The entire market in subprime debt is just 1.4% of the size of global equity markets. Or, to put it another way, a 1.4% downward fluctuation in stocks erases the same amount of value as if all subprime-backed bonds were collectively marked to $0.
Here is the link.
Why not put it another way and say that a 1.4% upward fluctuation in stocks offsets the entire amount?
The dollar value of the loans or present value of the future cash flows? These are different things.
Hank,
I’d think it’d have to. If I buy something for X with leverage/margin, what essentially happens is that somebody loans me the money to buy the portion of the asset I don’t pay for with cash. But in the end, nobody pays more than X. The cash might come from me, my creditor, the person he sells the debt to or whatever, but the total amount of the purchase transaction is still X.
This might _inflate_ the apparent size of a given market. If each resale of the initial debt is captured as a separate transaction, the whole machine might look bigger than it is. But in the end there is some asset bought and sold for X.
Of course, I didn’t read the link yet. :^)
These are distinct markets. This number is pulled from a larger
study done by the Bank of England that estimates equities at about
$50 trillion globally, with mortgage related assets more like $10
trillion, with the subprimes estimated at about $750 billion,
although there is another $650 billion of “alternates” that could
become subprime easily, making the total more like well over 10%
of mortgage assets. Mortgage assets and equities do not generally
trade or balance with each other. As noted in the Fin Times story
on this, the logic of “tipping points” in financial markets, especially
in a situation where nobody knows where the junk is (and risk spreads
are widening again, as they did in early August), means that this
1.4% number is basically a meaningless joke.
The Dow and NASDAQ both coincidentally fell the exact same amount today: -1.66%, which is more than 1.4%. Now, why do you suppose this (far from unique) event will generate much, much less coverage in the financial press than the subprime crisis has?
Gosh, I don’t know… maybe, just maybe, there is a good reason for it, no?
HankP has hinted at the answer.
It’s reminiscent of 9/11, where the collateral financial damage far outweighs the loss. In both cases you essentially see the magnitude of losses related to (irrational) risk aversion and complacency.
Yeah so? It does not matter–Dr. Cowen lets review finance 101. Subprime and prime mortgages are debt–not equities
So sub-prime is equal to 5% of agricultural otuput. Equity not equal to debt! Yeesh, you can always
tell a Harvard Man but you can’t tell him much. Hang a tad more w us finance faculty-we like economists and we like to explain a few things too…….
Subprime losses do not hurt the same investors than equity losses. It looks like of a subprime market of
around USD 1,400bn, USD 400bn could be at risk. A high proportion of these losses will be borne by financial
intermediaries. That makes a quite a difference to normal equity losses! Financial intermediaries will
(or must) react to the decline of their equity by deleveraging their balance sheet. Assuming a leverage
factor of 10, this would bring banks’ balance sheets downt by USD 4,000bn. That’s not a small number.
Major differences:
-The stock market has a chance of going back up after a 1.4% fall.
-A full subprime default woud be concentrated a lot more.
This ignores the effects of higher lending costs, which hit equities even more and reduces investments, and derivatives. Not to mention many of the other things stated above, such as lowering the value of other real estate. What you said is akin to setting up a row of 100 dominoes, knocking one over and saying, “What’s the big deal? I only tipped over 1% of the dominoes.”*
* Not to say that subprime will knock over the entire economy, but it reaches further than just the loans that are attached to it.
Sorry for the quadruple post.
The real issue is that the subprime loans are just the canary in the mine, whose keeling over has made it common knowledge that the entire mortgage lending business was shot through with fraud and egregious negligence, from the mortgage brokers up through the mortgage lenders to the investment banks that securitized the worthless loans, and the agencies that rated the securities.
Until that fraud and negligence was revealed, anyone whose employment depended on maximizing yield would have been called on the carpet to explain why they weren’t buying those high-yielding mortgage-based securities. Now that the story is out, it will be exactly the opposite.
It’s not just the subprime loans that are bad, it’s a large fraction of the mortgages made in the last few years — many, perhaps most, of those “Alt-A” ARMs and negative-amortization loans will go bad as the resets hit.
And it’s not just the losses on the loans that default. The valuation losses due to the coming 40% fall in home prices* will erase $8 trillion in wealth — and more than a little of it not just as paper losses.
And it’s not just the US — most of Europe has been in bubble mode, and so has China.
And it would not be surprising if a knock-on effect were to be a descent of stock market P/E ratios to typical bear market levels along with declines in earnings. So a $25 trillion drop in the $50 trillion global stock market valuation may be in the cards.
The increase in global asset valuations since the mid-90s has been quite remarkable, and probably has greatly outpaced growth in real value. It would not be surprising for the illusory wealth to disappear, and for valuations to overshoot to the low side just as they have overshot to high side.
(*as they fall back to their historical average ratio to incomes)
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