Subprime Mortgage Market – The tip of the iceberg

Is the subprime mortgage market just the tip of an iceberg? Well according to an 23 page report written by Daniel R. Amerman CFA and available on his web site “The Secret Power Within Your Mortgage“, it is. Please spend some time on his site it is excellent.

So how does this affect Baby Boomers and their nest eggs?

Most Baby Boomers who have a nest egg will have seen it eroded in the recent subprime debacle. If it isn’t the nest egg it is our house prices or it might be both. And we have taken a financial hit through no fault of our own.

However this may well be small beer when compared to what might be a credit derivative tsunami. You see according to Mr Amerman the credit derivative market is 30 times larger than the subprime mortgage market. I’ll repeat that – it is 30 time larger and if it goes the way of the subprime mortgage market we are in for a lot more pain.

The US Financial system has already socialized the losses on the subprime mess in order to protect the banking system. So what do you think they will do if the credit derivatives market starts to crash too? Its a $35 trillion problem.

Mr Amerman has written a free report called, “Credit Derivatives Dangers in 2008 & Beyond” which I believe is a must read. The prior report called, “The Subprime Crisis is Just Starting” is also on the read it now list. Here is just a small part of this very informative report to get your interest.

We all believe that competition is good for business, right? But where credit derivatives are concerned this may be totally wrong. Many assumptions have to be made about taking on a credit risk for a loan an institution makes to a major investor. Clever use of these assumptions can win very lucrative business. But more importantly by making only four minor and quite reasonable changes to the assumptions a firm can reduce their expected losses and double their profits.

What Mr Amerman adds is that if a firm can double its profit, then if you work for that firm you can double your bonus. So everyone quickly learns that making more and more aggressive assumptions that lower potential losses will give them increasing larger bonuses.

Then your senior manager approves the assumptions because they don’t want to spoil their bonuses when these assumptions look so reasonable on paper. So they sign-off on it. What competition does is to make each firm out assume the other to get the business.

It leads to what is called thermal runaway in engineering terms. One firm outbids another with their assumptions so the next time around the other firm makes more aggressive assumptions and it wins that business. And so it goes on until…..

The really sobering statements made by Mr Amerman are these,

“… this process … may have very little to do with maximizing long-term shareholder value.”

“As an individual you can make more money in one good year than a doctor or airline pilot can make in a career.”

“You can mint profits by the billions and tens of billions. without going through that messy business of actually building things, or selling toilet paper, or drilling for oil in two miles of ocean.”

It’s as if Wall Street set up it’s own internal trading system for extracting excessive profits for itself without adding value for anyone outside its own little world.

My own view is that our money has been used to leverage these investments to the benefit of the Financial Institutions and their people to the exclusion of “normal” investors. Virtual wealth has been created but as Mr Amerman points out bonuses have been paid out using real money.

There is far more to the report than I have covered here. It makes fascinating reading as well as informing you of what might be the next thing to attack your nest egg.

If you don’t think it will happen Mr Amerman has added this to the end of his report,

6th June 2008 – Moody’s is on the verge of placing an all-time record $772billion of corporate dent on credit watch. And downgrade the Aaa rating of both bond insurance companies MBIA and Ambac.

It’s not all gloom and doom though. From page 20 on he talks about how to protect your nest egg by investing in tangible assets. Then he says you might want to look at potential opportunities that could be available in the markets.

But the one thing he says which is the main aim and theme of this blog is, ” You are going to have to educate yourself, and work to not just understand, but to master some of the financial forces and methods in play here”.

May I say again – Please educate yourself. You might start with my $9.97 eBook downloadable from here. 😉 I will be increasing the price from 1st July.

Let me close by saying Mr Amerman has a workshop called “The Turning Inflation Into Wealth Workshop” you can attend to learn what you can do to protect your nest egg in retirement.

4 Responses to “Subprime Mortgage Market – The tip of the iceberg”

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  3. […] the subprime debacle and a looming potential disaster in the credit derivative market if any one ever tells you to invest for the long term and hope the […]

  4. […] I have written an earlier post on Dan under the topic, “Subprime Mortgage Market – The tip of the iceberg“. […]

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