go up in flames. More likely, we'll have a recession, thing look like crap for a few years, and then we have a new boom. I'll be slowly buying more property and shares during those few years. I don't believe I can time the market, so I'll just keep buying.
Alex

 

[WinstonWolfe]

A classic Jim Cramer behind the scenes perspective of the sub prime fallout...
http://www.cnbc.com/id/22706231

...Aussie bankers considered "MORONS" by aggressive US banks...

 

[WinstonWolfe]

Here's another serious ramification of the sub prime fall out......
http://www.youtube.com/watch?v=8lDxQ_0lPYQ

This one involves the risk of US mortgage insurers going belly up. Many sub prime mortgages are due to be refinanced over the next 3 months, which can be expected to increase defaults.....which would naturally increase claims against the mort. insurers.....

One of these insurers PMI, is one of Australia's two signficant mort. insurers...



The US market is cruelling the stock values....

http://www.123jump.com/market-updat...6/?PHPSESSID=4e216c0378813cd433629979bc5f3981
4:36 PM EST January 17 2008

12:00PM New York – Bond insurers fell sharply as worries mount on the capital adequacies.

Bond and mortgage insurance companies took another plunge after MBIA, Ambac Financial, and PMI Group fell sharply.

Ambac Financial (ABK: chart) fell 51% or $6.56 to $6.32 after it ousted its chief executive. The company’s plan to raise capital of $1.0 billion may not be sufficient. Sub-prime mortgage market continues to deteriorate and obligations of these bond insurers keep rising.

Ambac has insured $555 billion of bonds. To preserve its AAA rating AMbac may have to seek more capital according to the rating agency Moody’s.

MBIA ((MBI: chart) dropped 33% or $4.41 to $8.99 and the PMI Group fell 14% or $1.11 to $6.66.

MBIA raised $1 billion in the January offering by offering surplus notes with a claim on its future earnings. The notes have fallen sharply in the last three days of trading and now trade below 85 cents to a dollar.

 

[WinstonWolfe]

Following on from the above post, here's further insight into the plight of the bond and mortgage insurers......now the banks are being asked to bail them out......

http://www.ft.com/cms/s/0/107a1c0c-c9eb-11dc-b5dc-000077b07658.html
http://www.bloomberg.com/apps/news?pid=20601109&sid=a30y_cTn2Mz4&refer=home

How Ironic!!!!

The insurers are there to back the banks......and now the banks look like they have to back the insurers......Suppose if the banks don't back the insurers, then the erosion of confidence in bonds will be profound, and the banks will also suffer massive losses as property foreclosures escalate and values decline....

IMHO, the stock markets won't stablize until the channels of credit flow are cleansed. Sorting the insurers out is the first step.

 

[Kennethkohsg]

Hiya WinstonWolfe,

1. RBA's present main focus is on containing the domestic inflation in |Australia. Its present assessment is that the US Sub-Prime Crises and the impending US Recession will NOT significantly impact the Australian Economy, as the alternative growth twin engines of China and India are likely to make up for the potential loss of demand from the US.

2. It was further reported in the Singapore Business Times newspapers that China has effectively replaced the US, as the largest trading partner for Japan, whose economy is also slowing down significantly. China's economic growth for 2007 was a hefty 11.7%, one of the fastest growing economies in the world.

3. This is not withstanding the recent ASX stockmarket run since the beginning of 2008, which has since rebounded after Ben Bernanke and his US Reserve Bank cut implemented a surprise inter-meeting 0.75% interest rate on Tuesday evening.

4. For your further comments and discussion, please.

5. Thank you.

Cheers,
Kenneth KOH

 

[WinstonWolfe]

Hiya WinstonWolfe,

1. RBA's present assessment is that the US Sub-Prime Crises and the impending US Recession will NOT significantly impact the Australian Economy, as the alternative growth twin engines of China and India are likely to make up for the potential loss of demand from the US.


Don't agree with this.....and besides, I don't see the RBA or any commercial bank really understands what is going on behind closed doors of the larger movers and suppliers of capital in the world. If they did, then the sub prime mess wouldn't have unfolded. I believe Australia is highly vulnerable to anything that impairs the flow of credit.....currently the poor financials of the world's largest insurers of bonds and mortgages represent a profound risk to the flow of credit around the world......And as Australia is one of the worst saving nations on the face of the planet, anything that contracts credit will heavily contract our economy......I hope I am wrong but I just don't see why private banks would lend to an insurance company to cover its obligations to the banks themselves......very sticky situation.....the insurers are there for the banks to pass the hot potato to......so why would the banks accept a potato back that is about to internally combust......



2. It was further reported in the Singapore Business Times newspapers that China has effectively replaced the US, as the largest trading partner for Japan, whose economy is also slowing down significantly. China's economic growth for 2007 was a hefty 11.7%, one of the fastest growing economies in the world.



Well, that is all fine and dandy if the Chinese are prepared to lend some of their mulah to the west (mainly USA) so they/we can keep consuming....however, I am sure the Chinese are smart enough to know when it is unlikely the US can service further debt growth....I believe we are in that time now....and the Chinese will not be served by lending to a nation that cannot afford to pay interest at currrent or higher rates into the future......they therefore will be gradually unwinding their exposure to the US from now.....



3. This is not withstanding the recent ASX stockmarket run since the beginning of 2008, which has since rebounded after Ben Bernanke and his US Reserve Bank cut implemented a surprise inter-meeting 0.75% interest rate on Tuesday evening.

That cut highlights how bad things are.....if the free markets were in a healthy state, then the Fed wouldn't have to do such extreme things......however, the banks and ratings agencies have become so corrupt and poorly managed by greedy senior management, that they have leveraged themselves into untenable situations.....this isn't going to be turned around overnight......and the flow of credit will be at risk of shutting down again within 3-6 mths......why? because no one knows which banks have what exposure......and no one knows what to invest in anymore because the ratings agencies have been telling pork pies.........

My money is on the share markets and global credit flow suffering a massive hit before September 08....

If you are going to borrow money this year, my advice is to get it asap and fix securely with a major lender that has the least exposure to foreign funds. But keep in mind that if credit dries up, asset prices in Australia are going to feel it....



4. For your further comments and discussion, please.

5. Thank you.

Cheers,
Kenneth KOH

.............................

 

[WinstonWolfe]

Kenneth, as a follow up of my 1st point above, can I bring your attention to the fact that Aust's big 4 banks invested significantly in the US company Countrywide Financial (see below). This company had probably the most extreme exposure to sub prime mortgages. The ignorance of the Aussie banks regarding the risk posed by the sub prime situation is no more obvious than by this. So I'd reiterate, don't think the RBA or Aussies' major banks have their finger on the pulse. Nor the US Fed.... Greed and multi-million dollar bonuses have been driving senior management of world finance to take more and more corrupt and destructive paths....The mess they created won't be sorted out anytime soon....


http://www.theaustralian.news.com.au/story/0,25197,23030579-601,00.html

$1bn hit to banks from US





Scott Murdoch | January 10, 2008

AUSTRALIA'S big four banks have a $1billion direct exposure to the US sub-prime mortgage market, despite months of assurances that they were immune from the deepening financial crisis.
The revelation came as the Commonwealth Bank, Australia's biggest home mortgage lender, raised its variable home loan rate by 10 basis points to 8.67 per cent in response to the global credit crunch and independent of any action by the Reserve Bank. The National Australia Bank last week lifted its rates by 0.12 of a percentage point, and the ANZ followed with a rise of 0.2.
The Commonwealth's move came as the argument for the Reserve Bank to increase official interest rates at its next meeting firmed yesterday, with November retail sales rising by a bigger than expected 0.8 per cent.
The $20billion pre-Christmas spending spree, coming during an election campaign and just after an interest rate rise, prompted economists to warn that the Reserve Bank could be forced to act to further cool the economy.
The CBA, NAB, ANZ and Westpac's exposure to the US sub-prime market comes through an almost $1billion investment in troubled US mortgage group Countrywide Financial, which appears close to collapse.
The major players were part of a syndicate of 40 banks around the world that threw the embattled lender an $US11.5billion ($13 billion) financial lifeline last year.
The CBA and the NAB invested $300million each, while the ANZ pumped $150 million into the deal and Westpac $100 million.
Countrywide has been one of the biggest victims of the sub-prime credit crunch, and is facing a battle to survive.
The shares in the US's largest independent lender plunged by almost 30 per cent on Tuesday night after rumours emerged on Wall Street the company was seeking bankruptcy protection.
The potential loss by the Australian banks is a further sign the sub-prime crisis has the potential to damage the domestic economy.
The exposure to the sub-prime crisis through the Countrywide investment was confirmed by the banks yesterday.
Analysts have started to question why the banks sought to participate in the deal to rescue Countrywide, given the level of risk involved.
In the US, the lending group denied it was close to bankruptcy, but it has been damaged by the sub-prime crisis.
Sources said the Australian banks would have sought protection on the $850 million investment, but would sustain a major loss if Countrywide collapsed.
"It can easily be absorbed," one analyst said. "But it's an incremental negative and certainly raises other questions, like why are they doing this sort of business at all? Talk is, many of the largest banks in Asia were not on the list of 40, but the Aussie banks are."
The performance of the Australian banks has been one of the major drags on the stock market recently, and the share prices of the majors fell again yesterday.
Wise Owl sharemarket analyst Sven Restel said the Australian banks had to be exposed to the sub-prime problems in the US because of the nature of their business. The retail banks have argued that the fallout from the credit crisis would be limited because only 1 per cent of mortgages in Australia are considered sub-prime.
"The banks have been pretty quiet about their exposure to sub-prime; some have said they have not got that much exposure," Mr Restel said. "All of the Aussie banks have very high exposure to overseas markets. I think that it would be foolish to think that they would not be affected at all."
The fallout could have ramifications for consumers, as the banks battle to recoup the potential losses.
The banks would not comment on the level of protection taken out on the financing agreements, nor the reasons for the risky investment.
The CBA revealed yesterday it would join the rush of major banks boosting variable lending rates.
The 0.1 percentage point increase to CBA's variable home loan will add $14 a month to the average mortgage and leaves Westpac as the only major not to shift rates in the past fortnight.
CBA chief financial officer David Craig said the global credit crisis had cost the retail bank $100 million and its profit would be hurt if it did not take action.
"The impact of the cost of wholesale funds is something that is impacting all of the Australian banks," Mr Craig said.
Wayne Swan, whose warnings to the major banks have been ignored, said the bank bosses had to justify the increases in mortgage lending rates.
"Banks need to fully explain any increases flowing from the US sub-prime crisis," the Treasurer said.
On Wednesday he singled out the ANZ for criticism.
"The increase in the average cost of funds to the major banks is much more in line with the increase announced by the National Australia Bank than the increase announced by the ANZ," Mr Swan said. "So on the basis of all the evidence that I have received, I do believe that the ANZ's rise is excessive."
But he refused to say ANZ was being mercenary.

 

[alexlee]

If the majority of Australian bank exposure is to Countrywide, the risks just got smaller, no? Bank of America is going to buy Countrywide. While questioning the wisdom of the buy, no one is predicting that BoA is going to go bankrupt.

Having 'exposure' to the subprime thing in the form of lending to a bank / mortgage provider, which is going to become part of a bigger player like BoA is VERY different from being, say, invested in a CDO that's crashing because of mortgage defaults. Australian banks did not 'invest' in Countrywide (in the sense of buying its shares): they lent it money. Which presumably will now be taken over by BoA.

In any case, exposure does not automatically mean total loss. Just because Australian banks lent Countrywide 1bn doesn't mean they'll lose it all. I have $x exposure to the sharemarket. This doesn't mean all my shares will go to zero even in a crash.

I'm not saying Australian banks were necessarily better at assessing risk (they could just have easily lent money to New Century, presumably). But in this particular case, lending to Countrywide would be relatively less risky.
Alex

 

[WinstonWolfe]

Alex, an unsecured loan or one secured against assets of highly suspect value (such as CF's book), is in my view not a commercial grade loan........

hence my interpretation of the 40 bank lifeline being an 'investment'....though I accept investment is not the ideal term either....

as the article asks and the banks evade, one has to wonder why on earth Aus banks felt a need to take on such risk.......and then slug Aussie borrowers with rate rises for the extra (sub prime induced) cost of securing foreign funds...

at the end of the day, the banks do what they want in collusion....Aussie borrowers have little choice...and Swan and Rudd are morons to think they have any influence over them.

 

[alexlee]

Alex, an unsecured loan or one secured against assets of highly suspect value (such as CF's book), is in my view not a commercial grade loan........

No, but if BoA is buying Countrywide, are they going to default on any of their loans? I agree it depends on exactly what they've lent against.

at the end of the day, the banks do what they want in collusion....Aussie borrowers have little choice...and Swan and Rudd are morons to think they have any influence over them.

Yes, the big 4 banks certainly seem like they act in collution. Swan and Rudd don't have any influence over them, and why should the government have influence over independent companies? But I disagree that aussie borrowers have little choice: any foreign bank or company, for that matter, can come in and set up a mortgage operation. There is plenty of choice.
Alex

 

[WinstonWolfe]

But I disagree that aussie borrowers have little choice: any foreign bank or company, for that matter, can come in and set up a mortgage operation. There is plenty of choice.
Alex

Re lack of choice, I meant in relation to the origins of capital that have driven Aust property prices to where they are today. Whether RAMs or Aussie banks, Australia is more dependent on foreign sourced credit from the same sources, now more than ever before.

As I have mentioned elsewhere, the Aussie big 4 have almost doubled their reliance on foreign $ over the last 20 years, hence the banks' desire to slug the consumer with a non RBA rate rise.

Hence, IMHO, we have a situation where our property prices are more and more susceptible to the availability and cost of foreign sourced credit......and I am doing all I can to understand the source of that credit.....

Right on cue, John Mauldin's weekly newsletter arrived with further insight into the grave problems confronting the major mortgage and bond insurers in the US. John even postulates that the Fed didn't lower rates 75bp to save the stock markets, but to help ease the crisis for the insurers enough to help the banks bail them out. To complicate matters for the insurers, Warren Buffett is talking about coming in and setting up shop....So who is going to bail out the incumbents if Buffett is prepared to come in and erode future revenues?

And as Cramer says, if the insurers go belly up, there'll be carnage in the markets.


READ ON:


Jan 25. 2008 John Mauldin

[FONT=Arial, Helvetica, sans-serif]What Does the Fed Really Know?[/FONT]


I believe the monoline insurance companies like Ambac and MBIA are in worse shape than most realize, the counter-party risk in the $45 trillion Credit Default Swap market is much worse than we realize, and the exposure by various banks to their problems is much larger than currently understood. The Fed understands this, and realizes that they have been behind the curve but need to catch up. Let's go back and look at this quote from my letter just last week:


"If you are a bank or regulated entity, and you have mortgage-backed securities that have been written by a AAA monoline company, you can carry that debt on your books as AAA. But as the companies get downgraded, you have to write down the potential loss. Quoting from a recent note from Michael Lewitt: " 'MBIA's total exposure to bonds backed by mortgages and CDOs was disclosed to be $30.6 billion, including $8.14 billion of holdings of CDO-squareds (CDOs that own other CDOs, or mortgages piled on top of mortgages, or, to quote Jeff Goldblum's character in Jurassic Park again, 'a big pile of s&*^').



MBIA was being priced as a weak CCC-rated credit when it issued its bonds last week; it is now being priced for a bankruptcy. MBIA's stock, which traded just under $68 per share last October, dropped another $3.50 this morning to under $10.00 per share.


" 'The bond insurers' business model is irreparably broken. In HCM's view, it will be all but impossible for these companies to raise capital at economic levels for the foreseeable future and certainly in enough time to work out of their current difficulties. The performance of MBIA's 14 percent bond issue will prove to have been the death knell for this business. The market needs to come to the realization that the so-called insurance that these companies were offering is not going to be there if it is needed. The fact that these companies were rated AAA in the first place will remain one of the great puzzles of modern finance for years to come.'


"You can bet that the $8 billion in CDO-squareds is gone. It is a matter of time. MBIA's market cap is about $1 billion [it is now at $1.74]. Current shareholders will be lucky if they only get diluted 75%."


Think this through. MBIA is still rated AAA. Ratings downgrades are just a matter of time. Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital.
............................continued at....
http://www.frontlinethoughts.com/gateway.asp?ref=reprint

 

[alexlee]

Re lack of choice, I meant in relation to the origins of capital that have driven Aust property prices to where they are today. Whether RAMs or Aussie banks, Australia is more dependent on foreign sourced credit from the same sources, now more than ever before.

Fair enough, but why should we care? As a result of foreign sourced credit, we had lower rates than we've ever had before (not just the official RBA rate, but the DISCOUNT to the so called 'standard variable rate). After years of cheap credit, we're coming back to reality.

We, as owners of property, have directly benefited from all of this. Why bite the hand that feeds you?
Alex

 

[WinstonWolfe]

Fair enough, but why should we care? As a result of foreign sourced credit, we had lower rates than we've ever had before (not just the official RBA rate, but the DISCOUNT to the so called 'standard variable rate). After years of cheap credit, we're coming back to reality.

We should care because the end of cheap credit will effect short term property growth....

I agree the near tripling of prices in the last 7 years would not have been possible without foreign credit, which has been lubricated by securitization (the ability of lenders to keep higher risk loans off their balance sheets)...and we need to keep in mind securitization has been seriously shaken up by some dubious calls by the ratings agencies.

......if foreign credit flow into Australia is significantly tightened, it is logical property growth will stall, and possibly fall... I am already seeing growth in land on the fringe of Brisbane stall due to ever more buyers hitting a debt serviceability wall at current prices and credit terms.

And I'd add that there's significant pressure for local banks to rely more on foreign credit. It is more profitable for them and makes their balance sheets look healthier. The share of their funding coming from retail deposits has fallen from 40 per cent twenty years ago to 23 per cent today, and been replaced by foreign funds. (Graph 10). Some might argue banks have been trying to deal with reduced retail deposits by increasing their involvement in funds management. However, that trend has stalled in the last few years as indicated in the graph.

All this means to me that australian property growth is becoming more exposed to the volatility of global credit conditions. This hasn't been the case historically.

Not that I am pessimistic about the future of oz property...just that I expect a reasonable amount of volatility in the annual rate of growth in the short and medium term. And this will effect the timing of how I grow my exposure.

We, as owners of property, have directly benefited from all of this. Why bite the hand that feeds you?
Alex

I have no desire to bite that hand, just the desire not to starve if it halves rations.

 

[WinstonWolfe]

One more point....those who think fundamental demand for property will absorb reasonable increased tightening of foreign credit should keep in mind over 40% of new loans written nowadays are for IPs, not PPRs.

I would argue most investors are more sensitive to rate rises than owners, on the basis they are buying based on less elastic serviceability.