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The world forgot about the basics of practicing economic prudence while Ukraine must come to real terms about its own state of economy

In my financial education, I was taught:

1) Just because something is being traded at a particular price today, it’s not necessarily the “right” price, and 2) above all other fundamentals, try to understand the supply and demand picture of any given scenario.

To begin, briefly, how did this global economic crisis come to be?

Some may remember that about a year ago, there was a small mortgage bank in California that went out of business. It had been heavily exposed to something called “sub-prime” mortgage debt. We all are familiar with the term now, but what exactly is “sub-prime?”

Well, it can also simply be called junk. It was debt that was taken on by people who wanted to live the American dream and own their own castle or palace. The lenders, in these cases, gave people money with no background checks. People just turned up at the bank, told them how much they wanted and the banks handed it over, often at “loan-to-value” ratios close to 100 percent.

Why were banks lending so recklessly? The answer lies in supply and demand. There was so much money in the global economic system that lenders and investment banks had to come up with increasingly sophisticated ways of getting that money into the hands of others who would pay interest on this money.

Sub-prime lending was one of the tools for doing this.

Then some “risk manager” decided that if they would lend money to people at clearly dangerous levels, then they should have a margin over good-quality debt of maybe an extra percentage point or two. That, in their estimation, was enough to take out some kind of insurance against the debt going bad. Such insurance was conveniently packaged by the investment banks (like Lehman Brothers) into things called credit-default swaps. And those credit-default swaps, as they are known, were then underwritten by a big insurance company, somebody like American Insurance Group.

All well and good. Everyone gets a little bit richer and, on the surface, it seems like money for nothing. Well, money doesn’t come from nothing. It has to be earned by creating something for which there is a demand.

I have long held the opinion that the United States is a market in which value has been added through creating a perception of something being more valuable than it really is. And my thoughts on U.S. stock markets are that just because they were as high as they were, it does not mean that they were being traded at the “right” price.

I was taught an expression by an American acquaintance a couple of years ago: “perception is reality,” he said.

Well, no, it isn’t.

What we are now seeing is an unraveling of a myth. And while it is pretty spectacular and has to be hurting a lot of people, it’s not all bad, at least not for Ukraine. The nation has a different set of problems here that need to be tackled.

Around the world, we have been seeing a huge selloff in stocks. Ukraine’s stock market has lost 70 percent of its “value” since the beginning of the year, but who is to say whether the price of the index at the beginning of the year was “right” or whether today’s price is “right?”

When we see, as another example, the Nikkei in Tokyo go up by 14 percent in a single day and then fall back by 10 percent a couple of days later, it’s fairly obvious that we are experiencing markets reacting in a chaotic way to chaotic conditions. We are seeing huge share selloffs because, while panic continues to reign over common sense, there is no sense as to where or when the bottom of this might be.

We also hear politicians calling for punishment for fund managers and bankers who have taken “excessive risk.”

In whose opinion is the risk excessive?

Certainly, we are seeing exits of investments in Ukraine and this risk aversion is one of the reasons for that. My belief, though, is that the risk here is a perception, rather than a reality.

And this is when I go back to my opening remarks. What is the fundamental position globally and for Ukraine, both domestically and as part of the global financial system?

Well, globally there is certain to be a recession. Economies that have been inflated beyond their real worth now have to contract.

That will have an effect on Ukraine as demand for Ukraine’s exports – steel, for example – will reduce. Then also, as global corporations look at their internal risk, coupled with how much they themselves are frozen because of the credit crunch, the expansion of various industries and services into Ukraine will slow down. Therefore, we may well see a cooling in the job market across all sectors.

These things, in themselves, do not spell doom and disaster. The main players in the steel industry are certainly  insulated well-enough in terms of other assets that they have “acquired” over the years to ride this out for a year or even the rest of their lives…

A cooling in the job market? Good!

    • This entry was posted on Thursday, October 30th, 2008 at 3:28 amand is filed under California Home Loan Rates. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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