NEWS | Wednesday, 05 March 2008

James Bond, the Sub-Prime Market Crisis and the Credit Crunch

Bond has a strong reputation for being a secretive security in time of volatility. Distinct by nature, Bond would sit at a distance from the treacherous volatility of the equity markets. Bond is also particularly well known for the strong characteristic suavity of interest income.
I hope Ian Fleming can forgive me for the pun, however, as an investment analyst, in times like these my creativity is allowed to roam freely in order to think out of the box and devise methods to take advantage of the current economic situation.
A lot of readers may be wondering about the source of volatility in financial markets, others may be curious about what, in reality, is this hullabaloo about the sub-prime market crisis.
Well the sub-prime market is plain and simply the US market in which poor credit-worthy individuals borrow money. I know what you’re thinking. What sort of madman would loan money to a person who has already defaulted on his loans or credit card payments. Well, the truth is that there are a lot of madmen, for that matter, a whole market of them. In fact there exists a specialised market in the US which loans money, obviously at a premium, to individuals with poor credit ratings. Banks and Financial Institutions charge these individuals higher rates of interest and request higher guarantees. The problem evolved when the Federal Reserve started raising the interest rate. This action led individuals to default on their interest payments and in turn put stress on their already tight repayment schedules. This resulted in individuals defaulting en mass, houses placed as security were re-possessed by the banks and cleared from incumbents, creating ghost towns – entire towns composed of deserted homes. The effect was simply yet drastically, a drop in house prices further aggravating the situation and leading to a crisis.
One of the major consequences of the sub-prime market crisis was to make lenders more weary of who they were lending money too. This corollary led to the immediate soaking up of any liquidity in the markets. Investors feared that the far reaching effects of the sub-prime market crisis would get to the issuers of securities; these events were conducive to the decline in demand for bonds and equities, and hence led to a fall in their prices. In times like these, times of uncertainty, commodities such as Gold are used as a safety repository. A fact James Bond’s archenemy, Auric Goldfinger, was very familiar with when he planned Operation Grand Slam, which involved the contamination of the gold reserves at Fort Knox. To further emphasize the above point, since the sub-prime crisis has come to light, the price of Gold increased by 42.54% to close at a spot price, as at 30th January 2008, of $929.40 per troy ounce.
Interest rates across the US and UK have started receding, with the US leading the way. In the last five months the Federal Reserve dropped the rate from 5.50% to 3.50% over four rate decreases; almost one a month. The Bank of England has decreased its rate in November from 5.75% to 5.50% and still has the highest rate in the pack. The economic policy in the Euro zone remains the most stable of the group with its rate currently standing at 4.00%. This dovish approach from Central Banks will surely reduce the illiquidity and should assist Bonds in getting the upper hand over the crisis, in the same way that Pussy Galore assisted James Bond to defeat Goldfinger.
You don’t need to be a financial analyst to see the conclusion, being a film buff is sufficient. In line with all Bond films, the crisis is expected to be weathered by Bond, leaving his persona slightly battered though ready and rearing to provide infallible service to queen and country. In the long-run, Bonds too have always provided infallible service and can always be counted on to bounce back into portfolios in the aftermath of such crises.
Andrew-Neal Farrugia B.Com., B.Accty. (Hons), BSc. (Hons), MSc. (Edin), ACIB, AIA, CPA. is a Certified Public Accountant and Economist. He is the Assistant General Manager, responsible for research and investment strategy, of GlobalCapital Fund Advisors Limited, which is licensed by the Malta Financial Services Authority. This Article is published for informational purposes only and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments.