T-Salon

The recent turmoil in the global equity markets has changed the financial market psychology and has created an investors dilemma. Financial decision making was never so complex and intriguing as it has been now, thanks due to the effect of US Sub prime mortgage market collapse. The sub prime factor are the loans given to less US credit worthy borrowers with poor credit ratings, that’s below 640. The recent global meltdown wiped out nearly $ 5.5 trillion of investors wealth, according to S&P. And it happened just in a matter of few months. The long bull market that one experienced during the last 6 months is gone, and has been equally replaced by high volatility and liquidity crisis. With wide-spread reporting of substantial losses by hedge funds who invested in securities backed by assets (MBS),only to see those defaulting. The investor mindset was hit hard with some bigger institutional investors who bought these MBS bonds and traded across the globe are now feeling the ripples due to market collapse. The impending credit crunch triggered by sub prime collapse have resulted in a lot of delusions, market chaos and uncertainty about LBO and PE deals looming across the world. The investors risk appetites are low and they are liquidating their positions from the equity market across the world. Even the emerging markets were not spared. Right from Tokyo, Shanghai, Hang Seng, SGX, Taipei, BSE, Bovespa, and Russian markets, all have tasted the downturn, but the flavor was in-fact, more felt in US and Japan. This has prompted the major Central Banks across the world, along with the Fed, ECB and BoJ to pump emergency money of about $ 350 billion into the system to stabilize the market and prevent liquidity dry up. Equity and fund managers are trying their best to manage the ensuing volatility as it climbed to near 22%, an all time high in recent times. The life blood of financial system that is, ‘liquidity’ has become more expensive now, along with credit because banks are now more vigilant in fulfilling borrower’s appetite. And there is always the fear of global inflationary pressures and supply constraints. Banks and financial institutions are analyzing their systemic threats more closely than ever before and this is causing credit and debt market uncertainty. . The rate cut by Fed was welcomed as further rate cuts could be in the horizon.

Mortgage defaults by Americans are not new, in-fact we had such incidents recorded earlier, but not like the one we are having at present. Current global rout in debt markets could dampen expansion programs of corporate and some M&As are either stalled or written off. Emergency fund injection by central banks is in effort to reduce banks’ borrowing costs. Value at risk (VaR) and risks to bank have become the major concern for international banking communities as they are evaluating banks exposures to the US sub prime mortgage market collapse. We still do not know how much is such exposure, but some experts say that sub prime origination was at $ 400 billion during 2006,(S&P). There has been much dissatisfaction in the way the premier ratings agencies like S&P, Moody’s valued mortgage bonds that looked attractive to investors but are now dumped heavily. Re-pricing of sub prime portfolios show that nature of existing stock of ARM (Adjustable Rate Mortgage) and IO (Interest Only) are very high and could touch $600 billion in 2008. These have called for further stringent regulations of credit ratings agencies and track their income trends. Declining credit availability and tightening of lending standards by banks and NBFC are hitting hard some creditworthy corporate who are in real need of liquidity. Investors are at bay as economic costs of sub prime defaults are mounting. Home loan value score in US are now revamped and holds from 580 in the past to 620-680 now. We also observe some de-leveraging and capital flights in the LBO and the emerging markets.

Lessons have been learnt well and lending regulations in the subprime sectors have become tight, with increased minimum credit score, lower maximum loans, increased down payment and necessary paper works. Japanese markets also saw a lot of turmoil with unwinding of its ¥ (Yen) denominated carry trade by external borrowers who took advantage of very low interest rate prevailing in Japan. This caused ¥ to appreciate at its record high when it touched 113 to a dollar from 119. Most recently Japan recovered slightly from a prolonged stagflation, with GDP around 1.5% due to growths in its exports frontier. But the recent turmoil pulled down Nikkei heavily and investors incurred losses with resulting liquidity crisis which prompted BoJ to pump funds under MSS. The carry trade caused ¥ to appreciate substantially cutting down Japanese profit margins from exports. With markets nowhere near stable , investors and market watchers are expecting more news to come up, perhaps some good ones. A Fed rate cut brought some relief to them. With increase of credit spreads in overseas markets, leveraged transactions and Indian borrowings have become dearer. South East private equity (PE) deals are evaluating the risk/reward pricing for their investments. Some dramatic efforts are needed to stimulate further growth and sustain the Japanese economy that has been growing at a moderate rate. Bank of Japan (BoJ) is now in huge dilemma in keeping its view with economy whether to increase rates or keep it unchanged. Since it might prevent further carry trade and speculations about ¥ (Yen), it’s wise to increase rate, but this might create a further credit crisis due to increased borrowing costs. But Japan’s economy is growing so, a rate increase is desired. In the Indian purview, RBI has tightened ECB norms due to rising spreads. Overall, within these sub prime woes, global economy and particularly emerging markets presents an unprecedented GDP growth story and China with 11.9%and India, 8.5% are leading the yardsticks along with Brazil, Russia, Vietnam, the Mid-east and other emerging nations. Domestic consumer demand and demand for energy resources and high growth rate could mitigate the sub prime crisis to some extent, according to analysts. But there is much concern about the US economy, which is the powerhouse and still the biggest export partners (Importer of Capital goods) of all major economies where a recession, though not likely could spill a global downturn. Symptoms of good economy such as robust growth, low inflation, and high consumer demand, rising crude oil and home prices, efficient debt and credit markets are nowhere near equilibrium. With current volatility in the credit markets and ensuing credit crunch there has been a sustained appreciation of worry. The rescue mortgage operation with re-pricing and asset stripping contain the present situation. And there is much worry about sub prime factor moving to prime sectors could trigger corporate default rate due to high leveraging and slide in credit market. Widespread job cuts are in the horizon with the mortgage industry as well as in some banking and securities brokerage firms, i.e., Lehman Bros., cutting jobs of around 1,200 employees due to closing of its sub prime lending units. Perhaps its time now for the hedge fund managers and LBO firms out there need more sophisticated computer trading systems with advanced risk detecting interfaces that analyzes β risks. They need better quantitative models and high end market simulations to identify and mitigate risks. And perhaps we need more ‘humane’ touch to our models since behind every successful algorithm or model there is a human brain!