WHILE stock markets around the world continued to tumble, nobody seemed to be pointing to the elephant in the room. This current collapse of investor confidence has, it is being said everywhere, been prompted by severe problems with the US subprime property lending market where money has been extended to borrowers with poor credit ratings who are now defaulting on their payments.
But why should investors have panicked? A mortgage is probably the most reliable of loans, because it is secured against the property. If the borrower fails to make payments, the lender repossesses the house or apartment. For sure in a weakened market, the property may not be worth as much as was advanced against it. Equally, the lender will have lost projected income from the interest that the borrower would have paid, had the loan run to term. But in the end, most, if not all, of the value that had been advanced by banks and mortgage companies is still intact. The money has not disappeared into thin air as with Enron, or any other major corporate fraud or a country defaulting on its debts.
There are other factors, of course, in the subprime market’s troubles, such as unsecured credit card debts, but the basic proposition that investors in securities based on the subprime property lending market are in danger of losing every cent is pure hokum. The panic that has ensued and the market liquidity injections of central banks and the general air of doom and gloom that is gripping investors around the world is based upon fantasy, because the underlying assets — the bricks and mortars — are still intact.
This being the case, then another reason must be sought for this dramatic decline in share values. There have in fact been two events that have caused the massive sell-off. The event currently driving down prices is the herd-like rush to cash. Any crowd in panic has the IQ of a rabbit. The stock markets are no different. Investors’ fears are feeding on each other. Most cannot see the bottom of the market, since they do not have the time to think. Their phones are ringing off the hook. They are mesmerized by the tumbling red figures surging on their computer screens. Automated sell orders, cash calls, breached covenants are all creating chaos, particularly in sophisticated market segments, such as stock lending. The terror of ruin tightens its grip by the hour.
The more important earlier event will be harder to pinpoint. Key investors quietly sold their shares days, maybe even weeks, ago as the analyst community ratcheted up its phony warnings. They now sit on piles of cash waiting to buy back into the market when values have slid far enough. They probably already know the “floor price” and their return will stop the panic and restore confidence. They will have banked handsome profits and be back in shares at bargain basement prices, all because they anticipated how successfully other investors could be stampeded by nonsensical analyses.
