www.keeweetan.com

Presenter of 'Money Talks'

on 938LIVE,


MediaCorp Pte Ltd.

Singapore              

 

 

 
 

Subprime Pork Buns

(for MediaCorp 938LIVE’s Money Talks on 26 July 2007)

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 Singaporeans.

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 and greed.

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 into ICU.

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 hospital soon.

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 businesses.

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 also float.

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