Thursday, December 20, 2007

Investing in each other's products

My friend in America sent me this explanation on why the banks and stockbrokers have so much money in sub-prime assets.

1. The originating banks were not allowed to hold their own products.
2. They buy each other’s products and used them to increase the value of their earnings.
3. The products are quite complex; no one could figure out how to value them
4. Each separate mortgage has a different set of rules regarding a change in interest rates.
5. Most of the mortgages originate from brokers whose only interest is to earn a mortgage fee.
6. The lenders do not carry out due diligence; they package the loans and pass the risk to the investors.
7. There is a complex set of events which finally lead to this crisis

He told this old story. A buyer got a rotten Herring and complained about it to the broker who sold it to him. The broker said. "Oh that was a trading Herring not an eating Herring.”

2 comments:

Anonymous said...

It happens also with stocks. Worst thing is sometimes cannot even tell whether it is rotten because of herd instint and marketing hype of the day. Ordinary folks found out too late and left holding the baby. The dot.com bubble burst in 2000 is one. Will subprime cause the next sudden big burst? Or will it be like slow poison in the financial market ie take some time to see deadly effect?

Anonymous said...

Dear Mr. Tan

We would really like to read your views about this sub-prime thing and how it can affect us in Singapore. Is this billions of dollars of loss, a real loss or paper loss? if this is about home loan then lot of land, property etc in USA is owned by banks now? if it does then there is a good chance when the market goes up this real estate will recover most of those billions again?

When was the last time such huge billions of dollars were lost?

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