Post-Subprime Development in the Capital Markets - Essay Example

Name Instructor’s name Course 30 April 2009 Post Subprime development in the Capital markets Executive summary The paper covers four major events within the Australian capital markets. First, there is an examination of the government’s attempt at rejuvenating the housing market and gives suggestions that this may be detrimental to the capital markets. Second, it examines some of the global trends that may have repercussions in Australia such as re-emergence of the Asian economies. Thirdly, the paper analyses some of the groups that may be at risk during this post sub prime era; examples include investors without liquid planning. Lastly, some insight is given concerning those groups that may be safe from it and examples include long term investors. Contents Contents 2 Introduction 2 Recent events in the Capital markets 3 Government boosts the sub prime markets through lending 3 Opportunities and implications of the global financial crisis to other countries of the world and especially to Australia 8 Not all is lost for investors in Australian based international Capital markets 11 Groups that are at risk (Australian based but internationally oriented) 12 Conclusion 15 References 16 Introduction The world’s capital markets have witnessed one of the lowest moments over the past few decades. The latter situation started in the United States and eventually spread to the rest of the global economy. While Australia may not have born the full brunt of the global crisis, there is still overwhelming evidence to show that this situation may be incoming. The paper shall look at some of the developments that the country has been grappling after the sub prime era or what is identified as the post sub prime era. First, the report will analyze governmental attempts at rejuvenating the economy through the housing market. Secondly, interpretations on how Australia will be affected by the global financial crisis will be seen. Thereafter, some opportunities for survival in the International arena (from Australia) will be examined and lastly, those groups that are at risk will also be identified. Recent events in the Capital markets Government boosts the sub prime markets through lending The Australian government has not taken on a laid back approach to the current global monetary crisis. This is seen by the 200 million dollar stimulus that has been put into this economy. In 2009, the government released a special fund known as the First Home Owners Boost that was designed to serve the latter mentioned purpose. There have been close to three billion being directed to the housing market in Australia as a result of this intuitive and this will necessitate a careful examination of whether such a strategy is actually working. Some experts have argued that the economic downturn has already entered the Australian market owing to the fact that the unemployment rates have heightened in the recent past. This means that if little is done to correct the situation, then chances are that there would be more problems being faced by these respective groups. Besides that, other countries that have faced similar situations such as the US during the early 2000s. The US opted to implement such a scheme. (Mckie 70) However there are also a number of people holding a different school of thought concerning this issue. Most of them have utilized the same claim made by proponents concerning the US’s government lending process to oppose this move. These groups claim that if Australia does the same thing that the US did prior to its economic recession, then maybe the same negative results being encountered in the US could be witnessed in Australia. According to these adherents, the United States government began subprime lending after the technology bubble had bust during 2000. What such a move did was to worsen the economic crisis and to postpone it at the same time. In that year, the US government thought that it was doing the right thing and even gave the process a substantial amount of backing. What they did not realize was that they were setting the stage for economic reckoning by allowing excessive borrowing among some of the most unable or un credit worthy individuals in their country. Similarly, the same thing can be said of this sub prime program in Australia. The government is lending to the people who least deserve it. While the issue may not be on such a large scale as it was in the United States, one cannot undermine the fact that it is still going on. (Holt 90) This government scheme (the First Home Owners Boost) is a loan that centers on assisting people with poor credit histories assistance. However, analysts assert that some of the groups that are most likely to be targeted by such a venture are the young and newly employed. Nonetheless, these same analysts cautiously point out that if the Australian economy worsens, then they (the first home owners) are the first ones who will be out of work. What this implies is that the housing market will undergo a serious crisis because people who were designed to fill it up will be unable to do so. As if that is not enough, the latter groups will be the same ones who will be unemployed, without any money and they will also loose their homes. It can be argued that such a situation is inevitable and that trying to fight it is quite useless. On the other hand, one cannot help but see that such a government policy could change two problems into three i.e. a person that would be unemployed and homeless is now facing unemployment, homelessness and even bankruptcy to boot! The latter skeptics have also argued that it is this very group of home buyers that have been utilized by the Australian government to create the illusion of a housing bubble. For instance, when one looks at recent housing trends, one would be deceived to believe that the housing market is at its best. The following are some of the percentages of recent first home buyers within the Australian housing market January 2009 – 19.4 % February 2009 -23.6 % March 2009 -26.5% It has been asserted that the latter percentage is indicating some of the highest numbers of investments that have ever been done by first home buyers in the recent two decades. Not only has the first home buyers’ loan increased home purchases for those buying houses for the first time but it has also led to the enticement of a whooping ten thousand housing purchasers in the market. However, the latter groups have not brought in positive aspects, instead, they have led to substantial increases in the debt – it is estimated that this amount has reached approximately two hundred and seventy thousand dollars. It should be noted that this amount is twenty thousand dollars less than the amount being lent to non first house owners. However, one must be careful not to pin this entire increase in debt to the first home owners’ scheme alone because history has revealed that more often than not, first time home owners tend to borrow a lot more than their counterparts. This means that greater care should be given to other possible repercussions that emanated out of this loan scheme. It is almost certain that any first time home owner is likely to posses a lower income than other well established buyers. This is also coupled with the fact that first time home owners tend to look for less expensive houses. This means that the latter group of individuals is likely to contribute much lower deposits into the housing markets compared to their counterparts who had previously owned a house. In other words, a group that contributed minimal amounts and buying lower value housing is accountable for the biggest share of the housing market liabilities. (Randall 19) The Australian Financial Review indicates that some of the biggest loans are being dispensed to some of the most undeserving. For instance, they have shown that first time owners are relying on the government to finance close to fifty percent of their housing loans through this grant. Besides that, it has also been shown in the latter research that the amount of housing activity among first time home owners has gone up to the half a million pricing range. All these facts and figures have huge implications in Australia’s capital markets. First of all, the figures indicate that this loan scheme could be causing persons who are highly undeserving to enter the housing market. These very people possess some of the lowest paying or high risk jobs that exist today. Additionally, they have very low net worth and are entering into debt (through the government grant for first time home owners) when they should be busy reducing such scenarios. Other groups are less fragile than them and it would therefore be dangerous for the government to be targeting such a group. (Eagleton 75) The government has tried to justify their reasons for making such an arrangement by claiming that they are merely investing some 200 million dollars and getting three billion dollars in returns. Consequently, it is claiming that the latter loan scheme is a stimulus to the economy. The government should be greatly concerned with the potential repercussions of such loan grants because it may not be sustainable in the future. It has caused some ripples in the capital markets today but there are definitely some foreseeable problems coming their way. Economists argue that the amount of growth is diminishing in credit markets and that the economic activity caused by this growth will slowly disappear. This implies that jobs will decline and that there will be a crisis among the first home buyers. In the Sunday telegraph, there was a quote asserting that whenever someone has entered a mortgage arrangement in which his income had been exceeded by about 500%, then chances are that that individual may not be able to handle such without that job. This is exactly what is bound to happen once the Australian economy worsens. There is little doubt that the latter situation will occur in the near future and great caution must be taken to ensure that it dos not lead to any problems in the future. A number of economists have also shown that there is a high degree of over evaluation that may be prevalent within the Australian housing sector and that if this overvaluation is not kept under check, then Australia could be heading in the same direction that the USA did. At the moment, Australia’s inflationary indices in housing are following the exact same path that had been followed in the former mentioned country. The position that Australia is in now can be likened to the US during 2000. However, the fundamental difference between these two markets is that Australia’s housing bubble is about seventy five percent more than it was in the United States in 2000. This means that when the bubble bursts, then housing prices back home will begin going down and this may eventually lead to unprecedented debt. The latter process will entail an economic slow down that will make unemployment rates to increase to much higher rates than they currently are. In other words, the first time home owners who are more likely to have insecure employment will be the first casualties. (Randall 19) All in all, it can be said that the housing market in most parts of the western world is performing poorly. However, this has not been experienced immensely in Australia yet. Consequently, there may be a need to exercise caution in this very arena because failure to do so will lead to a lot of reckoning when the situation will already have spiraled out of control. This should serve as a warning to all concerned parties about the hole that the Australian government could be digging itself into. Opportunities and implications of the global financial crisis to other countries of the world and especially to Australia Because of the sub prime crisis, the United States which was considered as one of the centers of power is not in a position to claim monopoly of this position any more. In fact, evidence suggests that there is a shifting world order to other unaffected countries or minimally affected ones such as the ones in China. Here research indicates that there are a number of investment banks in Asia that have begun reorganizing themselves. Such examples include Sumitomo Mitsui investors, Nomura investment bank and Mizuho. All the latter banks have stakes in international capital markets and would therefore be in a position to fill the vacuum created by the US’ s financial positions. (Woo 36) Aside from the latter issues, foreign reserves in these Asian countries are at impressive values thus implying that the latter nations have the potential of recapitalizing western states. At this point in time, it has been recorded that there are four trillion dollars worth of capital in these foreign reserves. In other words, Australian investors need to watch out of opportunities in those respective areas. Another place that needs to get the attention of Australian investors in foreign capital markets is the Gulf region. Here, greater emphasis needs to be given to these areas because of the level of resource intensity in these areas. However, there should be a word of caution before diving into the Asian capital markets. The reason for this approach is that Asian countries tend to have a lot of confidence in their regional systems rather than in global ones. This is especially the case after the global financial crisis. Now most Asian investors would rather retreat to regional investments rather than venture out into what seems like a risky global market. This implies that if Australia is to consider entering the latter markets, then they must be in a position to market themselves and their situation as being separate and distinct from the US’s or any other western country that may be feeling the pinch of the global economic crisis. In other words, they would have to assure them that they are worth doing business with them. There are a number of implications that the emergence of a new world order or the post sub prime crisis will have on capital markets of the world and hence Australia. Capital flows will change tremendously because of the latter situations. Part of this has already began happening. Now there are numerous groups that have avoided US capital markets since interest rates have risen sharply and the overall economy is just not conducive for their investments. There are a number of implications for Australia in this regard. It is likely that there will be a shift from dependence on government owned assets in non western states that have not been affected adversely by the economic downturn. This implies that the latter regions will be very lucrative for the region. Another repercussion of the global shift away from the United States is that the strength of the World Bank will continue to diminish substantially. This is coupled by the fact that there are few emerging countries in the IMF and they hardy require the services of the IMF. This may affect the way global business is being conducted by Australians because the country can no longer rely on business conditioning often carried out by IMF compliant countries. The country would have to contend with independent capital market regulations without intervention from international institutions. This means that Australia would have to bend to the rules prevalent in those selected countries without excessive expectations. (Eagleton 50) It is also likely that the global arena will register lower levels of privatization and even deregulation. This is mostly because it is these very principles that have partly contributed to the global sub prime crisis. Consequently, most states are likely to apply more government intervention in their respective capital markets because they will be embracing a number of Keynesian principles. Such a move is likely to cause a number of free trade agreement proposals within Australia. This will mostly be by the emerging economies which will be interested in maintaining a series of open markets. Here, the latter changes may be prevalent because of the fact that the emerging countries are export dependent and any form of direct intervention would greatly hamper their level of success. Aside from the latter issue, it is also likely that these countries may advocate for these trade agreements because they may require an open environment so as to boost productivity within those countries. (Woo 69) Australia has entered into agreement with a number of emerging economies but given the post subprime crisis then more seriousness should be given to the Asian countries today. The kind of approach that had been used in the past of soliciting business allies based on shared values may not be very feasible in the future. Instead, there is a need to look for stronger relationships among these very groups in the current environment. Not all is lost for investors in Australian based international Capital markets There are certain groups of international investors who may weather through the subprime storm in Australia more successfully than others. One such group is composed of long term international investors. There are a series of individuals within the country who chose to engage in investments that stretch out for ten years or more. Some examples include reserve funds, foundations, superannuation funds and endowments. Such individuals are at a higher position compared to their short term counterparts because it causes a competitive advantage. The latter groups are cushioned from the subprime crisis owing to the fact that they are less susceptible to asset or liability mismatches. This is especially the case when the investment under consideration is a benefit schemes such as the Australian Defined retirement saving scheme. Short term declines within the market are quite easily mitigated by such schemes as there are tremendous opportunities that are prevalent on this side. Australia can ape the ways of the Asian countries during the Asian economic crisis of the nineties. These countries were able to come out of such storm because they had long term objectives and most of them were not dissuaded by fluctuations in capital markets even when those activities were very alarming. In the end, they rose far beyond what the world had thought they could. The second category of investors who are likely to do well in this crisis are those ones who had invested heavily prior to the crisis between 2003 and 2007. This is largely because there were very good returns at that time and those returns are likely to provide capital market stakeholders an opportunity to continue with their market activities without having to worry about funding. It should be noted that the period of uncertainty within this market is likely to continue, however, the high returns from the past five years are going to enable individuals to embrace a series of opportunities prevalent today. For instance, it is a known fact that skillful managers are required in cases where economic improvement is anticipated. However, in order to prepare, individuals require some sort of cushion which has already been obtained between 2003 and 2007 is needed. (Holt 69) Groups that are at risk (Australian based but internationally oriented) Those individuals who had failed to do liquidity planning are currently facing a lot of hardships and will continue to do so as long as this economic downturn persists. Australia possesses a capital market that allows its members to transfer funds from certain funds into others. However, the major disadvantage is that asset transference can be a very risky venture once the illiquid investments have been pursued by the transferring party. This is especially the case when considering superannuation funds. It should therefore be the reserve of the transference party to test the nature of liquidity within their investment portfolio and then find out exactly how robust that respective plan will be. This means that all the switching options should be assessed and analyzed thoroughly before any action can be taken. Those who have failed to pass through the latter steps are the ones who are suffering the most at this point. Another group that is at great risk during this economic recession is composed of those investors who have not done background checks on investment managers. At this time, the Australian capital market is highly volatile. In this regard, there are a number of operational risks that are prevalent within the current market and some of them could lead to extreme cases if left unchecked. The latter situation has been brought on by the fact that there are fewer funds being placed under management. This means that there are fewer operational resources and this has created low cost pressures – a situation that is never good for any market. Secondly, the current market is recording fewer unit trusts or other similar investments because of the fact that there are relatively high administrative costs being faced when handling those types of vehicles. In the end, such markets have become commercially unattainable thus presenting a huge risk to those who may have been interested in them. Thirdly, there are much higher unit prices in these types of investments as most administrators are simply trying to deal with high volatility that keeps changing from day to day. It is therefore very risky for stakeholders in such arenas. Unit trust and similar investment vehicles are undergoing a number of challenges owing to the fact that numerous investment banks have been doing very poorly (while some have closed). (Mckie 90) Consequently, trying to administer any form of counterparty arrangements is increasingly risky. Examples of groups that fall under this umbrella are; Prime brokers Forward contracts Derivatives Lending programs for securities Etc It should be noted that there is indeed another category of people who have been placed at a high level of risk because of the nature of the capital markets today and these are members of the securities market. Because of the high level of liquidity within the market coupled with substantial volatility rates, then there is a need to be wary of the high transactional costs that emanate out of the latter scenarios. This implies that futures overlays are becoming problematic and will continue to be so for as long as the economic slowdown continues. Cost leakage has therefore begun occurring and it may present several risks to these groups. (Marvenger 14) Foreign exchange markets have also been highly affected by the recent turn of events in the capital markets. Consequently, any person depending on the currency hedge market is increasingly at risks. This is largely because foreign exchange markets are known to be one of the most risky markets in any part of the world. It is therefore essential for individuals to avoid foreign exchange contracts that are forward in nature. In fact, current statistics indicate that transactions costs for an Australian Dollar versus US dollar fifty million transactions is up four times from last year. There are numerous loses that people with such forward contracts are recording largely because cash funding is required. Cash flow positions within such portfolios are going down and this has put the groups under consideration at risk. Nonetheless, not all individuals will record losses because there is some leverage for those who had already planned or anticipated this scenario. The weakening of the Australian dollar has also gone a long way towards boosting some currency managers who are active. Overly, it is those groups that keep altering their respective currency hedges that are in trouble. Those people who have invested in the securities lending program are also at great risk owing to the fact that there have been a series of changes being recorded in these arenas. Some of them include Collapse of brokerage houses Collapse of investment banks Loss of collaterals Transfer of investment businesses All these issues are likely to limit the level of transition investments that can be carried out internationally. Eventually all these events cause disruptions and may lead to poor performance of investments and stocks. (Marvenger 14) Conclusion Australia’s capital markets are not in the dire position that other developed nations of the world are in. However, this does not mean that the country has not been affected by the sub prime crisis. The first casualty is the housing market: Australia’s government has invested millions in promotion of first time home owners. However, numerous economic indicators show that this move is quite misinformed and may postpone a worse economic crisis in the capital markets. The post sub prime era has also brought with it a shift in capital outflows to emerging economies thus indicating that there may be a need to forge stronger relationships with countries within the Asian continent. Lastly, capital markets based on international trade such as forward foreign exchange contracts are likely to present greater risk to its investors. Consequently, a lot of analysis is necessary in order to weather such storms. References Mckie, David. Accounting regulatory and ethical failure. Carlton: Melbourne University Press. 2006. Holt, Derek. “Why US consumers withstand weak housing markets.” RBC Economic research Report. December 2007 Woo, Yeun. “China in the post subprime world order.” Centre for International Governance and Innovation Report. 26 October 2008 Eagleton, Simon. Capital Markets Update. Retrieved 30 May 2009 http://www.mercer.com. Marvenger, Timothy. “House price crisis looms.” The Daily telegraph (Melbourne). 22nd March 2009: 14 Randall, Dodd. “Subprime: tentacles of a crisis.” Journal of Finance and Development 33(54): 19 Read More