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Global Banking: Facing Up to the Changes Email Newsletter Business Opportunity - Helen Bairstow The Current Climate, a Threat or an Opportunity The Easiest way to do a Client Newsletter. An Analysis of the Cause of the Current Recession
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An Analysis of the Cause of the Current Recession

Click here to buy - A How To Book of SMSF's by Tony Negline

Tony Negline

Last week two academics from the University of Vermont released some interesting research into the sub-prime crisis.

Their focus was to look at quite a long laundry list of items - the actual foreclosure rates, how far the price of houses have really fallen, how much banks and other financial houses have lost and what caused the problem to emerge.

The opening sentence of their executive summary fires the first bullet, "National housing price declines and foreclosures have not been as severe as some analyses have indicated, and they are not as important as financial manipulations in bringing on the global recession."

They estimate a loss in housing value of about US$145b. As these academics say, "Traditional banks and investment banks have incurred losses far in excess of these estimates. By May 2008, banks and insurance companies already had written down more than $300 billion in asset-backed losses.

"The financial crisis was triggered by sub-prime mortgages, no down payment mortgages, resetting adjustable rate mortgages, and by some low income home buyers being manipulated by unscrupulous mortgage initiators ... In addition, the financial crisis was caused by house value to income imbalances in a few states and a modest number of counties and metropolitan areas, by easy credit to support these imbalances, and by MBSs and subsequently by credit default swaps which ostensibly spread risk and reduced risk, but which actually greatly increased risk. They created an inflexible structure which neither lenders, packagers, central banks, nor national governments were able to access easily to repair the underlying delinquent mortgage payments.

"Profitability of banks' manipulations of short-term borrowing and long-term MBSs required annual appreciation of 5 to 10 percent in housing prices. A set of practices and institutions that increased flexibility on the upside were inflexible and damaging on the downside. Some MBSs are financial instruments analogous to an automobile with several forward gears but no reverse gear. They can get you where you want to go most of the time, but when you need to reverse direction they are worse than useless.

"A problem faced by lenders has been the so-called "mark to market" accounting rule.

"If lenders retain mortgages in their portfolios, they can rely on their own experience in valuing foreclosed unpaid mortgages and reselling these properties at lower prices. They also can estimate write-downs by using data in this analysis for traditional median house value to median family income or median household income for a proportion of their mortgage loans that may default. Estimating the value of MBSs is more difficult.

"... most of [MBSs] are performing above 90 percent of payments due.

"Market failure has two components. The first is that the value of the underlying mortgages has not been disentangled from the MBSs, leading to excessive undervaluing of the MBSs. The second is that accounting rules, so-called "mark to market" requirements forced MBSs to be valued at what buyers would offer for them today, rather than based on the revenue stream that the underlying mortgages would provide."

It is for others to determine if their analysis is accurate. There's no doubt it's important research because until now nearly all the financial problems have been explained away by blaming the US housing price bubble.

There's obviously a bit more to the financial crisis than that. As the saying goes, "the truth always outs itself ... eventually".

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