Good credit after bad

The subprime crisis shows the value of extra financial research.

Is the so-called subprime investment crisis a responsible investment issue? Some may think it isn’t. A risk packaging and market pricing disaster, yes, but SRI? Yes actually, it is very much an SRI issue. Stop the semantics game for a moment and exchange the word subprime for what it used to be called: bad or predatory lending. Strip away the jargon of ‘collateralised debt obligations’ and ‘credit derivatives’ from the present market crisis and what is left at the bottom of the pile is an estimated two million American households, according to US market observers, that could lose their homes because they are unable to meet their mortgage payments. That is a staggering figure. A significant proportion of these people were sold mortgages they couldn’t afford – some on the basis of sweetener deals. If laws and regulators in financial services count for anything it is to protect people from these sorts of unscrupulous sales tactics. So where were they? Not only is this a US ‘social’ crisis – the oft neglected ‘S’ from ESG research – it looks likely to be a painful economic crisis.Some economists predict a gradual -10% asset deflation in the US. As Bill Gross, the respected bond trader and managing director at US fund manager, Pimco, points out, this is a drop akin to the Depression of the 1920s – not in volatile shares, but in bricks and mortar, the real backbone of the US economy. That bodes very badly for global markets and will undoubtedly become a major election issue, not only in the US but elsewhere if there is the usual knock-on economic effect.
Asides from the moral hazard of central banks bailing out the market (anyone recall Long Term Capital Management?), this subprime crisis has also called into question the accountability of the whole risk product supply chain. Bad lending has led to questionable packaging and rating of asset-backed securities. These have then been sold on by flighty, commission driven investment bankers as ‘risk-free/high return’ prospects to smaller banks, insurance companies and pension funds hungry for yield and gullible at the same time. Nobody – not even the so-called financial risk experts – can safely
say where the risks lie or how many months it will take for defaulting mortgage exposures, many of which were marked on balance sheets at cost, to show themselves on investor books. This is a monumental breakdown in the transparency and disclosure vital for market trust. We are seeing the fallout of this now in the worrying hike in short-term, inter bank lending rates as banks horde assets that they can actually value. It’s refreshing, however, to give good credit in an environment of so much bad.Responsible Investor hears from investors that Innovest, the SRI research house, lead the way in timely warnings on subprime mortgages. It became concerned after analysing US banks dealings in high risk, irresponsible lending as part of its research. Innovest’s work vindicates good extra financial research based on economic reality. It also recalls one of the basic tenets of investment: if you don’t understand something properly you shouldn’t be buying it. Baskets topped with juicy fruit can hide bad apples at the bottom!