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The Credit Crunch – As Karen Carpenter said – ‘We’ve Only Just Begun’

By Andy Shaw | January 23, 2010

Originally Posted 2nd February 2008

There’s a lot going on behind the scenes at the moment with the credit crisis and the Fed, even though they have openly cut rates by 0.75% and then 0.5% to try and give the look of having some sort of control. Yes, I know what you’re thinking, it doesn’t look like they are in control, and you’re right, but they actually want to cut more but they can’t cut too fast because the potential of a market collapse.

So at the moment the Fed is trying to look like an only slightly flustered Duck, yet its feet are paddling away as if there’s a dozen hungry Chinese chefs chasing after them.

I’d say that the rates which are currently at 3% in the US will be down under 2% as the Fed are trying to set the scene for the banks to trade their way out of trouble – Help me, Obi-Wan Kenobi; you’re my only hope!’. Obviously this causes large inflationary pressures, but I’ll come on to that in a minute as currently there is a much bigger problem to deal with than inflation.

You remember I said about the financial markets being so highly geared and that when one domino fell then another could topple after it and then the whole market could topple over. Well the first domino was the sub-prime crisis £300 – £350 billion, and as yet less than half of it is accounted for. So there’s still uncertainty there. Well this fell and pushed against the next domino. I thought that the next one would be the hedge funds (which would spell total disaster) but it wasn’t them. Well the next domino is falling and starting to put pressure on the others but the Fed and others are trying to stand it back up.

This domino is the Monoline Insurers. Never heard of it? Well this is a name that was new to me this week too but it’s only a matter of time before it becomes a term like credit-crunch or sub-prime crisis. These terms weren’t in our vocabulary either this time last year.

What is a Monoline Insurer - Monoline Insurers lend their balance sheets to weaker borrowers so that the weaker borrower can raise money in the global bond markets. Once the bond is insured then the big investors (pension funds for example) can buy it.

The problem is that the big investors are obligated to only hold onto investments that are either AAA or AA. Once they drop below that credit rating then they are obligated to sell. So if you imagine for a second that the insurance backing the bond is valueless, then that means the big investors are obligated to sell. What happens when everybody is obligated to sell at the same time?

Well the price goes through the floor of course. Now this causes the loss of value in several directions which is like sending domino lines fanning off. But coming back to the value of the assets, well they go all the way down to junk value and that ain’t good. So the Fed and others have worked out that the cost of shoring up those companies is going to be far less than the cost of the bonds becoming valueless.

I was chatting to my economist friend this week and I asked, ‘is the crisis as bad as when the third world debt couldn’t be repaid in the 70’s?’ His exact comment was, ‘Far worse, the only difference between now and 1929 is that the central banks are talking to each other.’ Now that’s saying something!

The early estimates for shoring up these insurers is another £300 to £400 billion. Somewhat less than the £1.2 Trillion if the credit worthiness of these bond insurers comes into question. But the early estimates for the sub-prime crisis were nowhere near what they ended up being. So the Fed is trying to come up with ways to stop this before the insurers have to announce the problem and therefore have the bonds value rating dropped. And so is Warren Buffet amongst others. From what I am told he is looking at using Chinese security to bolster up the Monoline Insurers. Which will of course solve this current problem if he and others can pull it off.

On a side note this cheers me up as a few years ago I predicted that Warren Buffet would overtake Bill Gates as the worlds richest man. Then he went and gave nearly 50% of his money to Bill for his foundation, so it looked until this week that my prediction wasn’t going to come true. However, I’d say that Warren is currently structuring the deal of his lifetime and the obvious question comes out, what next? This means that this won’t be the only deal he’s putting together.

Moving onto inflation - Well lowering these rates is going to cause inflation to rise, and to quote my economist friend again when I asked the question, ‘what are they going to do to keep some sort of control on that?’ He said, ‘when your roofs on fire, you don’t mind facing the terrorists in the garden.’ Which basically means if we stay in the house we’re dead, so at least we stand a chance facing the terrorists outside. I can’t help thinking that this is no way to run an economy :-)

The trouble is that this is how big business really makes money. They make money whilst everyone else is panicking so for those with plenty of cash or security right now is a good time to make enormous profits. Big business and the banks may or may not have orchestrated this crisis (that’s down to the conspiracy theorists to figure out for evermore), but the fact is that those who survive and have large cash reserves will win the spoils.

So, what does this mean for us buying little 1 & 2 bedroom properties?

Well frankly nothing’s really changed, there are lenders willing to lend, as they need to make a profit, so I would say that as rates go down further (which they are now certain in my opinion to do so) I don’t think the lenders will be passing on all of the rate reductions. They’ll want to make a higher spread on the money they lend to you.

But for the next few years we will see lower interest rates, so avoid the fixed rates at the moment if I were you. I think the Fed will drop down to 2% or maybe less and I think that Sterling could easily go down to 4% again, that’s once the spin doctors have figured a way of selling higher inflation to the population without public sector inflation rises J (prepare to see some strikes). Also on a personal note I am steering clear of any longer term tie-ins than 2 years at the moment, as the banks will have to raise rates after this crisis to curb inflation. And in 2 years time I’d say it’ll be on the upward turn so that would be a better time to lock into say 5 years. But I’m only guessing here, as frankly we’ve never seen a series of situations like this come along in our lifetimes. So I’m having to rely on human nature, my instinct and as usual deciphering the truth from all the rubbish out there.

The trouble is that Gordon’s spent too much and that means taxes are going to have to rise as the economy is not in nearly as good a shape as he says it is. It is good for us property investors, all the factors make it probably one of the best markets ever, but the economy as a whole isn’t good. Oh, and don’t be fooled by the fact that the headline rate of tax is lower than when he came to power, as an average thanks to stealth taxes I think we are all paying about an extra £1,350 per year, or something like that!

When it comes to politics, I think its safe to say for now that all the conservatives have to do is show up for the next election and they’re in. Which isn’t good for democracy, but then again we don’t really live in a democracy, do we? – but that’s for another time.

Yes, but what about us?

As for whether it’s a good time to buy property then the answer is yes, it’s always a good time to buy property. You should know that by now. But now the rules apply harsher than ever:

1) Know when you are going to get your money out (at least within 2-4 months of when you think it will be)

2) Know you can get the valuation you need before buying (at least within £10,000 of what you think you’ll get)

3) Re-finance as quickly as possible, get your money off the table and back onto your credit card or drawdown facility (try not to use Mortgage Express on the ‘in’ as you don’t have to wait for 6 months to re-finance)

4) Protect your cashflow at all costs. Do not use your reserves to purchase right now, even if the deal looks stonking. Protect your 34% reserve.

5) If you are already into your 34% reserve, then stop buying property and work on raising credit to get you back to that reserve – it will pay you dividends!

Remember the market doesn’t fall like the stock market it takes time so don’t completely ignore the press, but then don’t trust them wholeheartedly either. You are not buying in the property market, you are buying A property, from A motivated seller. Always keep that in mind while the so called experts are trying to get to you.

Remember you can increase the sellers level of motivation with your knowledge of how bad the crisis is right now, so use it to lower the price and get better deals. Then use it again to get higher re-valuations. You are selling to each person, the vendor and the valuer, it’s just a different sales line.

I’m going to be covering more on this but I thought this was enough to take in for now (and as I digest it all myself :-) ).

Best wishes

Andy

PS As I said recently I have never seen a better time to buy than right now. For example, we pulled a deal this week for £69,950 on an expected val after an £8k refurb of £145k.

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