The Sub Prime meltdown in the US in recent months spells bad news for home owners all over the world. What started as a problem specific to Sub Prime lending in the US has now spread to global financial markets with wide reaching consequences. As is typical in all bull markets as they near their peak, in recent years greed had replaced fear as the primary motivator. Put simply it has been so good for so long that everyone has forgotten about risk as they scrambled for higher returns. This includes the many billionaire Hedge Fund managers around the world who, to be frank, should have known better. The fact that they have managed to head for the exits in recent weeks at a speed that has to be admired suggests that they were probably more aware of the coming doom than most. The result is that anyone who currently has credit, of any form, anywhere in the world, is about to start paying more for it. Hedge Fund managers no longer have access to the cheap debt funding that has allowed them to leverage themselves to the hilt. The global private equity boom is over. The days of these guys being able to leverage up their investments, strip out costs and flog the new entity for a windfall profit have gone. They will now need to show they can add value to survive. Home owners the world over are about to face interest rate rises as the costs for non- conformers increase to more appropriate levels and the banks gradually follow suit to inject more margin into their loan portfolios. In hindsight the warning signs were there- major banks the world over have been complaining bitterly about losing margin for some time and they have the cheapest cost of funds going. For them to have had to slash margins to compete gives you some idea of how mis-priced risk has become. The global carry trade (borrowing in a low interest rate country like Japan to invest in a high interest rate environment like New Zealand and hoping you don’t get stung by a move in the currency) has unwound at a pace that has to be seen to be believed. High risk currencies like NZ and Australia have given up 10-15% in the past month! Central banks in Europe and elsewhere have had to intervene to stabilize their markets. The result in these countries will be imported inflation as the cost of oil and other essential imports rise dramatically. This in itself will pressure central banks to raise interest rates creating more pressure for home owners. Higher interest rates will reduce profits in business, leading to job loses- and once people start losing their jobs it begins to get really messy. That’s when the mortgage repayments get missed, the lenders foreclose and it all goes pear shaped. In the US non recourse lending and the current environment of negative equity for highly leveraged borrowers (they started the whole thing remember) means that Sub Prime lenders will continue to go to the wall as their balance sheets disintegrate from both the losses made when they foreclose and the lack of cash flow from missed payments means they cannot make their bond payments. This obligation or CDO as it is called comes from packaging up and selling chunks of their loan book to investors who are then entitled to receive the repayments attached to those loans in the form of interest payments from the Lender. Only problem now is that no one wants to buy CDO’s- at any price. (surprise, surprise). There is simply no market for them. Suddenly its not looking too good for some of the riskier lenders- Finance Companies for example. For homeowners it is fair to say we have just seen the end of the golden weather…