The top reasons for home loan fiasco

The bank for all the central banks and the oldest financial institution called BIS – Bank for International Settlements is also the most respected bank. In its annual report, the bank details the global financial crisis which warrants a closer look.

The major culprit claimed to be the reason behind the home loan fiasco is unrestrained credit growth and asset price inflation. The current steep fall in the global share market and downturn in most of the rapidly growing economy is unprecedented in the post war period. With the inflation rising steadily, one may wonder whether it is the tip of the ice berg and what the future may hold for all of us.

The main reasons cited for the poor credit crisis are formulation of loans of increasingly poor quality by the banks and selling it to greedy but gullible people who will in turn leverage on short term funding to increase the profits.

The principle reason assigned for the fiasco is the long period of easy money and laxity in the supervision in its implementation. The after shocks of the home loan fiasco still continue to echo among the financial markets and no country is an exception. The entire global economy is at crossroads.

While rich countries are facing the deflationary pressures owing to the collapse of the housing and financial sector, the opposite is true in the case of growing / developing economies like India and China where resurgence of inflation is a cause of concern. Nevertheless, global slowdown in the economy due to high inflation causes uncertainties, which are mammoth in nature.

The flow of funds out of the US has started and it is now looking for safer sanctuaries. Emerging markets like India may not be opportunistic in inviting the flowing find because India is not in the list of preferred investment destinations.

But don’t loose heart with all these negative points. There is a thing to cheer about. What is it? The crude had started falling down notwithstanding its continuous scorching pace of upward climb. Hope it would come down below the magic barrier of $100 a barrel. It will definitely sound good for one and all in the days to come…

What are the reasons for falling stock market?

The stocks around the globe especially the Indian and Chinese markets are experiencing a free fall. Everyone is proposing his/her own hypothesis for the fall in stock market values. Many reasons are attributed for the fall and it includes inflation, rising global crude prices, weak currency especially in the Indian and US currencies. Recent trends in the market reveal that fundamentals apart, perceptions have a big role to play in what investors are willing to pay for the stocks.

The following aspects are considered as major reasons for the fall of stocks of Asian economies and particularly India, which witnessed one of the worst nightmares in recent times.

Prices of crude oil
Within a price band of US $93-95 during the end of December 2007, the crude basket almost shot up to $144 a barrel, a hike of nearly 54% and nobody knows where it will stop or at what higher limit it will stabilize?. A rising interest rate in US, weakening US dollar, political uncertainty in oil producing countries (OPEC), and a drop in stockpiles of oil reserves in US are all negative points pushing up the crude prices. In any growing economy that imports crude to satisfy its ever growing demand for oil, there will be an inflated import bill and a jump in trade deficit. The increased crude bill sets off successive chain reactions which hits the common man hard and results in a widespread rise in prices of all other essential commodities.

Inflationary woes
A rise in crude with concomitant rise in essential commodities bulges the inflation level and growing economies view it as one of the worst bottlenecks to move forward. Inflation affects the stock market investors in many ways. Higher commodity prices could reduce the profit margins of companies if they could not rise the product prices and inflation restrict the consumers urge to spend on lavish things like a luxury car or purchase of a new bungalow. In an attempt to reduce the inflation, the government will naturally intervene and increase the interest rate which will further squeeze the demand and big corporate companies will be compelled to postpone their expansion plans.

Political uncertainty
The refugee’s money is more sensitive to political turmoil and hence with the slightest political instability, the foreign institutional investors are ready to pack their bags. In India, with the left parties withdrawing their support to the Congress led government, the political crisis looms large on the face of the common man.

Global cues
The stock market in a country can not insulate itself against anything untoward happening in the neighboring nation and the stocks are bound to be affected, especially so when it is moving down. The emerging nations take the cue from the developed markets and both are dependent on each other. Since there is no sign of recovery in the US economy, it will definitely have a negative impact on the Asian economies which are already reeling under high crude prices and galloping inflation.

India tops in erosion of market cap

Continuing with our discussion on the stock market erosion in India, the equity values of the Indian stock market has gone down by as much as 42 per cent till now this year, giving the nation the dubious distinction of the worst performer among the emerging markets around the globe. When the losses are calculated by the foreign institutional investors, the losses would have been higher given the depreciation in the value of Indian rupee against the US dollar adding another 4% and the net loss would be 46% when measured in dollar terms. The fall is steeper in the small and mid cap stocks than the large cap stocks.

The current market cap of Indian stocks account for $968,526 millions after the erosion. But take some respite from another country that really performed poorer when compared to India. That country is Vietnam. Another regional neighbor that competed with India in economic growth too competed in the stock melt down is China which lost a whopping 42% worth, comes next to India.

Among the emerging markets in the Asia Pacific region, Australia and Brazil somewhat fared better and we can say they resisted the correction which blew through the entire globe. Their commodities fared well even during the correction phase.

To everyone’s surprise, the country responsible for the global melt down, the US with its sub prime crisis, has just shed 15% of its market cap and behaved in a very mature manner during the progress of the correction phase. Among the other developed nations, Japan lost only 9% of its market cap.

Here is a table showing the degree of erosion of wealth in different countries

Country Decline in Market Cap (%) Market cap to GDP ratio
India -46 0.9

China -42 0.4
South Korea -25 0.9
Hong Kong -24 9.0
US -15 1.3
Japan -9 1.1
Australia -8 1.2

Brazil -3 0.7
Mexico -0.5 0.5
Argentina 2 1.8
Source : Bloomberg

The Indian stock market capitalization overtook its GDP value for the first time in October 2006 and it went up to 1.8 during the market peak of January 2008. Another prominent player in the market is South Korea whose market cap to GDP ratio has gone down to below 1 in the recent correction. You may ask a question at this juncture? Whenever the value of GDP-market cap falls below 1, will it make the Indian stocks (or South Korean stocks) attractive? But the investment guru Warren Buffet is of the opinion that the value of less than 1 is a good indication about the attractive nature of any economy.