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3 Of termites and index
mania By Julian Delasantellis
My wife and I now find that we have
reached the stage in our lives where our son and
daughter-in-law ask us questions on how to be
better homeowners, as the two of them have now
been in their first home for more than a year. One
of my choicest pieces of advice is, "If you see a
termite, take it seriously, because there are
probably tens of thousands more."
My wife
and I are grateful that our son and his wife now,
through
the
bracing gut kick of instantaneous maturity
acquired by producing and nurturing our infant
granddaughter (what sociologists call a "parental
emergency"), know what they must do upon seeing a
termite.
A few years ago, during their
pre-parental militantly vegan days, they probably
would have told us that they were organizing all
the house's occupants, bipedal and multipedal, for
voluntary attendance at a multicultural,
omni-species, all-property group grievance and
discussion session designed to raise consciousness
of the Western patriarchy's historic oppression of
the Isoptera order. Now they know: see one sign of
trouble, don't ignore it - take immediate action.
Would that high-powered investors in US
subprime mortgages had done the same.
In
two Asia Times Online articles last March, I
introduced readers to the woeful state of US
real-estate lending to homeowners with less than
stellar credit records and payback histories, what
became known as the "subprime" mortgage market
crisis. In my March 6 article, Rocking the subprime house of
cards, I explained how the global
equity-market selloff then under way was not, as
the conventional wisdom was declaring, resulting
from sharp selloffs in the Shanghai Stock
Exchange. It was more due to a growing realization
that the problems in the subprime market could
spread to present insolvency problems for some of
global finance's most highly respected names, such
as HSBC and Bear Stearns.
My second
article, The subprime dominoes in
motion (March 16), illustrated how
concerns about subprimes were affecting the stocks
of the companies involved. The frontline subprime
lenders, mostly fly-by-night suburban office-park
lenders such as New Century Financial and Fremont
General, saw their stocks decline 80% or more in
just a few weeks, and even more "respected" US
mortgage lenders, such as Washington Mutual and
Countrywide Financial, were seeing their stocks
suffer steep declines.
There it was, plain
for everyone else to see. The first termite.
Very much in contrast to what they say in
those soft-focus, soothing-themed television
advertisements for stock brokerages, professional
investors and traders at the great houses of money
do not come to work, fire up their quote machine,
and sit tethered to the trading desk for 12 hours
of Brobdingnagian stress every day to finance
your, or even their, retirement or child's
education.
Good traders were probably able
to fund those requirements for themselves in the
first six months or so of their careers, and
having done so means they sure don't have to care
about doing the same for you. It has to be some
other challenge that keeps them coming back every
morning for another bracing dose of ulcers, cold
Chinese food and hypertension. For many, if not
most of them, what keeps them in the business is
the challenge of beating an index.
Most
people are familiar with traditional market
indices such as the Dow Jones or the Nikkei, but
in the past few years, a bewildering array of new
indices have arisen that track just about anything
and everything traded in the financial markets.
You have big stock indices, small stock indices,
very small stock indices, government, corporate
and government agency bond indices, commodity
indices, mutual fund indices, indices of other
indices, even indices that measure the performance
of hedge-fund managers.
Index mania
originated out of University of Chicago Professor
Eugene Fama's Efficient Market Hypothesis (EMH),
which stated that investors could not consistently
outperform benchmark indices of whatever sector
they were investing in. The theory originally was
meant to apply mainly to stock investing, with the
performance comparisons being applied to
long-established indices such as the Dow or the
S&P 500, but eventually, indices were
established as benchmarks across the full spectrum
of current investment.
This served two
purposes. For those who believed the EMH, and thus
thought the search for outperforming individual
stocks, bonds or whatever ultimately fruitless,
index-specific investment products were formed
that allowed low-cost (no need to pay those pricey
fund-manager salaries) investment in a specific
index, with profits or losses accruing with
concomitant moves in the index.
The second
main function of financial-market indices is that
they give ambitious fund managers a specific
numerical target for which to aim to beat. Traders
whose investment performance beats their specific
sector index get big fat bonuses and press
releases from their firms touting their
accomplishments - even more so if they beat both
the index and the other traders in their sector.
As for the trader who can't beat the index - well,
he might have been the guy from the dealership who
sold you your new Buick.
Therefore, it
should come as no surprise that an index has been
established to track the performance of subprime
mortgage loans bundled together and then sold to
bond buyers seeking higher yields than traditional
US Treasury or high-grade corporate debt. This
instrument is called an ABX index.
The
specific ABX index most applicable to subprimes,
the ABX-HE-BBB-, started the year just under 100,
and then, as whispers of subprime difficulties
started to spread through the markets and, in
early February, as HSBC confirmed that, at least
for that bank, the rumors were true, the index
fell to 77.5 by late February.
As it
dawned on the world's investors that there might
be a nightmare of spreading financial insolvency
wrapped in the core of the great American dream of
universal home ownership, the world stock selloff
of the last week in February and the first week in
March at last diverted the media's attention from
the more important story they had been covering,
namely where Anna Nicole Smith's methadone-pickled
corpse would be interred.
Then, as the
financial markets are frequently wont, the
unexpected happened - nothing.
Things
started to look brighter than the gloom and doom
that pervaded the financial markets in early and
mid-March. the US and world equity markets
recovered (as did, to a much lesser extent, the
ABX), quickly surpassing the levels of late
February prior to the selloff. Although any and
all of the statistics that measure the health of
US real estate (new and existing home sales,
prices, mortgage delinquencies or foreclosures)
were coming in far weaker than in previous years,
it began to be thought that the basic underlying
strength of the US economy would act as a
counterweight to the problems in the real-estate
sector.
It was delicately noted that many
of the subprime borrowers had skin colors other
than white; if Wall Street had gone more than 200
years without caring about this population, it
sure wasn't going to start now. (A Fox News
financial commentator even used the subprime
crisis as an argument against Bank of America's
policy of giving credit cards to undocumented
workers - as if US finance had to be forever
vigilant against the dangers of extending
excessive credit to "those people".)
Most
important, it was thought that few of the great
houses of US finance had been so rash as to have
been much involved with subprimes.
It was
surmised that many of the home-mortgage borrowers
who got into trouble taking out more of a subprime
mortgage than they could handle would be spared
the ultimate sanction of foreclosure, since that
option was said to be a difficult, time-consuming
and
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