This time, the markets have a compound fracture. Housing is not the sole problem. Instead of sub-prime, it is the Alt A loan portfolio that is at risk. Banks are not recognising the second lien on homes and mortgage rates have not fallen to the extent of interest rates.
Taxpayers are borrowing more against their 401(k) savings. High crude prices are giving markets a rude shock. Outstandings in the derivatives segment are higher compared to earlier months and we happen to be in May, a notoriously bad month for equities.
Alt A is a type of home loan offered to borrowers who have credit ratings within regular Fannie Mae or Freddie Mac guidelines, but who require non-conforming loan terms. These terms can include higher than normal loan-to-value or debt-to-income ratios. Alt A loans usually involve interest rates that are slightly higher than those for conforming loans.
The ALT-A crisis may make the subprime crisis look like a bump in the road. The ALT-A space collapsing could cause a much larger crisis for the broader economy because ALT-A loans cut across all socio-economic boundaries and were used most heavily in the US's most affluent regions.
Banks are suddenly not recognising the second lien on homes. This route was used by house owners to borrow on the basis of the equity on their homes. This will have an impact on retail spending.
More From This Section
Despite the Fed slashing overnight federal rates to 2 per cent from 5.25 per cent earlier, credit is dearer and less available than before the central bank started lowering rates.
According to the Fed's survey, 68.7 per cent of banks had tightened standards for residential mortgages, up from 66.7 per cent in the previous survey in January, and twice the percentage of the peak in 1991. That's the typical shutting-the-barn-doors-after-the-horses-have-bolted response to the explosion of delinquencies.
An increasing number of hardship loans are being taken out against 401k savings. At the end of 2007, 18 per cent of employees with 401k plans had loan balances outstanding from their plans, up from 11 per cent in 2006. Employers report that workers are beginning to reduce allocations of pretax income to 401(k).
The world is beginning to veer around to the view that crude's buoyancy is as much a function of the demand supply scenario as a function of the weakening dollar. So a strong dollar in the future need not necessarily result in crude being torpedoed.
While the government will still protect the consumer from paying higher prices for petrol, diesel and LPG, the nation will pay a price for the mounting import bill in the form of an increased budget deficit.
This will mean a weaker rupee, which will mean a strong dollar for us and oil companies will pay a higher price for their import bills even if we could find a magic wand to freeze crude prices to where they are.
Meanwhile, in our markets the investors are back with a bang. Stocks are being bought on margins again and punters are beginning to build positions in the F&O segment as well. Though the outstandings at Rs 70,000-odd crore are not even half of the peak open interest, they are nevertheless large enough to create a flutter as the Nifty has breached the 4,980 mark.
The 5,000 strike price in the Nifty also happens to house a quarter of all put options in the Nifty. The markets could fall further as these put writers now scamper to cover. A set-up like this usually results in a larger fall down the line. At the time of writing it is not known how the US markets behaved on Friday. Unless they see a large rise, the Nifty may well be on its way to seek lower levels on Monday.
