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WERE ANY VIGILANT OBSERVERS SURPRISED?  WE HAVE BEEN PREDICTING THAT DERIVATIVES WERE A POTENTIAL MESS FOR MANY YEARS.

Surprise, the hedges that some failed speculators in the bond market have put on, failed to act in the way that they were mathematically supposed to act. This is according to Sowood, the failed Boston based, bond speculating hedge fund.

For years, we have been telling people in public and in private that those who write the derivatives, including bond hedges use mathematical models which do not understand the psychology and periods of illiquidity that exist in the investment markets.

The mathematicians make assumptions which experienced market professionals know are not always correct in times of crisis.  Currently, the models have failed to identify that there may be long periods where no one will bid for your assets at a reasonable/rational price. Yet your creditors may withdraw your line of credit and demand immediate payment of your debts.  How do you pay them if even your conservative assets can not be sold at a reasonable price?   Many of the mathematical models have been poor at factoring in fear and greed.

We hear over and over in past days that there is a buyer’s strike for mortgage bonds, and that the only buyers are offering ridiculously low bids.  All we can say is, welcome to the world of panicky markets where the only buyers are opportunists who know that they have you over a barrel and who plan to buy only if they can get a very, very good deal.

Mathematical models generally don't understand the consequences of being unable to hold onto positions until rationality reestablishes itself.  In essence, up to this point, mathematical models have demonstrated severe limitations in real world situations.  The problem is that many mathematicians are not familiar with the real world of trading, and traders are generally not sophisticated mathematicians.  However, anyone who has worked with derivatives and who simultaneously understands how markets work knows that it is true.

HOW WE ARE PROTECTING OUR CLIENTS

The majority of our client assets are currently held in cash.  The cash is held in government instruments: U.S., British, Canadian, and Australian short term government bonds. Our clients’ investments are in oil related, base metals and precious metals and a few foreign stocks in countries with very fast growth.

We have our own money invested along with yours.  We have decades of experience, we have been through many crises like this one over the past 40 years, and we have a long track record of avoiding or minimizing major world market declines in our client portfolios.

Currently, we are enjoying good returns this year, and are working hard to protect the profits that the portfolios have earned.

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These articles are for informational purposes only and are not intended to be a solicitation, offering or recommendation of any security.  Guild Investment Management does not represent that the securities, products, or services discussed in this web site are suitable or appropriate for all investors.   Any market analysis constitutes an opinion that may not be correct.  Readers must make their own independent investment decisions.
The information in this article is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation, or which would subject Guild Investment Management to any registration requirement within such jurisdiction or country.

Any opinions expressed herein, are subject to change without notice.  In addition, there are many market, currency, economic, political, business, technological and other risks that are beyond our control.  We make reasonable efforts to provide accurate content in these articles; however, some content and some of the assumptions, formulas, algorithms and other data that impact the content may be inaccurate, outdated, or otherwise inappropriate.  In addition, we may have conflicts of interest with respect to any investments mentioned.  Our principals and our clients may hold positions in investments mentioned on the site or we may take positions contrary to investments mentioned.

Guild’s current and past market commentaries are protected by copyright.  Apart from any use permitted under the Copyright Act, you must not copy, frame, modify, transmit or distribute the market commentaries, without seeking the prior consent of Guild.

About the author:

Mr. Guild founded Guild in 1971. Prior to founding the company he was an analyst at a bank and a hedge fund. Mr. Guild is a recognized expert in the areas of international investing and economics. He has been a writer and speaker on economic issues for 30 plus years and has been widely quoted in the world media. He holds a BA in economics and an MBA with highest honors.  For more company information please visit http://www.guildinvestment.com

Article Source: http://EzineArticles.com/?expert=Tim_Shirata http://EzineArticles.com/?Subprime-Meltdown—We-Were-Not-Surprised&id=673278

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Subprime lending has recently caused over 56 lenders to either go out of business or stop issuing subprime loans because of excessive foreclosure rates.  The lending community made decisions in the last few years that dramatically eased a borrower's qualifications with a resultant dramatic increase in foreclosures.

The housing demand was so strong that lenders started to compete for the insatiable mortgage demand by making qualifying very easy.  One example was the creation of the "stated income" loan, or the "liar's loan". In the loan application, the borrower only had to "state" his income without showing any proof of that that income.  Unfortunately about 60% of borrowers over-stated their income on their loan applications to qualify for their loans.  A review of lending practices showed racial disparities in African-American and Hispanic low-income neighborhoods which had 1 ½ times as many subprime loans at higher interest rates and closing costs as compared to low-income white neighborhoods.

The lenders planned to compensate for higher default rates by charging higher interest rates and closing costs.  But to make payments as low as possible for the borrowers, lenders developed low-initial interest rate loans (teaser rates) or negative amortization (Neg Am) mortgages.  With a Neg Am loan, a borrower would actually owe more than he originally borrowed when he went to sell.

The teaser rates combined with adjustable interest rates caused borrowers to be hit with huge mortgage payment increases.  Most borrowers couldn't afford huge monthly payment increases and foreclosure rates began to rise.  Lenders gave the loans on the assumption that the homeowner would do whatever necessary to make the payments, or the lender would get the property back in foreclosure and re-sell it for a profit in “hot real estate" markets.

Overlooked by lenders was the fact that real estate investors had become a major factor in the real estate market that had previously been dominated by the “retail buyers" or single family homeowners.  The actual statistics went from investors owning about 2% of all single family homes in 1990 to almost 28% in 2006.  This huge increase in investor ownership caused the "tail to wag the dog" and sent the real estate market into price advances that exceeded historical stock market gains.

Lenders were not discouraged, and to make loans even more affordable, developed 100% financing loans designed to eliminate "PMI" or Principal Mortgage Insurance by using an 80% first and a 20% second mortgage.  This 80/20 program was so successful that it became the standard loan for most new homeowners for an 18 month period in 2003 – 2005.  Now the borrower had two mortgages, the first at a traditional interest depending on the borrower's credit rating and a second mortgage with a higher interest rate of 3% to 5% above the first mortgage rate.

We are now seeing huge default rates among 80/20 financings because the borrowers saw an opportunity to refinance their properties, cash out an equity profit without having to sell their homes, and just walk away without making any mortgage payments.

Who are the losers?  Unfortunately, anyone with an adjustable rate mortgage who can't convert it to a fixed rate, investors who own mortgaged properties, new homeowners with challenged credit or minimal down payments,   the support personnel for the real estate industry, including realtors®, construction personnel, construction support industries, mortgage brokers and their staffs, lenders and their staffs, attorneys who specialize in real estate law, appraisers, surveyors, home inspection personnel, and just about anyone in a support industry related to real estate.

There are solutions, but barring governmental intervention, the average homeowner needs to focus his financial future on getting a fixed rate mortgage; trimming his expenses where possible; taking advantage of his property tax exemptions for homestead, military service, or senior discounts; [http://www.fsbopowersellingsystem.com/]be proactive in selling his home and slow to replace it with another home; stay away from "funny money" loans that could escalate sharply; and save cash for a larger down-payment to reduce his interest rate and monthly payments.  As bleak as the future appears for many economists, the financial markets have weathered worse financial storms.  I suspect the final solution will take years and need the banking industry to become more pro-active is the resolution of the individual homeowner's financial problem. An alternative solution involves the lending institutions developing a strategy of better handling of the re-sale of the bank owner properties by offering them directly to new homeowners by a national bidding system, involving all the lenders.

About Author :

David Dinkel has over 30 years experience in real estate investing which has given him a unique perspective into the real estate market. He has created a powerful Free CD entitled “How to Sell Your Home in as Little as 72 Hours” designed to help homeowners sell their houses quickly and save thousands of dollars.  It includes secrets that realtors won’t tell you and investors don’t want you to know.  The Free CD is available at [http://www.fsbopowersellingsystem.com/]http://www.FSBOPowerSellingSystem.com.

Article Source: http://EzineArticles.com/?expert=Dave_Dinkel http://EzineArticles.com/?The-Real-Casualties-of-Subprime-Lending&id=589737

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