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The End of Easy Money- by Greg Strid

The End of Easy Money

Stock markets around the world have been slapped
around the past few days, with the worst carnage
occurring today. The venerable Dow and S&P indexes
were each down by 2.3 percent, and the tech-laden
Nasdaq was off 1.8 percent. Losses of 2 percent were
the norm across continental Europe; the greatest pain
was experienced in Great Britain, which suffered a loss
of 3 percent by the end of the day’s trading.

This is the worst week that global markets have
experienced since February, when panicky Chinese
speculators were suddenly clobbered, igniting a
worldwide rout in stock prices. (This decline, however
was short-lived, and stock markets proceeded to
climb to record-breaking heights shortly thereafter.)

The winter drubbing was initiated by rumors of a
clampdown by the Chinese government on the growing
number of speculators using borrowed money to gamble
on shares. Then, in the U.S., fears were rising about the
health of the subprime mortgage market as companies
that peddled these toxic securities were failing in
increasing numbers.

But, the global lines of credit remained intact, fueling
the private equity feeding frenzy, and corporate buybacks-
both of which reduce the supply of shares outstanding,
therefore providing overall price support for equities.

Much of the renewal of good spirits had to do with
the fact that the subprime implosion seemed to be
contained, and Japanese interest rates remained low,
and more importantly, the value of its currency did
not rise. This allowed the infamous ‘yen-carry trade’
to fuel leveraged speculation in stocks and high yield,
aka ‘junk’, bonds around the globe. Speculators
borrow the Japanese yen at very low interest rates,
and then invest in higher yielding securities across
the globe. The trade works as long as the yen does
not rise in value.

Unfortunately, the subprime debacle is gathering
steam, refusing to comply with the sunny forecasts
that are still being touted by Wall Street and the
financial media. Two rather large hedge funds- both
of which used borrowed money to purchase these
bonds- collapsed a few weeks ago, leaving serious
dents in the portfolios of those foolish enough to
have taken the leap into this pit of questionable
securities. Bear Stearns, the investment bank that
managed these funds into the ground, sent out
“Dear Valued Client” letters in a vain attempt to
assuage its unfortunate, or should I say, unwise,
clients. And, with each passing day, new losses
related to subprime securities are popping up
around the globe.

Now there is another gorilla in the ointment:
the Japanese currency is starting to strengthen as
gamblers buy back the yen as they unwind their
risky trades. The reversal of these trades, and the
corresponding strengthening of the yen, will
remove a linchpin of support for the price of risky
assets around the globe. If speculators are denied
access to such a deep well of easy credit, then the
bids for a wide variety of assets around the globe
will diminish. This will have a knock-on effect,
forcing leveraged players to liquidate positions
before prices collapse further, and margin calls
force them to sell at debilitating losses.

The speculative gig may be up. It is already harder
to borrow money to buy a home due to the beating
many investors are experiencing as increasing
numbers of subprime mortgages-that were magically
transformed into investment grade bonds- are
deemed worthless. And now, with the appetite for
risk diminishing as credit becomes more costly, the
lords of high finance may have the plug pulled from
their prolonged orgy of excess.

© Greg Strid 2007

© 2007 Splendid Marbles.