global agenda 88.
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It Keeps Getting Worse - and will continue to do so.
The subprime crisis has this week shaken all the markets, particularly in Europe, as participants face the unpleasant fact that the rot is spreading from mortgages to all forms of credit, and from the US to all the main financial centers.
The buy-out mania, one of the key factors propelling equity prices higher around the world, has hit a brick wall because the buy-out artists cannot sell vast quantities of bonds anymore as the desire to buy huge quantities of this overpriced paper has suddenly evaporated. Without the ability to borrow massive amounts of other people's money, the private equity funds that have dominated global finance these past few years lose their sheen and become just another bunch of hustlers.
How bad things will get is the question worth several hundred billion dollars.
Opinions vary across the spectrum from global meltdown to a brief correction, with every option having a rationale and some supporters. But while the future remains wide open to debate, a consensus has emerged about the present - no more "the worst is over" blather, but rather a reluctant acceptance that I.K.G.W.
The past, too, has become clearer: How did we get into this mess? The benign view quoted in last week's column is fading out of sight, as the weight of evidence against it becomes overwhelming.
This view holds that the explosion of mortgage lending to weak ("subprime") borrowers that lies at the root of the crisis was actually good and even noble, because it allowed more people to own their own homes - and that it was the borrowers' fault if they got into trouble. The same holds true, in this view, for the process of repackaging the mortgages into complex financial instruments that were then sold on by investment banks to mutual funds, insurance companies, pension funds and even central banks. All this was hailed as positive and desirable, because risk was being distributed more widely, liquidity was increased and investors were enabled to achieve higher yields, supposedly without assuming greater risk.
If things have now gone wrong, then the caveat emptor ("buyer beware") principle holds true: the borrowers should not have bought houses they couldn't afford and the investors should have better understood the instruments they were buying.
The sad truth, however, is that millions of Americans were duped into believing that they, too, could speculate on the sizzling real estate market, when in fact they did not have the financial resources - income and/or wealth - to justify assuming hefty debt burdens. Real estate brokers and mortgage bankers, driven by performance-linked salaries and bonuses, arranged for them to receive mortgages with temptingly low monthly payments for the first year or two, but which would jump up thereafter. Other bankers -Wall Street investment bankers, this time - sliced and diced these mortgages and sold them in absurdly complex structures, to fund managers desperate to achieve high returns in a low-yield interest-rate environment. Both the investment bankers and the fund managers received hefty bonuses for their efforts - which included inventing rationales justifying why investors in mutual funds and savers in pension funds should be saddled with junk debt that the investment bankers themselves referred to, in their macabre and cynical jargon, as "toxic waste."
The entire financial sector implicitly colluded in a wholesale erosion of lending standards, to the point that borrowers were not asked how much they earned, or their declaration of earnings was accepted without any supporting evidence. These mortgages were then chopped into tranches and sold as bonds - to which ratings agencies awarded high ratings on the basis of models using assumptions that had never been tested - because the instruments they related to were too new to have track records. And regulators, as so often is the case in these situations, were way behind the curve, issuing vaguely worded expressions of concern as the negative phenomena mushroomed and only waking up to the scale of the threat when it was too late. Now, of course, they are clanging shut the stable door - thereby threatening to create a credit crunch in which even solid borrowers will be hard-pressed to get loans.
In the context of the financial markets, we are now well into the I.K.G.W. stage, with fears of "contagion" driving markets down as irrationally as the greed to jump on the bandwagon of easy money drove them up. But the general public in the US has not yet grasped what was done to it. When that happens, there will be a great outcry and the focus will move from the financial to the political front - just in time for the election year of 2008.
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