Friday, 10 August 2007

Dishonest lending clue to market tremors

Central bank influence

I am no economist but I know that one has to be a little smart about the handling of money and investments.

Somehow, I had be quite concerned about the way hedge funds and their private equity counterparts have been buying up companies in takeovers and buyouts with highly leveraged instruments that heaps debts on acquisitions and sells on debt though systems that eventually have one institution holding the baby with adequate baby nourishment.

Interest rates have been going up in all regions for the past few years as Central Banks work hard to keep inflation down with the blunt hammer of interest rate manipulation and the assessments written in a language that would make parseltongue sound like baby chuckles.

Central bank to the rescue

What really bothers me is the way these sophisticated debt instruments have now come full circle as these debts cannot be sold on to raise more capital that the markets are presumably suffering a credit crunch, as if that is not fearful enough, the Central Banks in Europe, the Americas and Asia have pumped $326.3 billion into the markets to maintain investor confidence to no avail, the markets are falling like flies.

For Central Banks to be pouring money into the markets in this manner, the one side of maintaining investor confidence should not obfuscate that deeper issue of the possibility of Central Banks knowing a lot more about the problems inherent in the market than they are letting on.

Sub-Prime lending farce

It is the accepted legend that this whole debacle was caused by problems in the sub-prime lending for mortgages in the United States. Basically, people who normally would not qualify for loans and mortgages are allowed to take on these liabilities with lax due-diligence and higher interest repayments with the banks hoping to cash in on these higher risk stupidities.

With rising inflation also fuelled by cheaper credit coming from the appreciated value of existing homeowners, interest rates are raised to contain inflation making sub-prime loan repayments unserviceable.

Avalanche effect

Foreclosures take homes from the borrowers who cannot keep up and banks are left with debts that cannot be repaid and houses that cannot been sold at a premium to cover their losses – the avalanche effect has had banks reeling from exposures that has tightened liquidity and in some cases closed banks.

I am not convinced that we have seen the extent of banking exposure to sub-prime loans and the existing contingencies obviously have not been enough to give investors any confidence as they are selling up before thy get more caught up.

Thankfully, it is Friday, another trading day this week could have meant a complete meltdown – well, something close to a run on the markets.

Dishonest and fraudulent

Some people have talked about predatory lending practices that take the inadequacies of borrowers, sweeten up their circumstances to fit within lending parameters to derive commission and profit at completion of the deal but leaving the borrowers with liabilities the brokers know for sure they cannot handle.

The Financial Times yesterday gave an insight into the workings of this sub-prime lending activity. I will quote the text exactly as it appears in the article – Payback time.

"At the height of the US sub-prime lending boom, taking out a mortgage could not have been easier. Low credit score and history of bankruptcy? No problem. Income too low to qualify for a mortgage? Inflate what you earn on a "stated income" loan. Nervous that your lender might check up on your "stated income"? Visit http://www.verifyemployment.net

For a $55 fee, the operators of this small California company will help you get a loan by employing you as an "independent contractor". They provide payslips as "proof" of income and, for an additional $25, they also man the telephones to give you a glowing reference should your lender need it.

But perhaps the most absurd aspect of the US subprime mortgage market in recent years is that lenders became so generous with credit provision for out-of-pocket borrowers that very few checks were ever made."

If this is not completely dishonest and fraudulent, I wonder what is. In all the analysis and reckoning from market experts everyone seems to have an explanation apart from the real truth, people have been dishonest, banks have collaborated in perpetuating a lie and conducted financial transactions that are no more borderline criminal whilst Central Banks are now trying to clean up the mess without addressing the cause.

This problem would continue until honest, principled, truthful and trustworthy men step up to root out fraudulent practises in banks and lending procedures whilst ensuring that sensible due-diligence guidelines are adhered to for every loan offered.

Now, this should not mean that credit should not be available to all who seek credit, it means if doubts of recoverability do exist more should be done to safeguard the manageability of the loan when times do get tough – if that cannot be done, it would be a field day for loan sharks and that would be unacceptable.

NB: Like I said at the beginning of this write-up, I am no economist and this is not an exhaustive analysis of the sub-prime lending debacle or market volatility, it is simply a layman’s perspective on contemporaneous issues.

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