Subprime Pork Buns
(for MediaCorp 938LIVE’s Money Talks on 26 July
The secret of making delicious pork buns is to use
lean meat and the freshest ingredients.
But what if, after making the best pork buns, your
customers choose to buy cheaper ones from your competitor, whom
you know uses low quality ingredients, and whose buns taste
half as good?
In response, you could change tact and use lower
quality ingredients. If you are unscrupulous about it, you
could substitute the lean pork with cardboard.
That was what a few Beijing cooks were supposed to
have done. In a TV report shown recently, cooks in a dirty
courtyard were seen soaking cardboard sheets, and then chopping
them up. The cardboard pieces were then mixed with minced pork,
wrapped in dough, and steamed to create pork buns.
The TV report angered Beijing residents. People
stopped eating pork buns and restaurants lost money. And they
asked themselves this: what kind of human beings would sell
such fake pork buns?
The same question should be asked of those who created
the collateralized debt obligations, or CDOs, for unsuspecting
investors to consume.
The CDO is an offspring of the recent US housing
bubble. With so much money slushing around then, many banks
were making lots of subprime housing loans. These are loans to
people with poor credit ratings. The total size of the subprime
loans has been estimated at US $1,500 billion.
Just as the Beijing cooks won’t eat their own fake
buns, these Wall Street banks didn’t want to keep the subprime
loans in their books. The obvious solution was to sell these
subprime loans to other investors.
How? By smartly hiding the subprime loans with
triple-A-rated debt, just like mixing cardboard with minced
pork. A new product, the CDO, was created. Hundreds of billions
of dollars of these triple-A-rated CDOs were sold to
unsuspecting investors worldwide, including
In the case of the fake pork buns in Beijing, it was
soon discovered that it was all a hoax. The TV report was made
up by a new reporter, who was driven by work pressure, ambition
But the subprime loans enbedded in CDOs are no fakes.
Initially, no one noticed them because US house prices kept
rising. Now that the housing bubble has burst, these subprime
loans have turned bad, and so has the US $800 billion market
for bonds backed by these loans. We're looking at huge losses
running up to US $250 billion.
Last week, the Dow Jones plunged on fears that the
troubled CDOs and subprime loans would spread to the US
economy. Although credit markets are seeing their worst
sell-off in five years, high yield bond spreads are only around
300 basis points. As long as the spreads do not rise to the
long term average of 500 basis points, the patient need not go
Here is more good news. The global economies remain
relatively robust, and the health of most borrowers looks good.
If the problems in the subprime CDO market do not spread
further, the liquidity-driven bull market can check out of the
In Singapore, besides properties, this same liquidity
is behind the rally in Singapore’s penny stocks. Many of these
penny stocks are financially-challenged firms with loss-making
It is true, what they say, that when the tide comes
in, small boats will float up together with the big ships. But
it is equally true to say that when the tide comes in, you know
the chunky bits that go along to make our Newater, that will