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Real Business : Winter 2008
REAL BUSINESS ISSUE 2, 2008 31 NET GAINS For more information, check out www.ft.com/indepth/ creditsqueeze loans, using huge sums of money lent to them by banks. When some investors in hedge funds quickly withdrew their investments at the first signs of trouble, funds had to quickly sell off assets. So why was the crisis so severe? Lack of clarity and fear were certainly factors. Complex financial instruments spread risk around the world, but no one knew exactly where it ultimately resided. Until some details emerged, banks and investors in general battened down the hatches and stopped lending. Hence the credit crunch. HOW HAS THE WORLD RESPONDED? The Federal Reserve (the US central bank), the Bank of England and other central banks have cut rates significantly. So, when variable rate loans are rolled over this year, the interest rate will be more comparable to the variable rate of two years ago. Therefore, the default rate is expected to decline. “The peak in those rollovers has occurred but there will still be high numbers until September this year,” Cornish says. DO AUSTRALIAN BANKS HAVE EXPOSURE TO THE SUB-PRIME CRISIS? Cornish says Australia’s non-bank lenders, in particular, have exposure to the overseas credit market, where the pricing has been affected by sub-prime. But they do not have exposure to sub-prime markets themselves. “Non-bank lenders have a higher need to raise funds overseas,” he says. “They borrow short term for part of their funds but lend out long term. So they need to roll over that short-term funding to keep providing long- term funds on that portion.” ISN’T THERE ENOUGH MONEY AVAILABLE FROM FUNDS BANKED WITH THEM? “No there isn’t,” Peter Pontikis FCPA, group treasury strategist, Suncorp, says. “The demand for credit here exceeds the domestic pool of savings. That is why we need to source a portion of funds from overseas. We are growing faster than our savings pool.” SO WHAT’S THE WASH-UP? Short term, it is harder to get finance and when you get it you have to pay more for it, according to Dr Shane Oliver, head of invest- ment strategy, AMP Capital Investors. That is evident in the Australian mortgage market. “Longer term, I think access to credit will improve but it will take a long time before it is as cheap as it was a year or so ago, simply because the flow of investor money into credit markets and credit investments will be a lot more cautious for the next few years,” he says. “We will see a tougher regulatory environment and tougher lending standards may be imposed on banks. We are already seeing that in the US.” ¦ DEBT DETAILS BY THE NUMBERS 15% In the US, sub-prime loans at the peak of their market accounted for 15 per cent of new housing loans. 1% In Australia, sub-prime loans account for about 1 per cent of total mortgages. 16% In the US, the Mortgage Bankers Association (MBA) reports the mortgage delinquency rate (more than 30 days outstanding) for sub-prime loans is 16 per cent and for prime loans just above 3 per cent. 1% The RBA measures arrears as greater than 90 days outstanding. The greater western Sydney arrears rate for housing loans is just over 1 per cent, which is the highest in Australia. Nationally, for prime “full-doc” loans, the arrears rate is less than 0.5 per cent. GETTY Bear Stearns, one of the largest underwriters of mortgage bonds in the US, is a tragic example of how companies can fall when they bet on securities based on risky sub-prime home loans. Even though there were rumblings about the fragility of the sub-prime market, it was the demise in June 2007 of two internal Bear Stearns hedge funds, heavily invested in mortgage securities, which helped kick- start the global market panic that peaked in August 2007. By December 2007, Bear Stearns had announced its first loss in its 80-year history. It also announced a US$1.9 billion write-down of its holdings in mortgages and mortgage- based securities. Just four months later, a US$30 billion credit line was approved by the Federal Reserve to help JPMorgan Chase acquire Bear Stearns. At first, JPMorgan agreed to buy all of Bear for just US$2 a share, an offer that was less than one-tenth of the firm’s market price two days earlier and a 50th of what it was a year before. Towards the end of March 2008, JPMorgan boosted the bid to US$10 a share in stock and agreed to buy 95 million new shares of Bear Stearns. This will give JPMorgan a 49.8 per cent stake in the failed brokerage business. CASE STUDY OF A SAD BEAR
Issue 3 2008