"Sub prime" & our grandmothers' advice

For the past few days, the equities markets have been hard hit by the "sub-prime" issue in the US. What exactly is the whole fuss about?

First, contrary to popular belief, the world's financial market is dominated NOT by the equities, BUT by debt instruments. The ratio is as much as 1:4, i.e. for every 1 dollar of equity, there is $4 of debt. Most of these debt instrument are bonds, T-bills, securitise debt obligation notes etc. Therefore, most financial crisis happened not because of equities, but by debt instruments. The equity markets just happen to be a quick indicator of problems.

Second, what can cause problem in debt market? Amongst all the MBA jargons and experts' smoke-screen, the answer is actually very simple. 30 years ago, my grandmother (yes, a traditional housewife auntie type) always taught me and my brothers: "Never spend beyond your means; if you don't have money in your pocket, don't buy things."

Simple as it sound, we, so call highly educated people, are fond of making things complicated (so as to justify our "intelligence"). The bankers in the US some how are able to convince ordinary folks to "live the life they desire". No money? Never mind, the bankers show you some slick brochures that you could leverage your current income by 30 times. The bankers make you think that your income will forever be rising, and therefore could afford to pay the monthly installment(forever). The ordinary folks therefore go and raid every piece of properties they could find. The bankers will fund 100% of the mortgage (yes, even the deposit can be "leveraged"). Ordinary folks began to neglect their day job, because they can make quick and bigger money by buying and selling properties. Some even re-finance the mortgage to invest big time in the stock market. For a short period of time, things look rosy, the bankers further reinforce that heaven has arrived. Ordinary folks began to spend on luxury items, eat good(but unheatly) food, have a few exciting(but deadly) relationships, the only thing they cut back was good work ethics.

When the liabilities on the banks' books become bigger, the US MBA trained bankers then securitize the liaibilities, give it a good name (Collateralised Debt Obligations (CDO)), and sells it to yet another bank or financial institution.

The party began to stop when the boss of ordinary folks finds that they are enjoying more than they work, and hence decides to sack them. Income drops, installment can't keep up, mortgage got defaulted, CDO's investors can't get what they are promised, sell the CDO, when more people are dumping the CDOs, the price got depressed, and the market got worried, people earn less and spend less, sell their equities to pay bills, when more people are dumping the equities, the price got depressed, and the market got even more worried......

The beginning of the problem: the ordinary folks spend ABOVE their means; they buy EVEN when they have no money in the pocket. (of course they blame the US MBA trained bankers, but the bankers will say it is "caveat emptor")

Will things get stablised. Yes, history has proven so. The events of men always depict a cycle. That's why grandmothers are always important people.