A Lender Who Will

By: Adrian Ash | Fri, Mar 16, 2007
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"...The bold step in finance - the market-leading decision - now comes by retreating from credit and refusing all risk..."

INNOVATIVE new debt products so ften sound scary.

Credit default swaps, negative amortization mortgages, synthetic collateralized debt obligations...

Doesn't Wall Street ever get its marketing guys to work on these things? You know, just to make them more friendly.

Because the truth is, innovation in finance isn't scary at all. Entrepreneurs and investors should embrace it if they want to get rich. Money loves innovation, and their offspring's called credit.

In fact, what's really scary in finance is failing to innovate. Refuse to offer easy new products on new, easier, terms...and your business will wither and die.

The same applies to mutual funds, credit card companies, department stores, auto retailers...you name it. If they're dealing with money, then their success is driven by credit.

And being driven by credit always means you need to drive faster. Just so long as the cycle points upwards.

Call it a race to the bottom in terms of security. As the supply of credit increases, financial firms need to sit right on the cusp, out on the leading edge. Either that, or they'll lose out to competitors who will.

You need to "push the envelope" and think "outside the box" of underwriting standards, sensible lending and proof of income. Just look at the opportunities that await!

"As many as 22 million households - 20% of US households - are unbanked," noted a 2005 report from the Center for Financial Services Innovation in Chicago. Experian put the total number of "unbanked" Americans at 55 million, nearly one-fifth of the population.

"At least 53% of Mexican immigrants are unbanked," the CFSI report went on. "The combined unbanked and subprime credit population may be 30-40 million households."

Fast forward two years to early 2007, and credit has now gone where credit never dared tread before. Innovation has made sure of that.

"Creative new subprime loans - 'piggyback', 'interest-only', and 'no-doc' loans, among others - accounted for 47% of total loans issued last year," reported the Wall Street Journal recently.

"At the start of the decade, they were less than 2% of total mortgage loans."

But that's the nature of innovation. It either accelerates...or grinds to a halt. Scream if you wanna go faster!

"As long as lenders made loans available on virtually non-existent terms," writes Paul McCulley, managing director at Pimco, "the price didn't really matter all that much to borrowers. The availability of credit trumped the price of credit. Such is always the case in manias."

Hence the Fed's failure to touch the US credit bubble with its 17 hikes in interest rates. For as long as credit remained innovative, the inflationary trend would stay on track.

And now?

"The ongoing meltdown in the subprime mortgage market," says McCulley, will "unambiguously render any given stance of Fed policy more restrictive...Just as mortgage demand seemed inelastic to rising short rates when availability was riding relaxed terms, so too will demand seem inelastic to falling short rates when availability faces the headwind of restrictive terms."

In short, the Fed couldn't stop lenders from lending simply by raising its rates. Nor could the Bank of England, ECB or anyone else.

The Bank of England began raising its rates at the end of 2003. So did the Australian and New Zealand central banks, too. The US Fed started to hike Dollar rates in 2004, and a year later, the European Central Bank tagged along too.

Japan and Switzerland finally began hiking rates - albeit from near-zero - in 2006. But the effect on world money supply has been negligible up until now. Indeed, the "reflation" unleashed by record-low interest rates starting in 2003 just couldn't be tamed, not by a few measly basis points at least.

A quarter-point here and a quarter-point there was nothing against the forces of financial innovation.

Seventeen hikes in US rates? So what! US broad money, according to John Williams at ShadowStats.com, is growing by 11% annually. Eurozone money supply has been growing at 9.8% year on year. Britain's enjoying a 14% year-on-year bubble in money, even though short Sterling rates have risen by one half.

The global money supply has come to have little to do with interest rates, or so it would seem. Some three-quarters of all liquidity comes in the form of derivatives and securitized debt, as the analysts at Independent Strategy have observed. And if raising rates did nothing to slow it, the bubble in money might just start to deflate even if short-term rates now get clipped back towards zero.

The top of the credit cycle may be in - not because real Dollar rates have finally turned positive (which they haven't, by the way...), but because the lenders themselves are shuffling back from the edge.

Leave the market-leader's position to somebody else. The innovative step in finance today is to retrench...ask for secure credit ratings...demand proof of income...switch from digital and paper promises to hard, physical assets.

Once everyone's crept back to tight lending standards and a hatred of credit, the time will have come to step forwards again - and clean up in finance by lending on easy terms yet again.

But that time's not now. The retrenchment has only begun. Be brave - and step back.

 


 

Adrian Ash

Author: Adrian Ash

Adrian Ash
BullionVault.com

Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK's leading financial advisory for private investors, Adrian Ash is the head of research at BullionVault, where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

About BullionVault

BullionVault is the secure, low-cost gold and silver exchange for private investors. It enables you to buy and sell professional-grade bullion at live prices online, storing your physical property in market-accredited, non-bank vaults in London, New York and Zurich.

By February 2011, less than six years after launch, more than 21,000 people from 97 countries used BullionVault, owning well over 21 tonnes of physical gold (US$940m) and 140 tonnes of physical silver (US$129m) as their outright property. There is no minimum investment and users can deal as little as one gram at a time. Each user's unique holding is proven, each day, by the public reconciliation of client property with formal bullion-market bar lists.

BullionVault is a full member of professional trade body the London Bullion Market Association (LBMA). Its innovative online platform was recognized in 2009 by the UK's prestigious Queen's Awards for Enterprise. In June 2010, the gold industry's key market-development body the World Gold Council (www.gold.org) joined with the internet and technology fund Augmentum Capital, which is backed by the London listed Rothschild Investment Trust (RIT Capital Partners), in making an $18.8 million (£12.5m) investment in the business.

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Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events - and must be verified elsewhere - should you choose to act on it.

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