How did it all start. What was the root cause of the current financial turmoil? Was it caused by weaknesses in the system of liberal capitalism, led by the United States as alleged by the 2nd Minister of Finance. Then we should ask our learned 2nd Finance Minister, what economic system does Malaysia practice, a closed socialist/communist one?? Lets not be a hypocrite when we are really no better.
Fong Chan Onn starts off the discussion with a simple explanation of the subprime saga where banks were aggressively lending, especially for housing below prime rates resulting in subsequent foreclosures when many house owners could not pay their mortgages when the prime rate escalated.
Next writer Eric Margolis gave an excellent write on the demise of Wall Street’s “masters of the universe” financial powerhouses, like Goldman Sachs, Merril Lynch, Lehman, and Morgan Stanley in “A Near Death Experience”.
The real root cause of the subprime mess is however “GREED” which our next article alludes us to.
And finally the subprime crisis explained in a funny way.
1. HOW THE TURMOIL STARTED
Q&A with Datuk Seri Dr Fong Chan Onn
Please explain in simple terms the financial crisis now strangling America.
The cause of the turmoil had its beginning in the aftermath of Sept 11, 2001. After the incident, consumers were in a state of gloom and there was loss of confidence. The Federal Reserve (Fed), in order to stimulate the economy, went on a policy of a low-interest rate regime.
Before Sept 11, the Federal Reserve discount rate (interest rate that banks pay to borrow directly from the Fed) was 3.7%, with cost of fund for prime rate (a reference interest rate used by banks) at 6.5%.
By the end of 2002, the federal discount rate was 1%, with the prime rate for loans at 4%. This low interest rate regime went on until mid-2005 and, because of these low-cost funds, banks were aggressively lending, especially for housing.
Mortgages were given to those without good record — no employment, no credit rating and no stable income.
The banks were doing that because by 2005, there was a steady appreciation in house prices. Banks were treating houses as very good collateral; in case of foreclosure, the price of houses were more than the mortgages.
Unfortunately, inflation went up. By 2006, the Federal Reserve had to increase the rates. In June of that year, the federal discount rate was 4.95%, and the cost of funds for prime rate was 8%.
This resulted in heavier mortgage payments for many house owners and they could not pay. Many had to forego their properties. The banks took over the houses and this created a slump in the market.
By 2007, banks were facing difficulties, including Citibank and UBS, which sought injection of funds. That was the initial stage. The property market kept on slumping and even good paymasters couldn’t pay.
This escalated and Lehman Brothers as well as Fannie Mae and Freddie Mac, the primary organisation for housing loans, were in deep trouble.
It must be noted that Fannie Mae and Freddie Mac had packaged their loans and resold them to buyers, including sovereign countries like China and Japan.
For the foreign countries, buying these financial products were akin to buying US treasury bills because they were implicitly guaranteed by the US government.
As for AIG, it became problematic because it provided insurance for many mortgaged properties. In a nutshell, even the final protector also collapsed.
> Some say the current American crisis is akin to the Great Depression.
The Great Depression was also due to loss of confidence. Investors lost faith in the stock market back then.
But there is a major difference: in 1929, the US government did not have the power to spend because laws restricted them from overspending, so it had no capacity and no hindsight to act.
Although the effect this round is considered not as severe as the Great Depression, there is only a small consolation – the Depression took 10 years and the Second World War to stimulate the economy.
> Is the Government doing enough to minimise the impact of the crisis?
Competition vis-a-vis the regional countries is tough. Singapore, Vietnam and Thailand are trying their upmost best to attract the slowing foreign investments.
And for the past seven months since the general election, the perception is the Government is not making concerted efforts to resolve issues because they are too caught up with politics.
2. A near-death experience
NEW YORK: The financial panic sweeping the globe is maddeningly complex, but the cause of the worst financial crisis since the 1930’s Great Depression is clear.
America has revelled for two decades in an orgy of debt. The US national debt is now twice its net worth. From Wall Street’s “masters of the universe” financial powerhouses, like Goldman Sachs, Merril Lynch, Lehman, and Morgan Stanley, to the humblest homeowners, America’s national motto became “borrow to the hilt and bet”.
The traditional regulated banking system was pushed aside by Wall Street’s financial titans who created their own money in the form of complex securities, and furiously traded these exotic instruments and borrowed recklessly against them with little government regulation or oversight.
As Kevin Phillips points out in his prophetic book, Bad Money, America’s primary business became non-productive finance. Manufacturing fell to only 12% of GDP. Wall Street titans grew obscenely rich by simply passing around paper. Inflated or semi-worthless securities increased in bogus value at each stage of the trading process.
Wall Street was allowed to virtually print money and peddle toxic securities around the globe because the big financial houses and heads of hedge funds bought the politicians of both parties. Equally important, the mammoth financial and housing bubble thus created was hailed by the Bush administration as proof positive of Republican free market philosophy and the true road to prosperity. More cautious European and Asian bankers were dismissed by Republican chest-thumpers as financially timid.
This Ponzi scheme worked so long as markets kept rising. When the music stopped, disaster.
It’s uncertain how far damage from America’s financial equivalent of hurricane Katrina will spread. Hedge funds, money market funds, and car makers could be next. Real estate losses may reach US$636 billion (RM2.17 trillion) by 2012.
All stock market gains of the past 10 years have been wiped out in the most dangerous crash since the 1930’s.
The “free market” Republican administration has ended up nationalising nearly US$1 trillion (RM3.4 trillion) worth of businesses, including the federal mortgage agencies Fannie Mae and Freddie Mac, Bear Sterns, and global insurer AIG. Welcome to Wall Street socialism.
One thing is now clear. When great empires run onto the financial rocks, their power quickly ebbs. France’s Sun King, Louis XIV, ended his once glorious rein in near bankruptcy caused by his long, ruinous wars with the British and Dutch. Louis XVI’s runaway borrowing to finance the American Revolution helped ignite the French Revolution. The Soviet Union’s collapse was caused by spending half its national income on arms, and failure to modernise industry.
Over the past decade, the US foreign debt doubled. Japan and China now hold 47% of the US foreign debt and finance Washington’s wars. The addition in recent days of at least one trillion in new debt will cause interests to rise and the dollar to weaken. Even the US government’s AAA credit rating is now in question.
Washington may no longer be able to spend half the globe’s defence budgets. The US$12-13 billion (RM41-44.4 billion) a month wars in Iraq and Afghanistan will end up costing US$750 billion (RM2.6 trillion) by December. There will be less cash in Washington’s kitty to buy foreign dictators and prop up their regimes, as in the Middle East and Central Asia. Less cash to pay for little wars in Africa. Less for exotic anti-missile systems and death rays.
America’s enormous global power is based as much on its financial might as military muscle. Wall Street has been the vehicle and policeman of America’s hegemony. It shaped the destiny of the globe, and made many nations subservient to the demands of New York’s titan-bankers. Wall Street is essential to raising capital for business expansion, but it often recalled New York’s ruthless loan sharks: once you borrowed from them, you never got off the hook. Americans will have to relearn the hard truth that you can’t borrow your way to prosperity.
Eric Margolis is a contributing editor to the Toronto Sun chain of newspapers, writing mainly about the Middle East and South Asia
3. The Real Cause of The Subprime Mess.
Foreclosures are at record highs. The stock market is extremely volatile. The government is stepping in. It’s almost the end of the year and everyone from consumers to retailers and investors are jittery about what lies ahead. Apparently the sub prime mess affected more than just lenders and home owners. Its amazing that we didn’t foresee this. As a real estate agent two years ago I didn’t find the stories of people buying $500k+ homes with 0% down strange. I didn’t think it was weird that I was able to get a loan on an investment property given my short credit history at the time. So what can we learn from the sub prime mess? Who’s to blame? There is much debate about that and I don’t think its a question of who to blame, it’s a question of what to blame. That culprit is none other than pure greed at it’s finest. Everyone got greedy, period.
This one’s a given. Some people in charge decided that it was worth the gamble to lend to people who either had bad credit, couldn’t truly afford the loan, or both. Underwriters got greedy to meet their numbers. Brokers got greedy and started lying to get their commission. The greed had an incredible trickle-down effect in the lending industry.
Homeowners and sellers got greedy as well. Some wanted to upgrade to a larger home so they took out bigger loans. Some wanted a new car, or a new kitchen and therefore took out second or third loans. They assumed they could buy whatever they want just by borrowing against their home since they thought the appreciation would never stop. Now a lot of people owe more than the value of their homes.
Builders got greedy and started building everywhere imaginable without thinking about whether or not there will be true demand. The ‘build it and they will come’ mentality is evident in many builders. Now they’ll throw in all sorts of wacky incentives to get rid of their inventory.
Buyers got greedy too. Some wanted a bigger and nicer house so they simply took out bigger loans. Renters jumped into homeownership after hearing stories of appreciation and making quick bucks. They didn’t realize that all the expenses associated with home ownership is guaranteed to be a lot more than what they were used to while appreciation is not. Real estate agents like myself at the time didn’t care either, we wanted the commission check.
Yes, investors got really greedy too. The concept of leverage was stretced to the max and people bought properties with little or no down payment. Some cashed out imaginary equity in their own homes to buy a second or third home in hopes of an easy flip. I’m also in this category as well. I gambled on a speculative property with a small down payment and I lost big.
The take home message here is to always strive for success in everything you do, but never cross that line where it becomes greed. Greed possesses a blinding force. At the time, no one cared to think of the consequences. Everyone looked at the short term profits. Greed blinded us at the time. The only thing we can do now is learn from it. Because I learned my lesson early in my life, I look at investing very differently now. I hope that everyone impacted by this is also learning a valuable life lesson. While success may lead to greed, greed will never lead you to success.
The subprime crisis explained in a funny way
08/12/2007 Many investors are hit by the subprime crisis. For “normal people” many things can’t be explained. But you are lucky since this movie by two top entertainers explains it all in this funny video. Explained: ..market sentiment… Volatility in the market …Mortgages salesman- .. Packages … Structural Investment Vehicles… High Structured Enhanced Best Funds … and some solutions !!!
Of course if you understand this you’ll discover that the one who is finally paying for all these incompetent bankers are the pension funds owners, YOU ARE THE PEANUT !