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Article: Fund Library "Sub-stantial Reasons to Relax" PDF Print E-mail

Not worrying about sub-prime mortgages.


Crisis: one definition:A point in a story or drama when a conflict reaches its highest tension and must be resolved. 

….Phew I was getting worried and now I can relax. 

As with a lot of market watchers, I was getting very worried because the markets seemed to be going up forever without a hitch or a glitch for years. This was because it DID go up without a hitch or glitch for years, especially in Canada.

I was hoping the sneaky blade that the Financial Minister-Matador shoved between the shoulderblades of the rampaging bull’s income trust sector last fall was going to be just that “glitch” and, for a little while, it looked like it would be. Then the market bull shook the looming tax-acero free, shrugged and kept rampaging.

Thank goodness for the low profile, high-risk mortgagors of America. For the last year or more they have been steadily and increasingly defaulting on their sub-prime mortgages. This is due, primarily that their interest rate has, in some cases, almost tripled. Most sub-prime mortgages offered a low interest rate for the first couple of years and then “adjusted to market rates.” Which means, of course, HIGH rates. This, coupled with many residential areas of the United States experiencing FALLING house prices means that there has been explosion of mortgage defaults.

Now, of course, the pain and grief these home-owners are experiencing is very real. But sub prime mortgages are only approx 10% of all the mortgages in the US. And an even smaller percentage of the total assets borrowed.

Companies like Countrywide in the US or Coventree here in Canada, bundle these high interest, higher-risk mortgages up into single fixed income investment products called Asset Backed Commercial Paper or ABCP and then offer them to –mostly institutional-investors, hedge funds, etc. This has been very popular until the investors began to notice the defaults. Then they weren’t so eager to invest in them anymore, or at least, not unless they received much higher interest rates.

This created the currently in vogue: “liquidity crisis.” This is a disruption in the flow of capital between lenders and investors. Meaning simply that Conventree could not sell any more of their money products at the current “prices.” Every industry has a liquidity crisis every once in awhile. The automobile industry, for example, is in a state of constant “liquidity crisis”. It cannot sell enough cars. AND See Below re excuses.


This is simplistic of course since THIS liquidity crisis has since spilled out of the tiny stream that is sub-prime mortgages and into the bigger pool of capital that makes up the global, oceanic fixed income/bond/money markets. 


And, of course, now the stock markets have been going sideways and down for the last couple of months.


Amazing, hilarious …and re-assuring. 


Why amazing and hilarious?

It is amazing and hilarious because, like so many previous market panics, it does not seem to be linked to any sort of substantial economic event. A few dinky mortgage investment packaging investment bank have a few weeks of lower sales of their ABCP product and Irish, Asian and Brazilian bank investors-for example, with NO exposure to the core US sub-prime mortgages, begin to swoon. And this is only going to get wilder and frantic as more and more of the mortgages come due in the next few months.


Why Re-Assuring?

I am re-assured by this market craziness because, for the average Canadian anyway, it is not real. If you are sitting with a five year mortgage from a big Canadian bank with 20 yr amortization, your payments are fixed and have not changed.


If you are a Canadian company with no excess cash invested in any of the products offered by Coventree or other firms then you do your sales, provide your services etc the same as you did two weeks or two months ago.(OR, if your company is not doing well, you can even use the legendary liquidity/sub-prime crisis to your advantage as a crutch to explain why your sales are down, your costs are up or why your toys are toxic, etc.) 


From what can I tell, this has loomed so large on the investor psyche because:

  •  Investors, after such a long bull run were getting jumpy and looking for something, anything to panic about.
  •  These investment products were over-sold and their true “risk” was not being properly calculated. It is reassuring that this has been corrected before it went too much further.


“…The current question for all investors including ourselves is: has the contagion of risky credits and possible default worked it's way into holdings of the Fund? Meaning for companies with surplus cash or investments, what have the companies been doing with the funds? At this juncture we do not believe this to be a serious issue…”

Mackenzie Cundill Value fund manager Andrew Massie -- Feeling the chaos?


Primarily, I am reassured because this means that, finally, that money managers have some good companies to invest in at cheaper prices. The fact that this “crisis” has also brought some fear back to investors and restored a healthier sense of reality into their expectations is purely icing.


Going Forward:

Now, I know I sound all rosy-glassed and polly-anna, or at least Little Orphan Annie-like: ie. “The sun will come out tomorrow.” Make no mistake, the news is going to get more frenzied and panicked in the next few months. The liquidity crisis will probably make it harder for individuals and businesses to get loans. It may lead to some companies folding, it may trigger a recession which may be a factor that depresses real estate prices and leads to a general economic slow down.


None of this sounds like fun. It isn’t. It just isn’t a CRISIS. It is simply a continuation of the economic cycle. Things go up, then they go down. If you are at least 10 yrs old, you have seen this before. Something has to trigger a recession, why not the sub-prime thing?


This could stifle economic growth

 So what should you do?

Hmmmm… at this historic time of global upheaval and paradigmic uncertainty and possible end of civilization as we know it, we need to embrace a mind-shattering investment strategy designed to help you ease you through the crisis:


Buy low, then sell high


And, the best part is, the first part of the plan is getting easier and easier to achieve.


Otherwise, reconsider any investment you were going to make looking for short term gain, whether that was investing in some risky stock or head-case hedge fund or putting a down payment on a new condo being built to later flip it. In fact ALWAYS re-consider these kind of investments, several times.


Further, do not move to America, become a high risk borrower and get coaxed into borrowing against your to buy a new F-150 or more stuff at Walmart. 

Most fund companies are juggling or transferring any assets they have in ABCPs to protect investors. If you own a money market fund, check on what your manager is doing about this, if anything.


Recognize that most loans will now be a bit harder to qualify for.


Other than that, ignore most daily stock market media (including this article) stick to your current investment plan, seek re-assurance from your advisor and/or money manager.

 “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it… Let blockheads read what blockheads wrote.”

Warren Buffet


The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please call an advisor to discuss your particular circumstances. And if you were ever to run into the writer and he sold you some mutual funds, these mutual funds would be provided through FundEX Investments Inc.