By John O’Donoghue, Consultant Adviser, Caratfin Ltd.
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As some may have noticed, the markets have been taking quite a beating recently! If ever I get round to writing my book, “O’Donoghue’s Little Book of what Financial Jargon Really Meansâ€, the entry for subprime lending would be: lending money to people who you know can’t and won’t pay you back, also; a dumb way to earn your bonus last year, because now you’re sacked!
A lot of major names in Wall Street are feeling the heat – in the last month Bear Stearns has seen it’s share price drop by 20%, Lehman Bros is -19%, Goldman Sachs is -17%, and a number of major Mortgage Lenders are in the process of going under. The subprime crisis is spreading to the prime lending market and leading to a panicky reassessment of credit risk; so far more than $60 billion destined for Merger & Acquisition deals has been withdrawn by Banks, who have seen investment institutions suddenly lose their previously healthy appetite for securitised debt instruments such as CDOs (collateralised debt obligations) and other complex derivatives. According to many commentators we stand (once again!) at the precipice. Or, as Gary Duncan, writing in The Times, puts it very nicely: “Turbulence teeters on the brink of turmoil.†A lovely little line of alliteration, that!
He starts his article, however, quoting the first line (and a bit) from Rudyard Kipling’s well known poem, ‘If’: “If you can keep your head when all about you are losing theirs…â€, and finishes with a less literary, but no less important, short mantra from two unlikely sources – the cover of ‘The Hitchhiker’s Guide to the Galaxy’, and Corporal Jones in ‘Dad’s Army’ – “DON’T PANIC!†In between these two gems he develops his point, which is that this tempestuous period is the result of the ballistic growth of the market in credit derivatives – a global market he values at $6 trillion at the end of 2004, and now at $30 trillion (yikes!) – and what he calls ‘market failure’ in their use by banks and other financial institutions (see definition above). As a result of ‘overambitious’ lending (see above) coupled with many successive interest rate hikes in major economies and falling confidence in the markets, plus the widespread (ab)use of ‘teaser rates’ (heavily discounted introductory 2-year interest rates on mortgages which are now maturing and being replaced by market rates following, um, 15 hikes in the last two years in the US?) the default rate is high and climbing probably much higher. I think I read recently that something like $2 billion worth of mortgages were under rate review in July in the States? An example quoted in the New York Times on Monday is of a rate changing from 6.3% per annum to 11.25%. Clearly a problem here, but Duncan views this situation as a ‘credit squeeze’ rather than a ‘credit crunch’, the difference being that in a crunch, for example, a corporate borrower with a sensible capital expenditure proposal and good credit history could not get a loan, whereas in a ‘squeeze’ he could, but it is likely that private equity seeking highly leveraged positions, speculators and hedge funds would have no luck. In other words, sound financial management could well be making a reappearance.
I have to say, hand on heart, that I found Gary Duncan’s article a pleasant change from the relentless ‘head for the hills’, financial Armageddon type comments I seem to have been reading for months, even while the medium risk diversified portfolio has put on – despite the problems – nearly 8% this year. That’s down 3.5% from its
I am wearily aware, though, after two years of doing it, that writing about a low risk portfolio is actually pretty boring both for me and for you wonderful readers. But then again, that’s what the portfolio’s supposed to be: no excitement, thank you very much, just produce a nice level of growth to fund an income, and we’ll be very pleased. So-o, in celebration of the imminent introduction of the Euro, I propose to – partially – drop the low–risk portfolio, and replace it with a higher risk € portfolio starting with €100,000 and targeting 20% p.a. I’ll still report on the performance of the low – risk portfolio occasionally, but starting a € portfolio in a challenging market should be interesting! Have a wonderful holiday!
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