Thursday, October 2, 2008

What Can Be Learnt From Subprime Mortgage Crisis?

The moral lessons from sub-prime mortgage crisis:

(1) The free-market system fails. US especially the Wall Street pundits are once a strong believer of the mechanism of free market forces in allocating resources. In 1980s to 1990s many of them preached that there should be more deregulations in the banking system & financial market. Deregulations mean allowing more market forces & lesser government intervention. But now, the same pundits are crying for the biggest government bailout in the history.

This shows that although free market economy is favourable in most cases, it cannot stand on its own. Mixed economy is the best. So is US a pure capitalist? Definitely not. To some extent it’s mixed as from time to time there will be government intervention. Just that it’s minimal

(2) The payoff for greediness. Any firms operating in free-market system have strong lust for profits. Because of this, they are willing to make reckless lending without even considering the credit background of borrowers. The bankers creatively design loan packages such as interest only mortgages & 100% mortgages just to put themselves into more ‘trouble’. They continued to do so as they bet that the housing market boom will go on ‘forever’ & borrowers will have no problem on repayment later. Unfortunately they have forgotten about the past. Everything that goes up, will eventually come down one day

(3) No one can time the market. It’s somehow incredible that not even the best economist or Wall Street experts can tell whether the market is already on its peak or bottom. This is accrued to two main reasons. First & foremost great length of imperfect information has made estimations difficult. Second, the herd mentality of many analysts. When a single prominent experts point for an upward trend, all other mediocre will eat that up & tell layman investors that the market is still not at its peak.

In fact I do understand that many investors as in this case property & stock market hunters, cannot resist the temptation to make quick bucks when they see continuous upward trend in house prices & share prices

(4) Banks should get back to traditional lending. Here it means, collecting savings from customers & lend it out. Of course at the same time, they must scrutinised the income & capability of the borrowers. For all that happens now, is because the banks has departed from traditional business model & involved in risky way of raising money. They borrow from other sources so that they can lend out more & make more money. But when more borrowers went into default, the banks’ collapsed will be followed by their financial sources

(5) UK & US people must increase their savings ratio. In UK, savings dip below 0% in September 2008, the first time since 1958. This reflects low level of savings & high personal debt in the economy. The same goes for US. The people there have high tendency to store ‘all’ their wealth in property market without even considering other options such as paper assets & banks. This is because they felt that property prices will always be more stable & the boom will continue ‘forever’. We often hear financial jargons such as diversification in stocks, now it seems that UK & US people must also learn how to diversify their sources of savings

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