It’s a debacle, it’s a mess, it’s the gloriously predictable result of giving people whose credit histories read more like horror stories enough money to buy a house - you guessed it, it’s the US sub-prime meltdown.
The financial world is once again learning the hard way that no matter how you dress it up, or how many maths PhDs you get to work on the sums, the fundamental laws of finance are pretty simple.
If you give money to someone who can’t pay it back, you’re going to lose that money. And unless you operate at the end of the loans market where the head of your credit control department brings a baseball bat to work with him, the chances are you’ll go out of business pretty sharp-ish.
As an increasingly large number of investment banks are finding out…
London-listed Caliber Global Investments is the latest casualty of the US sub-prime market collapse. Fund manager Cambridge Place was forced to close the $908m fund yesterday, reports The Times, “after suffering a net loss of $8.8m in the first quarter of this year”. The fund was about 60% invested in the US, “mostly in mortgage debts rated BBB or below.”
We gave a brief rundown earlier this week of how these things are put together (see The US hard landing just got harder (http://www.moneyweek.com/file/31298/the-us-hard-landing-just-got-harder.html)). Broadly speaking, the further down the pile you are from AAA (the top credit rating), the more exposed you are to individuals defaulting on their mortgages. But with defaults coming in much thicker and faster than anyone expected, even AAA is looking wobbly, so forget about BBB making you any money.
Caliber isn’t the first and won’t be the last casualty. When hedge funds go under, people sometimes point to the collapse of Amaranth last year. The multi-billion dollar hedge fund went bust with no wider ill effects on the market whatsoever. The only trouble is, the Amaranth situation was entirely different to what’s happening now with Bear Stearns and the like.
Amaranth made some bad bets on what was otherwise a liquid, well-understood market - the energy market. Basically, it bet on red when it should have bet on black. It didn’t have the money to cover the losses - but other investors came in, took over its positions, and rode out the storm to the tune of a very nice profit, in the end.
But the situation with US sub-prime is more like sitting at a poker table in the casino, and finding out halfway through the game that all those blue chips you‘re holding onto, which you and everyone else had thought were worth £1,000 each, are actually only worth £10 each. And yet, you’ve been placing big bets as though you were a millionaire - you’ve borrowed money from friends, from other people at the table - and all of a sudden, your asset base has turned to dust. On top of this, anyone who gave you money also realises that they’re not going to see it again - they’re not as rich as they’d thought either.
That’s the kind of thing that “curdles confidence”, as James Harding puts it in The Times. “Bond issues from companies as diverse as Kia Motors, Arcelor Mittal and US Foodservice have all been postponed in recent days. According to one estimate, losses on sub-prime could be as high as $75 billion. This feels like an epic with more chapters to come.”
We couldn’t agree more with Mr Harding - all he forgot to add is that, this is one epic that won’t have a happy ending.
Source-Money Morning