Sublime Sub Prime - Part 1 of 3
Keywords: Tony Melvin, Sub Prime.
By Tony Melvin, founder and Author

Just what is the sub prime mortgage crash anyway? Let’s look at the word “sub prime” – “sub” means less than or lower and “prime” means the first or the best of something. So the word means “less than the best”. In the mortgage industry it is “not the best type of loan” or a “riskier loan than a normal loan”. And to make sure you follow our drift, while sublime means “inspiring awe” it also means "to vaporize something!"

Such loans were approved with little or no requirement as to how the person taking the loan could repay it. The ability or proof to be able to repay the loan was not as strict as a normal loan (the ‘prime’ loans)

This means that it was easier to get a sub prime loan. The upside for the lender was that it allowed them to charge more interest because of the additional “risk.” Furthermore, this type of loan required less administration (less paperwork to stift through and checking of actual income) – plus it was a more profitable type of loan with a higher than average interest rate. It was good for the lender and good for the borrower – it was sublime (inspiring) for both!

As money became more readily available so too did easy finance and competition brought the “easy loan” into a similar realm to the ‘prime’ loan market or what is commonly known as the full documentation finance.

This opened up a whole new market to the lenders – people who couldn’t get finance the old way were now able to.

Driven by the underlining market factor of demand (or Greed) the markets remained strong and continued to grow. Until one day when the nemesis of Greed reared his ugly head and some people got scared and FEAR began to dominate. With so many businesses and financial transactions built upon a foundation of debt the whole lot has come crashing down like a house of cards. The sub prime literally vaporized overnight.

An event such as this that affects so many people generates a lot of questions and uncertainty. The most poignant questions that should be asked and answered are:

1. What are the possible repercussions of the sub prime crash?
2. What can the investor do to proof themselves for any future repercussions?
3. Why did this happen? (so we can learn from it)

This 3 part series is dedicated to answering these questions. In this article, part 1, let’s look at the first question and discuss the possible repercussions.

The possible repercussions of the sub prime crash

There are several main areas of society that will be affected, each creating further repercussions over the long-term; these are:

1. Scarcity of Money

With money made less available it will inevitably become more expensive (higher interest rates) at least for the short-term. The alternative for the government is to print more money (to make it more available) but this will lead to higher inflation and is not an option in our current environment.

2. Financial Chaos spread by the media

To further their own aims media will tend to focus on doom and gloom and total disasters. While there will no doubt be some casualties, remember this point: just because it is in every news paper or media headline does not mean it is happening to everyone, everywhere. It’s only because the media have the loudest voice (in print and TV) that it appears so.

The truth is, those stories that make the media headlines (such as stockbroker Opes Prime) were balancing a concrete boulder on a tooth pick. Very risky stuff indeed. This is not the same as buying residential real-estate in sought after areas and renting it out! So keep that in mind – its not happening to everybody, everywhere.

3. Big Corporation collapse

As I’ve alluded to already there will be some casualties, the bigger they are, the more geared, the more volatile the underlying asset, the harder (and faster) they’ll crash. As this happens (and I think they will be more to come) it will affects those directly involved with such businesses, but don’t think that it will happen to you directly with your own investing.

The Answer

The investor must keep themselves well informed and be able to separate fact from fiction.

It such an economic climate any bad financial situation can be easily blamed on the “sub prime crash” – it will become the scapegoat for bad business decisions, bad management and outright stupidity. The “sub prime scapegoat” will become the reason for certain sections to ask for handouts because of their inability to manage their finances leading to further duress upon the economy of the country. All manner of financial difficulties which would have happen regardless of the sub prime crash, will simply be blamed on the crash.

Therefore the investor needs to weary of this factor which will be fueled by the media. It will appear that it is everywhere and everything is being affected (which is happening now isn’t it?) The bottom line of any financial disaster is bad financial management, period. To proof yourself keep on investing and building your own portfolio (your asset column).

Lastly I’d like to leave you with this wonderful quote from one of the world’s most successful investors:

“We simply attempt to be fearful when others are greedy
and to be greedy when others are fearful”

Warren Buffet.

Until next time, don’t be fearful, separate fact from opinion and become wealthier.

Definitions

Nemesis: unbeatable opponent: a bitter enemy, especially one who seems unbeatable

Scapegoat: a metaphor, referring to someone or something that is blamed for misfortunes, generally as a way of distracting attention from the real cause.