Alan Greenspan - Fed didn't do it!

The Fed Didn't Cause the Housing Bubble

We are in the midst of a global crisis that will unquestionably rank as the most virulent since the 1930s. It will eventually subside and pass into history. But how the interacting and reinforcing causes and effects of this severe contraction are interpreted will shape the reconfiguration of our currently disabled global financial system.

There are at least two broad and competing explanations of the origins of this crisis. The first is that the "easy money" policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.

More at WSJ

Subprime Crisis

Subprime Crisis

Indian banks post Rs 410 cr MTM losses

The Indian banking sector saw a mark-to-market losses of around Rs 410 crore due to their investment in instruments of troubled US financial giants like Lehman Brothers and AIG, 75 per cent of which is accounted by ICICI Bank alone.

"In terms of MTM losses of the banking sector including private sector, stood at Rs 410 crore owing to financial crisis in some of financial institutions. Of this, ICICI Bank alone has MTM loss of about Rs 309 crore," a senior Finance Ministry official said in New Delhi.

MTM is based on the market value of underlying securities and keep varying. MTM is a notional loss but it would be reflected in the balance sheet.

Besides, some state-owned banks had exposure in the instruments of these troubled US financial institutions to the tune of Rs 234 crore.

"Exposure of a few public sector banks to credit-linked and floating rate notes of Lehman Brothers and other troubled institutions is about USD 52 million," he said.

In his first reaction after the collapse of Lehman Brothers and the bailout of the largest US insurer AIG, Finance Minister P Chidambaram had said India's financial institutions were on a sound foundation.

As far as PSU banks are concerned, in which the government is a majority owner, he had said they didn't have any ‘undue exposure’.

"In fact, many of them have no exposure at all. Whatever exposures they have are in accordance with RBI's prudential guidelines," he said, adding, ICICI Bank had some exposure which it has disclosed.

The London subsidiary of ICICI Bank had USD 80-million exposure in the senior bonds of Lehman Brothers.

ICICI Bank Joint Managing Director Chanda Kochhar had said the investment by the subsidiary constitutes less than one per cent of the total assets of the subsidiary and less than 0.1 per cent of the consolidated total assets of the ICICI Group.

On June 30, 2008, ICICI Bank and its subsidiaries had consolidated total assets of Rs 484,643 crore.

The Finance Minister had said while the country's banking system was reasonably insulated from the global crisis, the credit crunch could have some effect in India as well.

"If there is a credit crunch in the rest of the world, it will, to some extent, impact the credit availability in Indian market. RBI, day before yesterday, took steps to provide liquidity to the banks," he had said.

Why global markets are fluctuating

Ok, first let's talk about what really went wrong in an easy to understand layman's language

Financial Markets is all about confidence in the System and an underlying assumption that system will not fail. But, after the bankruptcy of Lehman Brothers in USA and Northern Rock in UK and the bailout of Fannie, Freddie and AIG investors world over have lost confidence and faith in the system. Infact some people have even started doubting if any system exists at all.

Their doubts are not unfounded as the tricky web of Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDO), which are traded privately and no one, yes no one including SEC, FED or US Treasury regulate them.

And this is where the problem lies. It is an unregulated trillion dollar market which has no system in place to track follow and regulate the flow of deals and transactions. It all started with the boom in USA real estate market a decade back. The cheap credit fueled the real estate rally for almost a decade. The innovative Investment Bankers at Wall Street wanted a pie of the action and devised some new innovative instruments like mortgage backed securities and insured them with Credit Default Swaps.

Tremors continue to rattle Wall Street

After last week's startling events on Wall Street that sent shockwaves across the global markets, many would have thought the problems facing the US financial sector were over. However, that was not to be, as more tremors struck the world's premier financial market this week that added to the global gloom. What's worse, at the end of another tough week, there was no clarity on whether the US government will be able to arrest the slide. An unprecedented bailout package proposed by White House to pull the rotten financial sector out of the abyss was stuck in the crosshair of political gamesmanship. The failure of the Bush regime to convince the lawmakers on both sides about the massive rescue plan sent global markets into a tailspin on the last day of the week. The fire sale of Washington Mutual to JP Morgan also had an adverse effect on market sentiment. Shares of North Carolina's Wachovia Corp. nearly 30% in early trading on Friday following the failure of Washington Mutual.

The Federal Reserve gave America’s last two big investment banks, Goldman Sachs and Morgan Stanley, permission to change their status to bank holding firms. They will be subject to stiffer regulation, but allowed to take deposits. Goldman Sachs raised US $5bn to shore up its capital by selling shares to Berkshire Hathaway, the firm run by Warren Buffett, a celebrated investor. The next day, it raised US $5bn more from a share offering. Mitsubishi-UFJ, Japan’s largest bank, agreed to buy up to 20% of Morgan Stanley for US $8.4bn. The Federal Bureau of Investigation said it was looking into 26 cases of potential fraud related to the collapse of America’s mortgage industry. The financial institutions under investigation are said to include the now-defunct Lehman Brothers, as well as AIG, Fannie Mae and Freddie Mac. In a bid to attract more investment to America’s struggling financial sector, the Fed relaxed rules on bank ownership. Private-equity firms will now be allowed to own bigger stakes.

How the Subprime crisis began

If you lost your money in the market crash of January 2008, here's the route to your loss, in chronological order.

2001-2005: House prices in the US begin to rise rapidly. Banks lend aggressively and create a subprime industry.

Sub-prime lending refers to lending (at slightly higher interest rates) to people who may not be eligible for a loan under normal circumstances. Maybe they don't have a regular job or income, or have defaulted in the past.

Banks traditionally did not lend to such people due to high risk of default. But since these loans were mortgaged against property and property prices were rising continuously, banks started doing so. If customers defaulted, they good sell the mortgaged property.

2005: The booming housing market halted abruptly in many parts of the US.

2006: Prices are flat, home sales fall.

February 2007: Sub-prime industry collapses in the US; more than 25 sub-prime lenders declare bankruptcy, announce significant losses, or put themselves up for sale.

While they were lending, banks did not factor in the possibility of a fall in property prices. When the Federal Bank (the US equivalent of RBI) started increasing interest rates, the sub-prime borrowers started defaulting and banks started selling off the mortgaged properties. As more and more properties came into the market for selling, the property prices fell.

August 2007: Many leading mortgage lenders in the US filed for bankruptcy

March 2008: Bear Sterns falls.

September 2008: Lehman Brothers file for bankruptcy. Merrill Lynch sells off to Bank of America.

Between 2001 and 2006, the US financial markets had developed a new product - a bond securitised against the mortgages.

In simple terms it means that the mortgage banks borrowed money against the mortgages on the condition that they would repay to lenders as soon as they recovered their mortgages. The lenders in this case were financial institutions (like Bear Sterns, Lehman and Merrill Lynch) who in turn sold retail bonds to individuals.

Sadly, the repayment never happened. And institutions like Bear Sterns, Lehman, Merrill Lynch and AIG were the casualties. Since the mortgages were not honoured, the banks could not repay these financial institutions who in turn could not repay retail investors.

Once in a Century Crisis - Greenspan

The US is in a "once-in-a-century" financial crisis and chances of it escaping a recession next year is less than 50 percent, former Chairman of Federal Reserve Alan Greenspan said on Sunday.

Greenspan, whose voice and views carry tremendous weight still on Wall Street, argued that it is not in the best interests of either financial industry or that of the economy to have the government getting involved in the short-selling in the financial institutions until the situation stabilised.

"If you had pressed me the last time I was here, I would say very unlikely," Greenspan told ABC News when asked on the prospect of the United States escaping recession next year.

"The remarkable thing is now the non-financial part of the economy is done...we've gone through a period of long-term interest rates being very low, and that enabled corporate sector and business generally to take its short-term liabilities and fund them into longer-term liabilities at low interest rates," he said.

Asked if the chances of escaping a recession now is greater than 50 percent, Greenspan said, "No, I think it's less than 50 percent. I can't believe we could have a once-in-a-century type of financial crisis without a significant impact on the real economy globally, and I think that indeed is what is in the process of occurring."

Greenspan was asked that against a backdrop of failure of the mortgage giants, in the folding of Bear Stearns and now with the crisis at Lehman Brothers, whether America is going to witness to more financial institutions failing.

"I suspect we will. But in and of it that does not need to be a problem. It depends on how it is handled and how the liquidations take place. And indeed we shouldn't try to protect every single institution," he said.

Washington Mutual troubles mount

Washington Mutual shares tumbled after the largest US savings and loan company projected another big write-down for soured loans and was downgraded to "junk" status by leading credit rating agency Moody's. At least four analysts cut their price targets for the thrift, though Goldman Sachs raised its rating to "neutral" from "sell." Washington Mutual released third-quarter projections six weeks early and said it had ample liquidity. The thrift has said losses from home loans could reach US $19bn through 2011. But Moody's lowered Washington Mutual to below investment-grade status, citing reduced financial flexibility, deteriorating asset quality, and expected franchise erosion. Fitch also downgraded the thrift. Washington Mutual ousted CEO Kerry Killinger, who failed to halt losses on home loans that already total US$6.3bn. New CEO Alan Fishman may have to shed 2,300 branches that hold US$143bn in deposits.

Warren Buffet - blame the banks!

Blame for the sub-prime crisis lies at the feet of banks who took too many risks in mortgage lending, US billionaire investor Warren Buffett told newspaper El Pais in an interview published on Sunday.

"The banks exposed themselves too much, they took on too much risk.... It's their fault. There's no need to blame anyone else," he said.

Buffett, dubbed the world's richest person by Forbes magazine, said he believed the situation in financial markets would not deteriorate further.

"I don't think the situation will get worse in financial markets. General conditions in the business world will get worse, but it will only last a while," he said, adding he had no idea when an upturn would come.

Buffett gave the interview on a recent visit to Madrid, as part of a European tour including Switzerland, Germany, Italy and Spain on the look out for new investments.

He said the idea of the trip was to increase awareness amongst European businesses of his holding company Berkshire Hathaway Inc, which holds stakes in businesses ranging from American Express Co to Coca-Cola Co.

He said he wanted business owners to think of him when they were looking to sell.

"We want to buy big companies that earn at least 50 million euros (USD 78.6 million) before taxes, and there's more of those in Europe than in other parts of the world," he said.

He would not be drawn on what companies in particular he was looking at, other than saying he was not interested in distressed businesses.

Subprime Losses - Figures

Subprime losses till date
Bank	Losses
Citigroup	$18.0 billion
UBS	$13.5 billion
Morgan Stanley	$9.4 billion
Merrill Lynch	$8.0 billion
HSBC	$3.4 billion
Bear Stearns	$3.2 billion
Deutsche Bank	$3.2 billion
Bank of America	$3.0 billion
Barclays	$2.6 billion
Royal Bank of Scotland	$2.6 billion
IKB	$2.6 billion
Societe Generale	$2.0 billion
Freddie Mac	$2.0 billion
Wachovia	$1.1 billion
Credit Suisse	$1.0 billion

Via Rediff

Citi - help comes via Abu Dhabi Fund

The Abu Dhabi Investment Authority will invest $7.5 billion in Citigroup, offering the nation's largest bank needed capital to offset big losses from mortgages and other investments.

The cash from the sovereign investment fund of the Gulf Arab state, which has benefited from this year's surge in oil prices, will be convertible into no more than 4.9 percent of Citigroup Inc.'s equity. Citigroup characterized the investment as passive and said the fund will not be able to name any board members to the bank.

The Investment Authority will receive equity units that pay an 11 percent annual yield -- a high price for Citigroup, whose dividend yield is 7.3 percent. They will then be converted into Citigroup common shares at a price of up to $37.24 a share between March 15, 2010, and Sept. 15, 2011.

The purchase, announced late Monday, would make the Investment Authority one of Citi's largest shareholders.

"We see in Citi a highly respected company with a premier brand and with tremendous opportunities for growth," said the Investment Authority's managing director, Sheikh Ahmed Bin Zayed Al Nahayan. "This investment reflects our confidence in Citi's potential to build shareholder value."

The investment, which was expected to close within the next several days, will be considered Tier 1 capital for regulatory purposes. That will help Citi reach its goal of returning to its target capital ratios -- essentially, its ratio of cash to debt -- in the first half of 2008, the bank said.

Go long to cut subprime losses

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Though the market has recouped much of the losses suffered in the wake of the turbulence in global markets last month, there are a handful sectors which have lagged the recovery process.

Investors in high-retail exposure sectors like IT, construction, automobiles and banks will have to stay invested long-term, if they want to exit without logging losses.

ET conducted a sample study on various sectors over the past three months to analyse the impact of subprime crisis on Indian stock markets. As predicted by market mandarins, the crisis has not impacted the market in toto; only stocks in sectors that previously attracted huge foreign institutional investors (FII) interest have been hit , owing to pull-outs and redemption by foreign investors.

“Subprime fears have been factored in by Indian investors. There is nothing that can link India to the US subprime zone. The market witnessed some downtrend during the subprime days; but that was just because of prevailing negative sentiments in global markets. Now is the time to buy good stocks. They should, however, be cautious in their approach,” Indiabulls Securities CEO Divyesh Shah said.

According to market watchers, sugar is one sector that has not been hit by the subprime at all. As a matter of fact, the sector has not been doing well over the past six months. Sugar stocks are taking a beating on fears that the sugar market is in for a surplus for next two seasons.

Secondly, sugar being a commodity is expected to have peaked in its upward trajectory in 2007. Locked-up investors should exit sugar stocks on the upside. If they are entering sugar stocks now, they should be ready to hold them for at least 3-4 years.

The only positive trigger that can propel the sector is a surge in crude prices to around $85 per barrel. This will ease global sugar prices and increase demand as most big producers would then get back to ethanol production, sugar analysts said.

Construction & realty sector has fallen nearly 7% over the past 33 trading sessions. Construction, analysts said, was one sector that was badly pounded as a result of the subprime worries.

Though indirect ripples could not be ruled out, subprime should not affect Indian real estate sector as much as it impacts European countries and the US. There may be some blips or dips in real estate sector as it is closely related to mortgage loans; infrastructure sector looks perfectly fine.

As far as India is concerned, the construction sector would continue to do well in the long term. The sector should do well once inflows start strengthening, experts said. “To be on the safer side, investors can overlook real estate stocks for some time; infrastructure companies look good even in these market conditions,” said a fund manager of a domestic mutual fund house.

IT shares are still not very encouraging as the sector continues to be linked to the irregular currency movements. Though, most analysts believe, IT companies would come out with decent earnings figures in the third quarter, there is still an air of apprehension among investors.

Broking houses are advising investors to value-buy frontline IT stocks. Sectors like hospitality, logistics, banks and automobile, too have not really managed to participate in the post-sub prime rally. All these sectors are down in the range of 3% to 6% since July 24.

Subprime Crisis - threat is real

By: Debarttasharan Dey

The recent subprime crisis in the US, which has affected banks and markets across the world, has again highlighted the relationship between real estate and bank credit and the ramifications it has for the economy. An analysis of some of the real estate booms and busts of the past century exposes a strong correlation between banking activity and the real estate. The two are remarkably correlated in a number of instances, ranging from developed countries to emerging economies. The speculative real estate booms followed by sudden bursts were due to banks lending on liberal terms and underestimation of the risk profile of borrowers.

1920s’ Florida land bust

The 1920s was one of the most prolific economic periods of American prosperity. The chain store movement revolutionised retailing and consumer products became affordable for the masses. Cars became the symbol of a new consumer culture. Easy availability of credit for automobiles spurred sales by 300% in a decade. Banks started to offer mortgage loans and their easy availability — often on liberal terms — resulted in frenzied real estate activity in Florida, pushing up property prices to unprecedented levels. It all came crashing down on September 18, 1926 when a powerful hurricane slammed Florida. It devastated the state with high winds and surging floodwaters. The huge task of rebuilding and the financial losses inflicted by the hurricane caused thousands of residents to abandon their new homes and return to northern cities. Thus, the Florida land boom cooled. Florida entered The Great Depression in 1926, three years earlier than the rest of America with the Florida land bust and did not recover until 1941.

1980s and the S&L debacle

In the late 70s, when the US witnessed double-digit inflation rates, real estate was viewed as a hedge against inflation. It was also around this time that the savings and loan (S&L) industry was deregulated and it began lending to commercial real estate, an area where the industry did not have sufficient experience. The industry lent to many third and fourth tier developers who built poorly-conceived projects. According to an IMF study, The federal income tax code was also revised in 1981, which strongly favoured real estate investment from a tax shelter perspective. Soon after Paul Volcker took over as Federal Reserve chairman in 1979, he went for monetary tightening to control inflation, which pushed up interest rates. The Federal income tax code was again changed in 1986, severely limiting the tax shelter aspect of real estate. Many developers and investors could not repay their loans to the S&L industry. A combination of rising interest rates, deregulation, real estate volatility, lack of regulatory oversight, mismanagement and overt fraud cases led to the crisis. The result of the 1980s building boom and the subsequent bust was the S&L crisis, which finally led to a bailout by the federal government in 1989.

Japanese bubble burst

Japan faced its worst banking and real estate crisis in the early nineties. Six trillion yen worth of loans by housing lenders who had borrowed heavily from banks and agricultural co-operatives turned bad.

Seven of the eight mortgage companies slipped into insolvency. In the 1980s, when Japanese economy soared due to its export incomes, the country deregulated its financial system. Faced with new competition, lenders turned to real estate developers, who were willing to pay higher rates than individuals. The market crashed in 1990 after the government put curbs on loans to developers. After peaking in December 1989, the Japanese stock market plunged over the next nine months to nearly half its value. As Japan entered its worst recession in decades, commercial real estate lost nearly half its value. Japan slipped into a decade-long recession.

Realty and the Asian crisis

More recently, in 1997, real estate speculation compounded the Asian currency crisis. Experience shows that financial liberalisation, though potentially beneficial, can be risky if undertaken in a fragile financial environment. For instance, a developer who borrows to invest in real estate and pledges land for collateral would put the lender at double the risk if property prices witness a sudden collapse. An undeveloped Asian market made it easy to conceal unreasonably high property valuations and borrowers gained greater leverage by mortgaging properties at inflated assessed values.

The proceeds of these transactions were invested heavily in new businesses as well as expansions in the existing lines of business. By the mid 1990s, the size of the real estate sector was huge, relative to the size of these emerging economies. It was estimated that in 1997, the value of real estate in the Bangkok metropolitan region was almost half as large as the GNP of the entire economy of Thailand. Lending institutions operated under implicit guarantees, which created a moral hazard. Poor management within financial institutions too was a major source of fragility. Thus, the absence of effective market discipline and inadequate prudential regulations led to poor quality of bank’s asset portfolios.

US subprime crisis

The initial trigger for the US sub-prime crisis was increasing delinquencies in the US mortgage market. The crisis was boosted by highly leveraged lending against rapidly rising house prices. As house prices slumped in 2006, delinquencies and defaults on subprime mortgages soared, despite a benign economic backdrop. When housing prices rose, borrowers with poor credit history had the option to sell their property and square off their loans.

But when prices slumped and interest rate rose, many borrowers defaulted. This had a cascading effect on banks and hedge funds, which had mortgage-backed securities and collateralised debt obligations. Hedge funds specialising in subprime mortgage-backed securities took huge losses.

Although real estate comes across as a solid security, experience shows that real estate prices are prone to cyclic phenomena. Moreover, in countries where lending has been liberalised recently, lenders do not have the ability to assess the risk profiles of borrowers. This makes the financial system very fragile, as lending is not made on the basis of risk.

Via Economic Times

Subprime crash costs Infy a client

Yet another casualty of the US subprime crash in the Indian BPO sector is the Bangalore-based Infosys BPO, which has lost a prime client, Green-Point Mortgage. GreenPoint Mortgage, a mortgage arm of Capital One (a financial services company) declared its bankruptcy on August 20 in the US. This will eliminate about 1,900 jobs across the US alone.

In India, over 100 people were working at Infosys BPO on this process. Infosys BPO, however, says that the impact on it will be minimal as it plans to redeploy people working on the processes of the lost client.

In a statement, Infosys BPO’s CEO and MD Amitabh Chaudhry said: “Infosys BPO has exposure in larger mortgage firms that have the capacity to tide over the subprime crisis and we have been working proactively with them to address the issue. As such we expect minimal impact on account of the same.”

This is second such incidence in the Indian BPO sector in the wake of the subprime mortgage market crash in the US. Earlier this month, the US-based First Magnus pulled out of WNS just hours after its gave its earnings guidance. The company revised its guidance after its client declared bankruptcy. “We were informed on August 17 by First Magnus Financial Corporation that they will stop all work with us in light of the economic trends in the credit market.

The loss of the First Magnus Financial Corporation and other mortgage businesses is expected to result in our revenue being lower by $20m per annum and the net income before tax being lower by approximately $4m per annum,” said WNS CEO Neeraj Bhargava.

GreenPoint Mortgage was a client of both Infosys BPO and i-Gate Global Solutions . Both companies expect the impact due to the loss of GreenPoint Mortgage to be minimal. According to sources, GreenPoint had also opened a captive unit in Bangalore to do backoffice tasks.

Infosys BPO, previously called Progeon, had signed a $30million deal with GreenPoint Mortgage in 2002. The company used to provide customer services, investor and financial reporting from its India centre. Capital One had bought Green-Point last year for close to $13.2 billion.

Experts say that the US subprime crash will have a short-term impact on Indian BPOs as many mortgage processes will be wiped out. In the last few days, many USbased mortgage companies have reported financial loss due to the meltdown.

Some of them are Thornburg Mortgage Inc, Luminent Mortgage Capital, Countrywide Financial Corp, Headlands Mortgage. “In the long-term , as the industry recovers from the meltdown, more and more mortgage jobs are expected to be outsourced to India,” said BFSI vertical at WNS’ CEO Arjun Singh.

Subprime problems spread

The subprime mortgage crisis is spreading to a somewhat unexpected place: homes costing more than $500,000.

As lending has rapidly gotten more restrictive for borrowers taking out large loans, sales of expensive homes have fallen sharply around the country during what should be one of the busiest seasons for buyers and sellers, mortgage bankers and real estate agents say.

To some degree the change is due to difficulty getting financing, as borrowers are finding fewer lenders willing or able to fund "jumbo" mortgages, loans for amounts greater than $417,000. Such loans are too big to be guaranteed by government-sponsored housing finance agencies Fannie Mae, Freddie Mac or Ginnie Mae.

Given the troubles in the subprime sector, investor appetite for all types of mortgage loans not guaranteed by housing finance agencies has nose-dived.

Banks until recently were able to offload the risk of many jumbo mortgages by selling the loans to investors. But now, as investors burned by the subprime debacle have become extremely picky about what they will buy, banks are having to keep more of these loans on their own books and as a result are charging higher rates.

Some lenders -- such as Countrywide Financial Corp. -- have made a point of saying they're now most focused on making loans that can be guaranteed by Fannie and Freddie.

Other lenders have simply tightened up their lending standards, for example by no longer making jumbo loans to lenders who can't fully document their income, even if they make large down payments and have stellar credit histories.

The banks that are still making jumbo loans are charging substantially higher rates to compensate for the lack of investor demand. Borrowers who could have gotten rates as low as 6.5 percent in June are now having to pay as much as 9 percent.

But aside from the financial impact of higher rates, in certain high-priced real estate markets, the effect of the suddenly tighter lending environment is more psychological, mortgage bankers and real estate agents say, as buyers and sellers alike don't want to plunge into an uncertain future.

"Showings are down, contracts written are down, and sellers are just as backed away as buyers are," said Lou Barnes, a partner in mortgage bank and brokerage Boulder West Financial Services in Boulder, Colo. The company arranges for financing on many higher-priced condominiums and houses in the state.

"I think the psychological damage is worse than the financial damage" which is already bad enough, he said. Even for buyers who have plenty of cash or can easily afford higher mortgage rates, the sudden change in the financing environment reduces "the ardor to buy a house unless you have to," he adds.

With numerous buyers and sellers sidelined, the higher cost of big mortgages is bound to put downward pressure on home prices should the lending environment stay tight for a long period of time, said Ellen Bitton, president of Park Avenue Mortgage, a mortgage bank and brokerage that does business in several states, including New York, Florida and Utah.

In New York, the most pronounced effect so far has been at the very top end of the market, for properties priced $25 million and above, said Dolly Lenz, vice chairman with Prudential Douglas Elliman.

"Every single person I have at the highest end is on hold. They're going to wait and see what happens," she said. "It has nothing to do with them being able to afford" properties or not, Lenz added. "It's a confidence thing. They somehow feel poorer, whether they are or not."

In California, where the median home price is well above $500,000, jumbo mortgages are as much as 44 percent of all mortgages issued in certain metro areas, according to data from First American LoanPerformance.

In and around San Francisco, where the median home price is about $1.1 million, the tougher financing environment has created a "hesitancy" and has led to some canceled escrows for buyers around the $1 million range, said Rick Turley, president of the San Francisco and Peninsula Region for Coldwell Banker Residential Brokerage

Via AP

US sub-prime crisis & Indian economy

Both global and domestic markets got a churn, by the US sub-prime mortgage defaults. Though the markets are recovering, helped by the interventions of central banks of major economies in the system, to ease the liquidity and credit crunch, experts are still taking a cue of the long term effects of the financial crisis.

The crisis having its origin in the US posed higher risk for itself. The problem started to take off in the early years of this decade, when housing prices began spiraling upwards in the US, residing on lower borrowing and lending rates. The latter, thus, boosted the demand for, and supply of new and existing houses. Tempting to capitalized the opportunity, many institutions offered home loans to borrowers with very poor or no credit histories, by charging higher than normal repayment levels. For the purpose, `sub-prime mortgages` were created - to attract investment banks and hedge fund owners, to bet big on this emerging aspect of the US economy. Seven times hikes in interest rates by the US Federal Reserves, since June 2004, however started to spoil the party and housing prices plummeted on rising borrowing cost. Consequently, sub-prime mortgage holders defaulted and headed to bankruptcy in March 2007.

Though the stock markets all over the globe, are now digesting the losses, the very first impact will be observed on the US economy. The resultant housing slowdown may hurt consumer spending, leading to an economic contraction. The economy, consequently, will grow at even slower pace than estimated before the mounting of losses. (Experts are mulling over the possibility of a recession)

The subsequent question can be raised, whether the global economy will really continue to grow at nearly 5%, amid the US slowdown. The managing director of the International Monetary Fund, Rodrigo Rato has said that, financial markets turbulence probably will curb global economic growth slightly this year. According to him, a downward correction is possible but will not be in a dramatic manner. He also accentuated in his recent interview that, the measures taken by the central banks of various countries to resolve the credit problems in the markets are `adequate and efficient`. Even so, it is noteworthy that the managing director altered that, in spite of the calmer mood in markets in recent days, it is still too early to draw definitive conclusions on the dimensions and effects of the crisis.

Indian economy, amidst the global slowdown however, is likely to remain intact from the spread of crisis, as the growth of the economy is rooted in its own ground. The attractive 8% plus growth is mainly driven by Indians, unlike other export-driven economies, which depend on US consumption.

Interest rates, more sensitive to any financial shocks are likely to come down in US with a faster pace than budgeted earlier. The emerging markets like India would be amongst the beneficiaries, as lower rates in major economies would make Indian assets more attractive. On the same ground, US dollar would be a big looser (Read: US dollar would depreciate against other currencies). A slowdown in US economy, weak liquidity and credibility might force investors worldwide to reduce their exposures in the world`s biggest economy.

The Indian economy, thus looks more safe as of now.

Subprime woes erupt in US, but India, Japan hit most

Though the US market is in the epicentre of sub prime crisis, Japan and India have been the worst affected.

A dipstick study into the movements of select Asian and European markets infers that Japan’s Nikkei and India’s Sensex have shed 12.4% and 10.13% respectively over the past one month; the American Dow Jones Industrial Average Index has only fallen 5.49% over the past one month.

Concerns over a crisis in the US sub prime lending market - where loans are offered to borrowers who do not qualify for market interest rates because of poor credit history - had sent global markets into a tailspin since the mid-week of July.

The current sub prime meltdown in the US is consequential to scores of sub-prime housing loan defaults that began in late 2006 and has continued into 2007. The sharp rise in sub prime credit defaults has caused several major sub-prime mortgage lenders to shut down or file for bankruptcy, leading to a general market downtrend and negative sentiment.

Though most equity analysts maintain that there would be `negligible indirect effect’ of sub prime credit defaults on emerging and distant markets in Asia and Latin America, the cumulative impact has been drastic. For instance, since July 25, FIIs have sold around Rs 9741.40 crore in cash market and about Rs 3132.06 crore in the derivatives segment.

In terms of FII retreat, India, Taiwan, Korea and Thailand have been the worst affected markets in the world. China, even though with huge exposure to the US market, managed to log positive gains at 22% over the past one month.

Lalit Thakkar, director - research, Angel Broking opines that the sub prime fallout is a bigger burden for the US economy but the irony is that emerging markets have corrected more than American markets. “India receives sizeable FII inflows; within FIIs, we also get money from hedge funds.

While it has always been difficult to quantify how much influence hedge funds have on stock markets, the fact remains that time again, hedge funds owing to their over-leveraged positions have lead to liquidity issues,” he adds.

According to analysts, the trouble starts when large-sized funds (with exposure to highly leveraged sub prime markets) start liquidating their holdings in emerging markets to make good their losses in a sinking sub prime market.

In the case of Chinese market, FIIs are not allowed to pull out money at their whims and fancies; there is a lock-in period for staying invested in that market. Japan has fallen more on accounts of yen instabilities while Dow and FTSE have fallen marginally because of timely central bank intervention, say analysts.

“Whenever hedge funds start making losses, they temporarily exit from profit-making destinations. This time round, it was more of an uninformed fear-led sell off from foreign institutions. One cannot blame them (hedge funds) as the risk premium on equity investments has been rising and there could have been tremendous pressures from investors to pull out of emerging markets,” said Amitabh Chakraborty, president - equities, Religare Securities.

“Sub prime fears have clearly been factored in by Indian markets; In fact, politics has overtaken sub prime fears in Indian markets. If what we know is right, most FIIs would adopt a wait and watch approach till the government reaches a firm decision on the nuclear deal,” said a senior official of an Honk Kong-based investment company.

Invest wisely in the subprime chaos

While the world equity market was reeling under the subprime chaos, there was a small news item, which probably slipped attention of many. Investment guru Warren Buffett was quoted as saying “worsening credit and housing markets may provide some real investment opportunities.” Generally speaking, when there's a certain amount of chaos in certain sections, it is unpredictable where the fallout will be, but the fallout offers some real opportunity. It may surprise many but investing in the end seems all about conviction and lateral thinking.

Mr Buffett with his successful investment track record has created a cult of investment followers. In fact, some days back S&P's came with finding that Infosys , Wipro and Satyam would have fulfiled his investment criteria. His investing picking style is unique, in that he uses a blend of value and growth investment philosophies. He once said “ I am half Benjamin Graham and half Philip Fischer” . While the former is a thorough value based stock picker, the latter has dabbled with growth strategies . Worldwide equity investors seem to be divided into these two distinct styles of stock picking - Value and Growth. Both are quite popular stockpicking strategies so let's first understand who's who.

Value Investing - 'Offer till stocks last'

Don't we rush to pick things on sale thinking that its real worth is more than the offer price. This is what value investing simplistically put means. Investors that follow this style specifically target companies with strong fundamentals in terms of earnings, dividends, cash flow, etc but are trading below their actual worth (technically it's called intrinsic value). Investors believe that a value stock is created due to over reaction to particular news affecting the industry only in the short term. Benjamin Graham pioneered this method of investment. His investing style was invented from his bad experience in the 1929 stock market crash in US and therefore one could see that his investment principles are more defensive in nature.

He insists on 'margin of safety' , which is nothing but the discount to the intrinsic value that the stock price is currently quoting at. Wider the discount , more is the margin of safety. The parameters he uses to pick stocks are low price-to-earnings ratio, price-to-book ratio or price-to-sales ratio. Some of these stocks may no longer be the flavour of current investors but again, the fundamentals make a strong case that the stock will bounce back and 'show its true colour' . Value stocks are not sector-specific as an attractive bargain can almost be found anywhere, but the probability of locating them today is more in energy, financial service or healthcare sectors.

A word of caution here - a value stock available at a bargain does not mean that any stock that has taken a plunge will qualify as a candidate in this category. A company that has hit 12-month low may not necessarily be a value stock. A stock's sudden fall may be the market's reaction to some fundamental problem of the company and thus refuting the basic criteria for categorising a stock as a value stock.

Before qualifying a stock as value pick one must ensure that the debt of company does not exceed its equity and it has shown a healthy earnings growth over the past few years. One might also get into 'value trap' in which the low stock price never recovers in one's holding period and hence may not get expected returns.

Growth Investing - 'Mining Diamonds'

Unlike a value investor, a growth investor is concerned with the future potential of a company, and less interested in its current trading price - quite like mining diamonds knowing that it will give good returns once it is 'cut and polished' . Growth investing is based on figuring out companies that have the competitive edge to become the next Reliance, Infosys, ITC or Hero Honda. A typical growth company has expanding business model and reinvests its profit for extending operations.

They are represented by high price-to-earnings ratio and price-to-book ratio. As a thumb rule, they generally show considerably high return on net worth/ equity (RONW or ROE). This indicates that its shareholders are current enjoying its growth story in the form of higher ROE. A company that has shown robust growth in profits and is expected to do even better in future is a good candidate for classification as growth stock. Investors are ready to pay a premium for such stocks factoring in the future growth potential which leads to its high P/E ratio. They believe that increasing top line and bottom lines will automatically translate into higher stock price and hence will take care of the return. At current juncture, companies in the infrastructure and IT sector would be good examples of growth stocks.
The risk involved here is actual growth falling short of expectations, for which you have already paid a premium. This may be due to poor revenues and earnings and may lead to a slump in the stock price.

To pick or to mix

Now this is an on going debate. It is difficult to predict which strategy will outperform the other. If there are cases showing that value investors have outperformed growth over a period of time, the support on the growth investor side may be no less.

In fact, both these stock-picking strategies compliment each other well. So, instead of sticking to one strategy , an investor may strive for decent returns with low risk by combining growth and value investing - quite like diversifying one's portfolio across sectors to minimise risk and add up returns.

Common parameters used by fund managers:

P/E below 16 or P/B value below 1

Debt to equity ratio below 1

Dividend yield of 5% or more

Companies showing consistent growth in sales and profits

High return on equity (16% plus)

Firms with higher earnings margin

Sub-prime woes: BPOs rule out immediate layoffs

Business Process Outsourcing (BPO) players including WNS and iGATE Global Solutions — hit by the meltdown in the US sub-prime mortgage market — have begun redeploying affected employees in other internal projects, while ruling out any immediate layoffs.

“About 500 of our employees were engaged in the First Magnus Financial Corporation contract. We are working on creating internal opportunities for these employees and there will be no layoffs,” the WNS Chief Executive, Mr Neeraj Bhargava, told Business Line.

Mr Bhargava said that the WNS team had started matching skill set of such employees with the internal requirements.

“There is enough growth in the market to take care of the flow of people from the contract, and efforts are on to absorb bulk of them internally within the practices such as financial services, travel and knowledge services. In the rare case of employees with skill sets unique to the client, we will assist them in getting jobs externally,” he said.
First Magnus contract

Last week, the company in a filing to NYSE, said First Magnus Financial Corporation, one of its top clients in the mortgage business, had decided to stop all work with WNS in light of the current volatility in the mortgage market.

WNS also said that its revenue less repair payments were expected to be between $286 million and $291million for the year ended March 31, 2008, about $16 million lower than originally estimated.

The sub-prime woes have prompted iGATE Global Solutions to redeploy close to 150 employees into other services, said the Chief Financial Officer, Mr N. Ramachandran.

Some of the employees have been redeployed into other practices such as insurance, finance and accounting, infrastructure management services and in pH (Process Health) Matrix consulting team.
Voluntary attrition

iGATE also saw some 20-25 people leaving the company voluntarily during the past few months. “We have not filled up the vacancies arising due to voluntary attrition during this period,” Mr Ramachandran said.

At present, iGATE has some 500 employees in its BPO operations. Revenue from mortgage processing, which accounted for about 10 per cent of iGATE’s total revenues two quarters ago, has now come down to around six per cent.

“At present, we have three clients in the mortgage segment and all of them have been affected by the sub-prime crisis. Unlike other companies which have collapsed recently, our clients are big enough to withstand the crisis,” Mr Ramachandran said.

However, the Nassscom President, Mr Kiran Karnik, said that it was early to press the panic button. “While at individual company-level it could hit operations, from the Indian BPO industry standpoint it may not have large implication primarily because the industry’s exposure to mortgage market is quite small and the services are specialised.”

Subprime concerns, implications for India

The global equities sell-off of the last four weeks reflects a sharp rise in risk aversion. Higher risk aversion has come on the back of the disarray in the credit markets and the growing concern that an emerging global "credit crunch" as well as the continuing US housing slump, will force the US economy into recession over the next 12 months.

In addition, the re-pricing of risk took on yet another ugly dimension on Thursday and Friday of the last week with the dramatic unwinding of "carry trades" across Asia leading to a sharp rise in the Yen, and further major declines in Asian equities, including the Sensex.

How should investors react? Clearly the last four weeks have been very painful for many and the immediate market outlook is very uncertain.

But long term investors should take comfort from the overall health of the world economy, including India. Outside the US housing sector, the world economy is very strong with good GDP growth, generally well-contained inflation, high corporate earnings, and healthy business and consumer sector balance sheets.

We believe that the most likely outlook is that global markets will calm down by or during September and that the sense of panic of recent weeks will recede.

In addition, if the markets sell-off does escalate further and seriously threatens the economic outlook, the US Federal Reserve has shown that it is sensitive to the threat that the re-pricing of risk becomes even more disorderly. The Fed (along with other central banks) has lifted its liquidity injections into markets and on Friday lowered the so-called discount rate at which it lends emergency funding to financial institutions - by 50 basis points to 5.75%.

In addition, if its largely technical measures do not do the trick in stabilising markets, the Fed has also indicated that if necessary it would also reduce its key policy rate - the Fed Funds rate (currently at 5.25%). The Fed remains reluctant to be perceived as bailing out investors for unwise decisions.

But US inflation is no longer a serious problem and markets may well have suffered enough pain for lessons to have been learnt. The risk of a US recession and a prolonged stocks meltdown is higher now than a few weeks ago but still looks only something like a 30% risk, in our view, over the next 12 months.

The fear in markets may take some time to dissipate and volatility is likely to stay high for a while. But a global equities rebound should come through over the next few months, and this should lift Indian markets as well. It will not be a straight line but our end 2007 target for the Sensex before the current turmoil was 16000, and we are sticking with that target. From the close on Friday August 17th, this implies a 12-15% climb and a 15% gain for 2007 as a whole.

The stocks turmoil stems from losses on US sub-prime mortgage lending, where lax lending standards in the US in 2005-06 combined with falling house prices in some areas since then are now bringing a wave of mortgage defaults.

Even on very pessimistic assumptions about the US housing prices, the total losses look set to be around $200 bn, losses which when spread around the world's investors should not be dangerously large.

But the problem is that many of the sub-prime mortgages have been packaged up into other securities, such as collateralised debt obligations (CDO's), which are now impossible to value.

The uncertainty over valuations caused the CD0 market to dry up in mid-August. This uncertainty, combined with the news of major losses from the general markets sell-off, have spread doubt about the liquidity of the financial system.

As a result, banks have been hoarding cash, pushing up short term lending rates and forcing central banks to respond by adding more liquidity into the system to keep market rates close to policy rates - 4% in Europe and 5.25% in the US. Have central banks now done enough to calm markets?

Central banks have probably done enough but it is far too early to be sure. In addition, the US housing sector looks almost certain to worsen further. The reduced availability of mortgages to weaker borrowers as well as higher interest rates will discourage new buyers. With many local markets already suffering from acute oversupply, this means that US house prices are likely to fall further and that the drag on the overall economy from the housing slump will probably continue into 2008.

The continued drag from housing makes the current crisis very different to the 1998 LTCM crisis when liquidity injections and Fed rate cuts quickly restored confidence. Nevertheless, the key economic uncertainty remains the extent to which house price weakness will translate into sharply weaker US consumer spending

The good news here is that there are several reasons not to be overly pessimistic although much will depend on whether stocks weaken further. On the positive side, US household wealth remains strong and should be able to absorb the hit from weaker housing and the stocks sell-off. In addition, income gains remain solid and employment continues to expand.

The US economy should also continue to gain from strong exports whilst good corporate balance sheets should offset the negative impact on business investment of tighter lending standards.

As a result, a US recession still seems unlikely and we still expect that the Federal Reserves will be able to keep rates on hold at 5.25% into 2008.

But the uncertainties around this "no change" Fed Funds forecast are very large. If the current markets turmoil does escalate further and threatens the economic outlook, and/or the credit crunch widens even further from mortgage, then the Fed would respond quickly by cutting the Fed Funds policy rate.

The problems in the US will overhang Indian markets for a while but, provided the US avoids recession, the pressures should be manageable and Indian equities upswing should continue. Back in 2000-01, India and Asia more generally were far more dependent on the US and the US equities downturn hit very hard. In 2007 and 2008, economic growth in Europe and Japan should continue to be resilient to a weak US economy.

In addition, there are more alternative sources of domestic economic growth - from private consumption in India and business investment in India. In addition, the Reserve Bank has raised interest rates since 2004 and so now has plenty of scope to make monetary policy less stringent if the Indian economy looks like slowing significantly.

The key risk scenario for Indian equity investors is the threat that the US economy does move into recession over the next 12 months. A US recession would happen in 2008 if the contagion from the housing market is much more severe than we expect, and crucially, the Fed is too slow in responding to any systemic economic weakness and does not cut interest rates quickly enough.

In this event, Indian equities would likely move sharply weaker over the next few months. Investor should not rule out the Sensex falling back well below 10000 by end 2007 or early in 2008 before eventually finding a bottom. We do not think that this we happen but Indian investors would be wise to stay much more aware of the potential downside market risks.

Via ET