First of all, for the benefit of those who do not closely
follow the financial markets, let us review what the sub-prime
market is all about and why its collapse has caused reverberations
beyond the shores of the US where it all started.
Lending to people who cannot repay
It all started with the booming housing market and the very
low interest rates encouraged by the US government following
the gloom that resulted from the bursting of the technology
bubble, the 9/11 terrorist attacks and the era of the Enron
scandal. As house prices rocketed, loan companies relaxed
their requirements to the point where they were offering mortgages
to people without jobs or with poor credit records. Their
logic was that so long as prices continued to soar the collateral
would be more than sufficient to cover the loans in the event
of default. The market was also fuelled by other factors such
as the overzealousness of the mortgage sellers and an element
of pressure on loan companies not to discriminate against
minorities.
The outcome was predictable. Borrowers started to default
in such large numbers that the foreclosures on properties
started to have an effect on property values. This made the
situation worse for lenders since the collateral was now worth
less than the loan. As prices fell, buyers were frightened
off, so the lenders were left with empty properties. Because
of their own debts to investors several loan companies consequently
went into bankruptcy.
So why didn’t the losses stay there?
A few years ago this might have been the end of the story.
The defaulting borrowers would be thrown out of their homes,
the loan company would go out of business and those who put
their money into the loan companies to earn interest would
have lost part or all of their investment. But we are now
in a different kind of financial world where many markets
are interlinked, often without the knowledge of depositors
or investors.
In the case of these sub-prime loans, the loan companies were
not satisfied to just sit back and wait for the capital and
interest payments to come in. Instead they ‘packaged’
the mortgages and sold them on to banks and other institutions
such as hedge funds. With the fresh income from these sources
they could then expand their lending ability and, to keep
the business flowing, they almost certainly lowered their
lending standards even further.
The domino effect
So when the house of cards finally collapsed it was not just
the original borrowers and lenders who were affected but also
the institutions that bought the packaged mortgages. Several
hedge funds went out of business in the US and Europe as a
result. Even major banks admitted they had incurred heavy
losses, amounting to billions of dollars in total. These included
prestigious names such as UBS, HSBC and the Citigroup. Fortunately
they are big enough to swallow the losses but they can all
expect the experience to have made a dent in their bottom
lines.
Separately, Northern Rock, a bank specialising in mortgages
in the UK, then ran into difficulties leading to panic withdrawals
by thousands of investors, despite a rushed guarantee from
the British government.
A consequence of all of this has been a tightening of the
credit markets. This has hurt consumer confidence and is having
a further knock-on effect on the price of houses.
Is the worst over?
Much depends on how the US and other housing markets hold
up over the next few months. A fear in the US is that low
interest ‘teaser’ rates to new borrowers are coming
to an end and that they are now faced with significantly escalating
mortgage repayments coming at a time when the value of their
equity in their homes is falling. Some predict that house
prices will fall in the US by as much as 20% in the coming
12 months.
On the positive side, the US Federal Reserve has lowered the
base lending rate to 4.75% and is likely to reduce it further
in October. This will make credit a little easier to obtain
and should take some of the pressure off the housing sector.
Despite lower consumer confidence there has been little impact
on the stock market other than a correction that followed
when the sub-prime news broke, but markets returned to their
highs within weeks.
Interest rates have not yet been reduced elsewhere (which
is one reason for the fall in attraction of the US Dollar).
While there is certainly a hint of pressure on the housing
market in the UK and elsewhere, countries like Australia are
largely unaffected, although there is a good chance that their
day will come. Historically, whenever there has been a boom
there invariably follows a bust. Timing the bust however has
never been easy and investors too nervous to go into a market
have so often missed out by staying out of it.
And what about Bali?
It all comes down to supply and demand. While the tourist
industry goes through wild cycles (right now it seems definitely
and happily on the up) the local property market has a life
of its own. Where expats are concerned it is near impossible
to get a mortgage even with a proven and secure income. But
to most buyers, this does not seem to be a concern. There
is plenty of cash around and buyers seem happy to part with
it without even taking the minimum steps to check out the
properties they are buying as they would in their home countries.
Such is the magic attraction of Bali!
If you own properties in the US, Europe or elsewhere you are
of course going to be affected by the strains on the various
markets. If you are looking to buy, you can probably get better
value today than a year ago and if you have a steady income
as an expat you should have little difficulty in raising an
offshore mortgage, although the tightening credit market may
result in your having to pay a slightly larger deposit.
If you are investing in the world’s stock markets (as
you should be!), then logically we should expect more volatility
if the housing market worsens in the West and consumer confidence
falls seriously. Not a problem if you are looking long term
and not a problem if you have been following my advice and
have your eggs well-distributed into a number of baskets!
Colin Bloodworth is a senior adviser with Financial Partners
International. The opinions expressed are his own. If you
have any questions relating to personal finance you may contact
him at 021 520 8099 or colin.bloodworth@fiancial-partners.biz
