SMH - Crunch we had to have

Crunch we had to have
David Potts
August 5, 2007

OFTEN a market meltdown has little to do with what were the jitters du jour.

To this day, for example, nobody can point a finger at just why the sharemarket decided to have its biggest single-day slump back in October 1987, only that it was a bubble waiting to burst.

And so it is with the US-induced global credit crunch that's put the wind up sharemarkets. The sub-prime disaster, where borrowers got loans they couldn't afford to repay, has been the first symptom of what's gone wrong, but it may not prove the real problem.

Rather, there was a hint of it last week when a respectable US lender said some of its good customers were having trouble meeting their debt repayments. That's where the alarm bells should be ringing: if we've moved from a sub-prime to a prime disaster in the US, then the worst is still to come.

That's because mainstream borrowers who took out their mortgages when interest rates were at the ludicrously low level of 3per cent or so are coming out of the honeymoon period during which there were 12 rate rises.

Those low rates caused the subsequent global glut of liquidity and soaring asset prices which are starting to unwind. One thing's for sure, this "repricing" of their mortgages just as the equity in their homes is dropping away will be as painful to the banks as it is to them.

Considering the sub-prime fallout wasn't even in the banking system but among spruikers selling loans from the boot of a car, imagine what would happen if the market lost confidence in, gasp, an American bank.

Anyway, these dubious loans have been bundled up and sold to hedge funds by what the red-braces brigade called collateralised debt obligations (CDOs). More like collateral damage in overdrive.

The junk is hidden behind the good stuff, taking advantage of the fact that the market, in reality them selling to each other, would spread the debt around so far that it wouldn't matter.

Worse, the funds that bought them were borrowing as well, so it was really debt buying debt. No wonder it's all unravelling now, except that perfectly safe debt, such as corporate bonds, is being swept into the maelstrom as well.

And while corporations, both in the US and here, have been cleaning up their balance sheets by paying off debt, the banks have been running up theirs, cleverly disguised as derivatives, which is a debt on a debt over a debt.

So, to coin a phrase, this is the credit crunch we had to have.

Just nobody panic.