Risk Repriced as Subprime Credit Problems Become Prime Credit Problems

“Risk is being re-priced,” said US Treasury Secretary Henry Paulson. But don’t worry; he went on to add that there was “no threat to the overall economy”.

How much do you have to pay someone to say such soothing lies? Paulson knows far better than most people that there is plenty of risk to the overall economy. He and everyone else in a position of financial authority must be worried about it – perhaps desperately worried.

But that won’t keep them from lying to Americans…after all, ignorance is bliss – and bliss doesn’t deter you from buying your new SUV, overpriced painting or Coach bag. Nope, they have to keep filling everyone’s heads with nonsense to prop up our faltering economy – and they have no problem bankrupting you while they are at it.

First, there is the direct problem that the crisis in the subprime market may be infecting other parts of the credit market. “Subprime crisis shows signs of spreading,” says a headline in the Financial Times. What? Is the FT just imagining things? We don’t think so.

“Bonds hit by credit dip,” is a follow-up headline in the FT. And one of the largest hedge funds – Sowood Capital – reports a 10% loss for the year in its US$3 billion fund.

It would not be at all surprising if subprime credit problems soon became PRIME credit problems. It would be surprising if they didn’t. Whether you are referring to financing mergers and acquisitions…lending money to emerging markets…or mortgaging doublewide trailers – the phenomenon is essentially the same. Lenders made money by originating loans…not by following them to their completion. Financiers got rich by making deals…not making sure that the deals actually increased shareholder value. And hedge fund managers earn their money by speculating…not by guaranteeing that their bets pay off.

As more and more liquidity became available…more and more bets were placed. And like everything else in life – almost everything – as quantity increases, quality decreases. Soon, the mortgage industry was lending money to people who clearly could never pay it back. Hedge funds were underperforming the market indices – and still charging 2 and 20 for it!
And the big private equity deals seemed to make less and less sense.

As long as the credit bubble was expanding, everything looked good. The marginal borrower could always find an even more reckless lender to give him money. It was a system in which people made their money by providing credit to other people who weren’t really credit-worthy. What can it do but implode?

This is similar in some respects to what is happening in Zimbabwe. There too, people have more and more money available. Still, the system is falling apart.

Another thing that must be worrying financial officials is the yen. It is going up. When the yen goes up, it puts speculators in a tight spot. They’ve bet hundreds of billions that they yen wouldn’t move. They borrowed yen to fund speculations. If the yen goes up, many of those gambles will blow up. Between the rising cost of credit…and the rising yen…how many speculators are already in trouble? We don’t know…but we will find out.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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