My Experience with Subprime crisis

Entrepreneurship
Not everybody can be an entrepreneur to start business from scratch. I took an alternative route to participate in business through equities, with one single motive to own 26 % stake, one day, in one of the good companies…….AMEN…!!!. I’m well aware of statistics that 80 % of the new venture fails but the figure is not big enough to stop me from investing.

My Dreams
Stock Prices was almost at a kissing distance from the zenith with new zeniths being made everyday. I was just waiting to infuse my capital with a single dream of becoming Nouveau riche overnight. I overheard, now or never, this kind of bull market happens once in a life time.

Crisis Management

My little experience with stock market is that one need not to be a finance graduate, or a great economist, had this been the case LTCM (Long Term Capital Management) a US based Hedge Fund in 1990’s or more recent Lehman Brothers or Bear Stearns would have never failed. They have been picking graduates from best of B-schools and at high premium packages.

Discipline of Emotions

I know few consultants who have been recommending their client about impeccable business plans but fear to tread when it comes to investing their own capital, based on those plans. Great investors are not made with great education but with greater discipline of emotions. Always, invest in business that one understands well. The capital market is known to be greatly influenced by grapevines and speculation. Listen to everything but don’t react to everything. Sometimes to not act is to act.

The Beginning of the end

Last few years stock market was skyrocketing, wealth got multiplied as never before. My dream seemed nearby in the very next boulevard. Suddenly something hit the stock market and the wealth of investor’s got eroded in a big way. I called this crisis as financial tsunami but today it is more popularly called as Subprime crisis.

The Subprime Crisis begins

Low Interest rate regime
In retrospect, several years back when the American economy was in recessionary phase after 9/11 and dot com bubble burst. A challenge emerged in front of the then Governor of Fed Reserve Mr Alan Greenspan to drive economy out of slowdown. He introduced the monetary policy of low interest rates regime to boost economic growth. The idea was to infuse enough liquidity into the system. Reduced interest rate leads to enormous liquidity in the system resulting in increased lending and borrowing activities. Besides, low returns on other traditional instruments brought investors towards higher risky instruments to get better returns. The greed didn’t end here.
The Bubble
When greed comes they say it comes in jumbo packs. Companies in order to earn higher return extended loans to low credit worthiness people. This is what we termed as Subprime lending. In several instances, initial teaser interest rate was introduced which later was gradually increased. Besides the subprime borrowers had poor track record of repayment hence lenders gave loan at a higher interest rate to them. People with limited financial strength borrowed large sum of money which was readily available and invested in housing property. This lead to housing boom in US market.
It was taken for granted that the way asset price was inflating even the subprime borrowers can pay back the loans easily. Many Big Hedge Funds and Financial Institutions found the investment in sub-prime to be very lucrative and made big exposures.

The Fall of Giants
People bought assets beyond their means. Gradually interest rate once again started rising which raised the cost of borrowing capital. Housing supply was already surplus however demand got saturated, and the property price started plummeting. Due to increased interest rate number of defaulters increased. The property value dipped below the value of mortgage loan itself. The investment started turning bad. Companies like Bear Stearns, New Century Financial, Lehman Brothers and several others have to file for bankruptcy.
Government sponsored enterprises like the Fannie Mae and Freddie Mac role was to buy up mortgages and sell them as mortgage backed securities to investors. This secondary mortgage market which got created increased the liquidity for mortgages lending and hence for fresh home purchases.
They made profit from the differential in the interest rates homeowners pay and the investors. As per estimate, together they hold or guarantee $5.4 trillion of mortgages, about half of the USA's home loans.
Both the institutions were expected to make huge losses which could hit US market badly. Federal took over the control of both the institutions.

Indian market

So far there is no news of direct impact of subprime in Indian market. However, FIIs capital inflow which was one of the key factors for the recent bull market rally in India got hampered. With recent bankruptcy in USA liquidity seems to have evaporated. External factors will drive the India market down in short term, however India is a domestic demand driven economy and has long way to go.

Today’s market

Today US Senate passed the $700 billion bail out package which will bring some relieve in the Indian stock market. Besides, the US has approved the nuclear deal of India.
Even God doesn’t know the movement of stock pre-hand but probability of favourable outcomes seems to be good and we can see positive rally today.