What all of that means

Saw this article in the Business Times, dated 29 August, which gives a good explanation of what the whole humdrum about the subprime mess is all about and what's coming up in the coming weeks:

"When easy money dries up" by Carter Dougherty

Securitisation
- 1970s
- the packaging of mortagages and selling these as securities
- buyers earn a return on these as borrowers pay down their mortgages
- the beauty of the system was its ability to spread the risk of default across many shoulders, so that if the unfortunate happened, no one sustained a fatal hit
- allowed more people to get financing for homes and other activities, e.g. starting businesses, because banks were more willing to lend
- this easy $ fuelled spending and economic growth

So good was the system at spreading risks that mortgage lenders in the US provided home financing to people with bad credit histories, at higher interest rates.

These are the "sub-prime" borrowers and before the unfolding crisis, they provided income for the banks that underwrote the securitisation and ratings agencies that evaluated these innovative financial products.

Carter then warns of the impending lawsuits against these banks and ratings agencies.

Now these securities are marred by the prospect of defaults by borrowers who can no longer make payments since interest rates are higher now. Thus they sit in the bowels of the financial system like an undigested lunch.

Carter then goes on to explain that the most logical way out of this mess is for the lenders to remove the risky "bad sectors" of their lending portfolios as was practised by the Dutch bank NIBC which shaved off its sub-prime holdings at a discount.

"But you would be terribly wrong"

Instead he believes what the Federal Reserve will do, under tremendous pressure by consumers hungry for cheap money, traders and lenders who earn their daily bread by lending, borrowing and trading is to cut interest rates aggressively.

This would mean investors borrowing their way out of facing the hard truth. And to Carter and other economists with a conscience, it's bound to be a case of covering the hole with quick sand.