Sunday, September 21, 2008

Commonsense Rules

I heard of the 'sub-prime' crisis a year ago and I was quite clueless on how this might lead to the possibility of a financial crisis. I attempted to follow the discussions in the papers but was not getting any wiser.

I know very little about Finance and Investment and I am braving myself to say my point of view here. If you too are struggling in the "$$$" world like me, it might make some sense to you. However, if you are an expert, you have my permission to ridicule.

Here goes.. a simple account of the recent financial saga, the juvenile version:

Apparently, it all started a decade ago in the US housing loan market. Back then, it was easy to get money from the bank to buy houses. It did not matter whether you had adequate means to pay back or not, the banks were just as happy to let you have their money. That led to increased demand in houses and prices went up.

A property market with high property prices boosted market confidence. So, more people bought houses. Banks began to fight for a bigger share in the housing loan market and granted even more absurd loans ie. barely secured with collateral.

Then, the banks dragged investors into the picture. They started selling investment products with promising payback. The bank had intended to keep their promise with money from loan repayment. So, investors around the world started to soak up this 'outwardly-good-looking' products. If you have bought some investment products in the past few years, chances are you might have indirectly put your money into this wealth spinning game.

The banks who came up with those investment products needed to keep their promises to payback. So they granted more sub-prime loans. They were not so worried because home prices were hitting north. They could easily recover the loan arrears by selling off houses at a profit.

The balance started to tip when home prices came down. Banks no longer can recover the loan. As a result, they were unable to pay the investors and the value of those investment products came down too. The investors started to stay away.

So the banks became desperate. They needed new funds but it was no longer easy to convince the investors to part with their money. At the same time, they grew scared of giving out loans to home owners for fear that they could not pay. That was the end of 'cheap and easy' housing loans. In the meantime, the banks were seeing their losses mounting.

The financial crisis erupted when the banks could no longer hold on due to astronomical amount of accumulated debts. These are some recent 'explosions' in the financial world:

ONE: Six months ago, Bear Stearns, one of the largest global investment banks was in big trouble. The US government came to bail them out to prevent a potential market crash. Bears Stearns was subsequently swallowed by JP Morgan Chase.

TWO: In early Sep, the US government again was caught in the same predicament when they had to bailout the Fannie and Freddie duo - the two mortgage finance giants who were blown up by the sub-prime crisis.

THREE: Last week, the world was shocked by the fallout of Lehman Brothers, a large global financial services firm. Poor Lehman did not get the much needed help from the US government. A large part of it was picked up by Britain's Barclays Bank at a scrapyard price.

FOUR: At the same time, the 'great American sale' took place when Merrill Lynch quickly found a shelter. It was sold to the Bank of America in just 48 hours!

FIVE: It was followed closely by the near collapse of AIG. If the world's largest insurers suffered an instant death, it would surely send a financial tsunami to the rest of the world. It was a close shave. AIG got the biggest bailout in history and a disaster was avoided. So it seems.

In Singapore, many panicked AIA policy holders queued up for hours outside the AIA office and demanded to cash out their policies. Although this represents a small fraction of AIA's local policyholder base, it is a first sign of panic in the recent years.

Has the storm subsided? Or are we experiencing the calm before a storm? The market holds very mixed views but one common question constantly pops up: "Who's next?"

When something goes wrong, fingers start to point and many are pointing theirs at the regulators and the financial institutions.

I agree. It takes two to tango. The regulators were not tightening rules to watch over the financial market and the financial institutions were shoddy in risk management. It's a case of lax parents with misbehaving children.

I don't have a good idea on the implications of the current financial saga. All I know is that, not one investment is entirely risk free. The next time someone sells you a low risk investment, just remember, it's 'low risk' and not 'no risk'.

To me, commonsense rules. If something sounds too good to be true, it probably is. Don't be greedy.

Perhaps, the regulators should take this expensive lesson and not to stick to old book rules. The series of heart-stopping fallouts goes to show that the regulators ought to act very swiftly. They also need to step up actions against institutions who fail their duties before any reversal is too late.

Right now, I would love to see some sensible sentiment and confidence management by the regulators. The investors may not have very strong hearts to go through more roller-coaster rides. For heaven's sake, do more to protect the investors.

I apologize if all that I have written sounds Greek to you for I am really writing in a 'language' unfamiliar to me. So, if you do not follow what I have been saying so far, I can fully understand your predicament.

Caution: Do not act based on the above.

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