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Mortgage Mayhem hits Markets

The Australian stock market looks like it may experience three negative months in a row for the All Ordinaries price index. In June it was down 1.0%, in July down 2.6% and based on last close on Friday 17 August it is down 8.9% so far in August. The last time we had 3 negative months in a row was in September 2001 when in July, August and September the All Ords was down 4.5%, 1.6% and 7.1%. This was in response to fears following Australia's last negative quarter of economic growth in December 2000 (-0.8%) and the terrorist attacks on the US in September 2001.

This most recent volatility is due to what has been labelled as the "sub-prime" mortgage issue. Aggressive mortgage brokers extended finance to less financially secure home purchasers in the US at the tail of the recent housing boom and when money supply was kept looser than it should have been in the US. Cunning off-loading of the home owner’s repayment risk into mortgage backed securities meant that once the mortgage broker received their placement fee, the credit rating agency got their packaging and rating fee and the sponsoring bank rid itself of the loan, responsibility for managing the poor home owners' ability to keep repayments up is dissipated along many degrees of separation from the original transaction.

The result is a concern by central banks as to whether corporate finance markets will continue to operate efficiently as holders of interests linked to these mortgage securities or lenders to them, have their net worth and solvency downgraded. This is a recent phenomena but has some parallels to the Asian financial crisis of 1997-98 or the unlisted property trust crisis in Australia in the early 1990's.

Posted Sunday, 19 August 2007

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