| "Why is it, that the subprime loan crisis has such a | | | | For years this subprime game turned out all right and |
| rippling effect on many sectors of the economy?" | | | | gigantic amounts of cash were invested into |
| "Why are even companies outside the USA also | | | | real-estate in Florida, Delaware or Texas by U.S. and |
| affected by the U.S. mortgage crisis?" | | | | international equity markets. No one thought that so |
| In the last 7 days I received lots of emails from my | | | | many borrowers would go broke at the same time. |
| subscribers asking me questions like these, and I'd like | | | | According to the U.S.Federal Reserve, loans of up to |
| to take the opportunity to explain what this housing, | | | | 100 billion dollars could bounce. At the same time, this |
| mortgage, subprime loan, credit crisis - whatever you | | | | seems to just be a drop in the ocean considering the |
| want to call it - and the presentsituation is all about. | | | | effect it could have on international capital markets. |
| Between 2002 and 2004 the interest rates in the | | | | These bad loans could be the biggest single risk for |
| United States were as low as never before. At least | | | | the global economy. In the past, many in America |
| as far as I can remember. I'm not that old yet! The | | | | spent their money stout-heartedly thus, stimulating |
| effect of such low interest rates was a real-estate | | | | and cranking up the economy. Their houses became |
| boom in the U.S. often financed with so-called | | | | worth more and more and banks literally threw loans |
| subprime loans. These are loans given to borrowers | | | | at customers with low interest rates. |
| who do not qualify for the best market interest | | | | This could all backfire now putting a lot of pressure |
| rates because of their deficient credit history. | | | | on the U.S. economy, because the money that was |
| Subprime lending encompasses a variety of credit | | | | spent so generously is now being held back. Also |
| instruments, including subprime mortgages, subprime | | | | because borrowers that are now up to their ears in |
| car loans, and subprime credit cards, among others. | | | | financial troubles can't spent anymore money |
| The term "subprime" refers to the credit status of | | | | because there simply is none left to spend. This, in |
| the borrower (being less than ideal), not the interest | | | | turn, takes a lot of liquidity out of the markets. |
| rate on the loan itself. | | | | Also companies and corporations that have nothing |
| But banks didn't worry too much about this because | | | | to do with the current real-estate turmoil are drawn |
| interest rates were low and simultaneously, | | | | into the subprime crisis. If they want new capital |
| real-estate prices were rising continuously in the 90's. | | | | from banks, they have to pay higher interest rates |
| So back in 2002/2004, anyone that could count to 3 | | | | as an additional premium for risk. Or, taking things into |
| was given a loan. Many people in America were | | | | extremes, they won't get a loan at all making it |
| suddenly able to afford expensive single family | | | | difficult for companies to grow, especially if a |
| homes and other kind of real-estate that they | | | | company wants to merge with another which often |
| couldn't before. | | | | costs billion of dollars. This all drops out now thus, |
| But in 2006 the U.S. interest rates had tripled and | | | | reducing earnings and profit outlooks. |
| now, especially the subprime borrowers couldn't pay | | | | And there's another, equally bad effect on all |
| their monthly installments anymore. So more and | | | | companies. whether attached to any real-estate or |
| more of these subprime loans started to crumble. | | | | not. Hedge funds bought these converted mortgage |
| But that's not all. Some banks and other financial | | | | bonds by the millions and very often using margins i.e. |
| institutionals converted millions of these subprime | | | | buying on borrowed money. And now they are sitting |
| loans into bonds. These were then sold for billions of | | | | on a huge heap of losses and debt. In order to pay |
| dollars to banks, insurance companies and mutual | | | | back those debts they have to sell stocks, |
| funds that assumed this to be a secure | | | | commodities and other equity. And this obviously |
| investmentbecause bonds usually are. That's why | | | | pushes prices down. Also stock prices. It's like a chain |
| they're also considered a safe haven in stormy times. | | | | reaction. |
| And not only were these bonds sold to U.S. | | | | And that's basically the reason why the markets |
| institutionals, but International ones too. You see, in a | | | | around the world are in such shambles right now. |
| nutshell, everyone invests everywhere. America | | | | Back at the trading floor, for Bullish trading the best |
| invests in Europe, and Europe invests in America, etc, | | | | hope for continued long trading is in turnarounds and |
| etc.! | | | | bounce backs. Rather than hold your breath and open |
| So you can imagine what happened when these | | | | new long trades why not take the Bearish pat and |
| loans started to crumble and the practice of | | | | trade puts or stand on the side lines for a time? |
| converting them into bonds backfired. It all swept | | | | Is my trading bias still Bullish? In the short-term no. In |
| over the borders of America into other countries as | | | | the mid and long-term, yes. So I'm definitely not |
| well. The German industrial bank IKB invested 13 billion | | | | opening any new long trades right now. But in the |
| dollars in these bonds and now they are looking at a | | | | future, we'll be looking at plenty long trade |
| $5 billion loss. | | | | opportunities. That's the good side of it all! |