If you’re not a serious student of economics, and I’m guessing that’s most of us, then you’ve probably seen some new terms start bouncing across CNBC, CNN, and other major news outlets: ‘subprime lender‘, and ‘carry trade.’
The above-linked articles will do a better job of describing what each item is than I ever could. The one thing to keep in mind is that both of those things have something in common: both are heavily utilized by hedge funds, those private equity brokers who like to play fast & loose with other people’s money. As I noted in an earlier post, hedge funds are playing very dangerous games with ‘financial weapons of mass destruction‘ – derivatives.
While Wall Street seems to have found it’s footing once again after last week’s fun & games, we will undoubtedly see more patches of turbulence, and soon. As more and more adjustable-rate mortgages start resetting this year, odds are good that the overall rate of foreclosure will rise accordingly, and if the problem is large enough, there will be spillover into the regular housing market. More foreclosed houses means more units for sale in any given market, which in turn means lower housing prices, which just exacerbates the problem.
Most analysts are expecting more subprime lenders to fold in coming months, and if a big one or two goes, that could have some nasty follow-on effects. The now-ended housing boom of the last few years has created a wonderful credit instrument known as “Mortgage-Backed Securities” – basically a lender packages up a bunch of mortgage loans and sells them one the open market. Some of these MBS’s are units of high-quality loans while others are not. As more and more of these MBS’s default, it will have a negative effect on whomever is owning them at the current time. All of this stuff makes my head swim, to be honest, but I try to understand as much of it as I can since it has the potential to not only rock the financial market, but possibly trigger a recession in the wider US economy, which will affect all of us.
I just found out this week that Ditech, one of the bigger subprime lenders around, is a subsidiary of General Motors. This probably isn’t news to most people, but I wonder how that already-ailing company could handle having one of their main cash cows take a hammering from the unwinding of the subprime market.
Finally, if you haven’t paid attention to the VIX index, it’s a useful tool to look at when Wall Street goes bonkers, for it’s a measure of the amount of volatility in the market. Analysts disagree as to it’s usefulness, but last week it jumped when the stock market started shedding money.
This has been a somewhat rambling post, and I apologize for that. I’m a mediocre student of economics yet I feel the need to share this information with anyone who understands it even less than I do. We seem to be entering a period of ‘interesting times’ in the markets and it will have direct impacts on our lives, whether you hold investments directly, have a retirement fund, or are just watching the prices for good starting to rise.