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Has the global crunch begun? Has the global crunch begun? Has the global crunch begun?

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07/29/2007 12:41 AM
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Has the global crunch begun? Has the global crunch begun? Has the global crunch begun?
Has the global crunch begun?

[link to abc.net.au]

By economics correspondent Stephen Long

Posted Fri Jul 27, 2007 7:50pm AEST

Global share market losses have topped $1 trillion, including $41 billion in Australia. (AFP: Greg Wood)

Market sheds $41b in biggest post-9/11 fall The fall-out from the US mortgage meltdown has caused a rout on world stock markets and credit markets. Is this the correction we had to have or the start of a major credit crunch?

Wall Street shed about $500 billion overnight after the release of numbers showing a slump in home sales and a rise in mortgage defaults.

CNN called the carnage from the trading floor.

"We have plenty of new data to give investors reasons to worry, whether it's the housing market, whether it's a credit crunch, whether it's higher oil prices," a reporter said. "What you see is a nasty brew and it's playing out to one of the worst point losses."

In London, the FTSE suffered its biggest one-day fall since 2002. The toil and trouble from that nasty brew spread south through Asia to Australia.

All up, the losses from the sea of red in global share markets topped $1 trillion.

But the share market losses are a sideshow. The rout in credit markets is the big concern.

Across the globe, there has been a fundamental repricing of risk. It has hit just about every form of debt, pushing up the cost of borrowing.

CNN Wall Street reporter Allen Chernoff says that has big implications, not the least of which is a likely end to the private equity boom that has inflated stock prices.

"We have a very strong concern that the buy-out boom that has helped to fuel the stock market may be coming to an end, partly because there seems to be a drying-up of liquidity," he said.

"This driving up of liquidity is a major problem for Wall Street."

The catalyst is the worst US housing downturn in 16 years, stemming from massive defaults in the subprime mortgage market.

How could the fall-out from irresponsible lending in the US cause such shock waves across the globe? It is all part of a game of pass the debt parcel the world has been playing.

Traders, Guns and Money author Satyajit Das predicted just such a credit crunch last year.

"I think one of the key things to understand here is the globalisation we often talk about is mainly in flows of capital, so the investors in these subprime investments are actually not only Americans," he said.

"They're Europeans, they're Asians, they're Australians, as we've discovered in recent weeks.

"I think there isn't a fund manager, insurance company, bank or even central bank in individuals in any part of the world who doesn't either directly or indirectly have some level of exposure to this kind of problem."

Mr Das rejects the counterargument that the risk is spread so far and wide that the fall-out will not be bad.

"That ironically is what the central bankers have believed. In fact, my view is exactly the opposite," he said.

"What has happened is that banks have essentially sold the risk out of one part of the bank to these investors but there's other parts of the bank which have then used these securities which reference these underlying risks, and what they've done is lent money against that.

"The irony is, the risk is now concentrated among very, very few banks because the people who do this ... prime broking are a very, very few banks, less than 10."

But those are the big Wall Street investment banks, some of which could be in for heavy losses. Mr Chernoff has a similar concern.

"Bankers are not able to sell a lot of the debt, a lot of the bonds that have been financing all these buy-outs," he said.

"They've had to shelve these debt issues and absorb the financing themselves."

There is a supreme irony to all this. The credit markets were meant to kill risk by spinning debt and risk off the banks' balance sheets and spreading it far and wide, but the risk seems instead to have been magnified.

It is too early to tell where it will all end. It could merely be that this is the correction we had to have - a healthy repricing of risk that cools the hot money and cheap debt that has been rolling around the world, pushing up asset prices.

But it could be the start of a credit crunch where the music stops on the game of pass the debt parcel.