Dawn to Dusk..... US Market an Overview


By

K.S. Nirmal Maharaja
MBA Student
R.L. Institute of Management Studies
Madurai
 


Hot topic under discussion for the past few months is US recession. Debt market along with sub prime crisis collapsed US market in which its heat spread globally.  Billions of dollars in the investors wealth has lost, banking system crippled and plugged millions of people jobs.  To face the turmoil US government bailout $700 billion.

SLIP IN A WAY MAKE I-BANKS TURN DOWN:

The same type of financial crisis occurred in US in 1929.  Till 1929 commercial banks injected money in share market by means of SLR.  Then after government made some regulations and informed the commercial banks not to involve in trading of shares or investing in equity market and the activity was stopped.  After 1930 Investment banks (I-Bank) become familiar among public.  They traded the investors wealth in the market based on some commission.  I-Banks earned more profit by getting commission itself.

On seeing the fruitful profit in share market, I-Banks started proprietor trading (Investing their own money in the share market) I-Banks earned huge profit in proprietor trading. After 1990, Federal Reserve Bank relaxed some norms for I-Banks.  Earlier the borrowing limit was ceiled only to 12 times the asset value what I-Bank have.  But later the ceiling was removed.  With this advantage in hand I-Banks borrowed more amounts beyond their limit.  Lehman brothers borrowed 30 times their asset value from outsiders.

After 1999 subprime loan prevailed in market.  This is the loan given by the commercial banks to NO INCOME NO JOB AND ASSET (NINJA) group.  These loans were issued to customers through special purpose vehicle.  Lehman brothers borrowed the home loans already issued to the customers and converted into collateralized debt obligations(CDO's) i.e. cutting the home loans into smaller pieces, packaging the pieces based on return, value, tenure and selling them to investors across the world after giving a nice name "High Grade Structured Credit Enhanced Leverage Fund". 

In US, government bond is considered as a safety and secured bond but Federal Reserve Bank reduced the interest rate to 1 percent.  So investors started to search alternate investment.  At this juncture CDO's were considered as secured investment because Lehman brothers backed up the CDO's by insuring with AIG Insurer to meet the default if any.  So people hoped that their money won't get ruined off.  So they started investing in these CDO's.  As more CDO's are wanted by investors the investment firm gave pressure to banks to issue more home loans.  This made the banks to issue more loans to NINJA groups.

 Investment banks invested lot their money in these CDO's.  Then arises the problem.  The economic condition of US started tighten, which made the interest rate to rise.  Most of the home loan borrowers were NINJA category they were not able to repay the loan with high interest.  Many loan takers defaulted and more houses came to sale in the market.  The demand for the houses also reduced drastically and the chain of mechanism among commercial bank, Investment bank, Investors and Insurance company (AIG) blocked.  Companies globally which invested in Lehman brothers also suffered lot.  So most of the share price of the companies turn down and reaches yearly low.

WHOM TO BLAME?

With this scenario in hand whom should we blame?  Is the commercial banks who released home loans to customers whose credit worthiness is questionable? Is the I-Banks who made attractive funds from home loans? Is the investors who foolishly invested in CDO's without making any value analysis? Is the insurance companies who backed up the I-Banks?

If we analyze this it is clear that all the above people contributed their part well for this financial crisis.  This mechanism looks more like "Pull System". The diagrammatic representation is shown below.


But there are some value investors like Warren Buffet never invested in CDO's where these people account to small number.  This clearly reveals that market is full of greedy and emotion rather than rational.  All investors cannot be rational people.  At the same time the market should have some proportion among rational and emotional.  If any one these proportion increases beyond a level problem will peep in.

FUTURE US MARKET:

The dilemma in US market is only temporary.  The correction in market will come but it take some time to have it.  Fundamentally companies (manufacturing and other industries) are still strong and their businesses are going well.  When people are greedy and fearless it's not a time to invest.  When people are fearful that's the right time to invest.  Now it is the right time to invest in the equity market by having our risk profile under view point.

CONCLUSION:

Dawn to Dusk is a continuous process.  Currently US and other world markets may in dusk but soon they rise and add value to investors.  Till that time investors should wait patiently and look ahead the future with optimistic view.
 


K.S. Nirmal Maharaja
MBA Student
R.L. Institute of Management Studies
Madurai
 

Source: E-mail October 29, 2008

 

        

 

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