Butterfly Effect and Butterflies in my stomach

Chaos in the Markets – How a home loan default in America hurts investors in India

The recent crisis in global equity markets as a result of the sub prime mortgage meltdown in the United States has caught many investors by surprise. Economic fundamentals of most global markets had no major changes yet the disturbances were severe enough to erode and nullify recent rallies in the market. The subsequent panic caused in world currency and equity markets were severe enough to raise multiple levels of concerns in central banks, governments and the investors. What analysts worldwide called a re-rating of risk appetite has led to severe loss of appetite for many investors.

While on one hand it points to the increasingly close knit network of the world financial economy with all its subsequent gains in efficiency and capital investment, it also points to a new area in evaluating equity valuations in varying times of global risk. It is thus necessary for the Indian investor to understand not only those markets in the world are now strongly co related but also the macro economic drivers that affect various markets including hedge funds , sub prime markets, and the US federal bank’s unparallel influence beyond its borders.

Introducing the Butterfly Effect- The butterfly effect is a concept in chaos theory. It refers to the idea that a butterfly’s wings might create tiny changes in the atmosphere which could lead to a tornado appearing somewhere else. Thus changes which apparently seem random are actually caused by small changes in the initial system. The flapping of wings represents a small change in the initial condition of the systems.

Similarly the loosening of credit in the United States sub-prime mortgage system partly due to the increased liquidity in the system and collateralization of loan based collaterals to financial intermediaries has caused the widespread chaos in the worldwide financial systems. Simply put, there was too much money in the market that mortgage companies could easily borrow, and transferring risk was also easy due to securitization of these loans. As a result, while financial discipline was lost while lending to a booming real estate market, the risk was systematically transferred and in fact hidden during the collateralization process to the whole financial system.

Quite notably, the about turn by the United States Federal Bank also caught the market by surprise. By cutting the inter –bank lending rateand the later the key Fed rate, the Fed ,led by Bernanke in it’s first crisis since the post Alan Greenspan era, effectively did a volte-face on it’s previous stand of waiting and watching. Indeed markets in Alan Greenspan’s time used to talk of the Greenspan put – basically a concept that is asset prices tumbled too far the Federal bank would step in to take control.

Note: This has important lessons for even Indian lender. In the United States median house prices almost doubled from 1993 to 2005, while incomes rose just 49 percent. In India, the real estate boom has been even faster and thus the increased danger of the bubble bursting.

The recent crisis also pointed to the fact that Indian Markets continue to be sensitive to downward global cues, to the point of ignoring value investing. The concept of value investing was created by Graham –Dodd and most successfully used by Warren Buffet. It said that it was better to concentrate on the fundamentals of the company and expected cash flows rather than try and anticipate its future price. The metric used was the long term rice to earnings ration of a particular stock. Thus the ups and downs of the market have actually taught both the retail and the institutional investor the fundamentals of investing on actual value rather than be caught up in bearish or bullish swings.

At this point, the recent record fund raising by mutual funds is also an increased area of concern. The regulators led by AMFI, SEBI and the RBI should focus that mutual funds are sold transparently with easy to understand tables of disclosures, and adequate amounts of effort is spent on educating the common man, who is the worst affected in any stock market bust.

Bulls ,Bears ,Tigers and Asses

Bull and bear in front of the Frankfurt Stock ...
Image via Wikipedia

Behold the once mighty Bear Sterns

One haughty, now sold for pennies in turn

Its a bear market they say,

Which made Bear Sterns fall away.

The Bulls were rampaging ,

for many a year or two.

Now its the bears turn,

to ravage me and you.



The tiger economies ,

are falling like pussy cats,

As exotic mortages ,

turn fearless men into scared rats.

In between , you will

find an occasional investment guru /ass too.

Promises to know it all, seen it all,

Pontification on TV for you.

Is this a market, we ask,

It seems like a jungle out there,

Leave us in peace, O Wise Ass,

Screw the bulls, and Kill the bear.

Why Expensive Oil is Good for your Mortgage

Here is an analysis of US Income, thanks to Gapminder , another company acquired by Google Inc http://preview.tinyurl.com/37n6qe


US Income has risen steadily ,despite the Korean War,Vietnam War ,Cold War,Iraq War(s),Oil Shock(s),Japanese Imports, Chinese Imports, Indian Outsourcing.

The simple reason is that a flexible economy is more efficient at using capital than any other economy and the US continues to show the maximum readiness to deal with crisis urgently and with flexibility . Take the sub prime crisis in which the Fed is effectively financing the mortgage debts by its revenues (by sale of Treasuries) to the rest of the World.

Now ,coming back to the title- Why expensive oil is good for you ?

Well ,one thing, Arab terrorists don’t get even a fraction of Oil money. In 50 years of continuous oil revenue, hundreds of billions have been invested by Arab countries in the US financial system , which continues to be the safest and most reliable system in the world. The 9/11 attacks cost only 1 million dollars, and money to terrorists is not an issue because of the much less cost in buying truck bombs, etc..

Well , if Oil rises to 104 Dollars a barrel, where do you think the Arabs will invest those dollars- estimated to be 1-2 trillion of additional global liquidity. Would you prefer Arab countries to have enough money to feed and educate their populations or would you want them to be unstable , with lesser money. Same is the effect of extra money on Russia. Well fed populations are less likely to be frustrated and resort to desperate attacks.

The answer is those dollars are likely to flow back into the US financial system giving Wall street more liquidity than the Fed can give, Arabs and Russians more pride and less frustration, and the banks are less likely to foreclose if they themselves have money in the bank.

Remember banks want to make profits and that can happen if you pay their loans for longer tenures.

Thus expect banks to reduce mortgage payments by increasing tenure, rather than foreclose too eagerly and invite political scrutinies and backlash.

And the Arabs may just save the day for the US financial system.

This is an example of Adam Smith’s invisible hand… Think about that.

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