rams a test for sub prime, page-10

commodorecaptain,

A couple of points:-

However, the credit crunch and gridlock in the commercial paper market is not tipped to take 'months to resolve' - the central banks CANNOT AFFORD this to happen.

I entirely agree. However, who ever said that central bankers are doyens of understanding and sharp-witted, incisive decision-making?

September 5 – Financial Times (Jonathan Guthrie): “The credit crunch has “sown the seeds of a very major downturn,” according to Jon Moulton, the prominent ­private equity investor… The scenario sketched by Mr Moulton in a speech in Birmingham will add to foreboding among non-banking businesses over the tightening of credit. This has seen inter-bank borrowing rates rising to historically high levels above the Bank of England’s official base rate. The private equity investor said the Bank was hampered in its efforts to manage the crisis by its sketchy knowledge of such important debt vehicles as collateralised loan obligations (CLOs). These are securities backed by leveraged loans, which can include US subprime mortgages and whose creditworthiness may be questionable. Mr Moulton said that during a breakfast meeting with Bank officials ‘it became clear they did not know what a CLO was. I had to show a senior man [by drawing a diagram] on the back of a napkin… It was really reassuring to see they did not know what was going to explode on them.’” [emphasis added]

And don't go thinking it's just the Brit's who have these problems. At the end of the day, RBA staff are tenured (and often cloistered) public servants.

It has lasted just over 2 weeks sofar which completely baffles credit market participants and none IN THE INDUSTRY would expect it to last another couple of months - that would be HISTORICALLY UNPRECEDENTED and hugely damaging to the financial infrastructure as a whole (not just minor players like the non bank lenders).

This, now, is what you must all understand. If you look at graphs of past housing booms as a percentage of disposable income, you'll see that this one blows all of the others out of the water. Why? Because of the rise in the mortgage origination business.

In the past, lax liquidity settings by central banks allowed the commercial banks to lend a greater percentage of their capital out than usual. However, they always had to be mindful of the fact that those loans would remain on their books until term, so even in "aggressive" environments, they still maintained some standards.

Additionally, when the credit contraction was seen as overdone, they were all in the business of banking: many had seen this kind of thing before and knew what an overdone market looked like. Additionally, their ongoing business relied upon the market continuing to function, so eventually they rolled up their sleeves, said a prayer and started lending again.

This time, it's different. Banks stopped being the major "lenders" in this cycle some time back. Instead, they've made way for the originators, who find and write the mortgages, package them up and on-sell them to pension funds, insurance companies, hedge funds, etc. Indeed, the banks have also gotten in on the act, increasingly acting like originators, rather than traditional banks.

These "new" investors in the mortgage world don't have the same understanding or corporate memory of why lending standards exist, or why it's not a good idea for to over-extend credit to the unworthy. They just see the promise of above-mean returns. They've been seduced by the marketing and the packaging. They've been the fuel that's caused this fire to rage far higher than ever before.

However, now they're scared and burned. Importantly, while the overall world mortgage market is huge, these new investors don't have it as their core business (in the way banks do). They might have had, say, 5% of their investable funds in MBS and ABS products. They have other alternatives for investing and, have suffered losses and experienced heightened fear, if you think they're going to be returning to this market in one month, two months, or a year, I believe you're sadly mistaken. They're not returning anytime soon.

That leaves a big dilemma for these markets. If just the traditional banks, with their traditional lending standards (albeit adjusted for a lax liqudity environment) had been in charge throughout this real estate boom, I believe that they would have stopped lending when house prices were somewhere between 25% and 35% below current levels. Now, they are scared too and they won't be taking a "business as usual" approach, until they start to see fundamentals at a level where their internal metrics flash, "green".

Therefore, I don't see the banks coming back into this market in a big way until prices fall substantially (they're in survival mode, at present).

The focus of discussions here recently is whether or not RHG can roll over its $6bn XCP facility in 6 months. I think this is a case of forests and trees, people.

I don't see that as the most immediate concerns for you shareholders. They have shorter term facilities which I'm sure are being reviewed on a daily basis by their bankers. However, and most importantly for shareholders, where and how are they writing new business?

Remember, they only have $1m of net assets. The moment they cannot write new business, they are in deep strife. Don't worry yourselves over the $6bn XCP six months hence. If RHG survives that long, it will have weathered the storm, IMO. The question is, how are new originations going and where are they placing all of that new business, ATM?

That's the question which has been exercising my mind and I don't have an answer. However, I find it extremely hard to believe that it's all hunky-dory, business as usual.