NINJA Mortgages

Back in those halcyon days when I was a student, locking horns with the secrets of science, our professor informed us that Mathematics was the underlying current of life. It bound everything together. Understand it, and the rest followed naturally...

Well, sadly for Professor Bailey, it seems Mathematics has been replaced by another phenomenon that binds the world together. The Credit Crunch.

In today's Sunday newspapers, the credit crunch links a good number of stories in a way that I had not fully appreciated until the tail end of last week. From the UK Gov polling report to the value of gold, it's all related to those sub-prime mortgages.

A lecture from a world-savvy Economist has turned me from a novice into a genius* on this very subject. I know, it only took an hour or so...! (* not that I am ever one to exaggerate)

So here goes, an 'idiot's guide' to the Credit Crunch and how it affects us all:

Well, it all really starts with these NINJA and 110% mortgages. These products that were available in those heady, FTSE-strong days when assets were liquid and money was plentiful. Consequently, credit was cheap. The big banks were throwing the stuff at us due to the low interest rates around 2002-04.

Note that NINJA mortgages related to products for people with No Income No Job or Assets. Yes, that's right, people on benefits were being offered private sector mortgages only a couple of years ago.

It's also worth noting that if you had a mortgage with HBOS (say) then it doesn't necessarily sit there for the next 25 years. HBOS will bundle it up with other mortgages and sell it on like a piece of stock.

Well, around 2004, these mortgages were getting grouped with each other and sold on the financial markets as something called a "Collateralised Debt Obligation" (CDO). Or, if it was American based, "Collateralized Debt Obligation". That z instead of an s is pretty important as the Americans had interest rates down to 1% at one point. 1%!! Can you imagine the cheap credit that was available over there? Well, consequently, the CDOs from that part of the world were more risky as it was backed up by these NINJA mortgages with people from Hicksville trying to pay interest on their property when they barely had 2 cents to rub together in between shooting tin cans with Grandpas guns and waving at aeroplanes.

The thing about riskier financial products is (you're gonna love this) it comes with a higher yield. It actually makes for a more attractive product to investors!

You see, the higher the risk involved, the more of a return the investor demands.

So as interest rates started creeping back up again, so too did the monthly costs for peoples' mortgages and so too did the number of bankruptices. But these CDOs somehow kept the same yield.

All these cash rich banks had millions and billions of spare cash to invest and they were blinded by the chase for the yield. They wanted the highest return going and didn't stop to question the CDO assets they were buying. Further to this, the credit rating organisations hadn't caught on to what was going on and were still giving out AAA ratings to products that were about to be almost worthless a couple of years down the line.

And then the conditions in the market changed drastically. Interest rates rebounded sharply. The mortgage arrears went through the unpaid-for roof.

To put this into perspective, in 2006 alone €200billion of assets based on CDOs and dodgy mortgages were issued into the financial markets.

So what was the trigger?

Well, Credit Lyonnais basically. In 2007 it reassessed its risk exposure to these sub-prime mortgages and the alarm bells started to ring around the world. Every other bank and financial institution that had such exposures followed suit and almost instantly the liquidity tap was turned off. The short term asset market dried up as panic started to spread. Just what have we been buying for these past 4 years? everyone seemed to ask at pretty much the same time.

Basically, no-one wanted to touch sub-prime mortgages or CDOs. None of the banks or building societies could shift these loans from their balance sheet and the returns they bought into, those high yields of 10%, had been significantly over-estimated.

Spare cash was hoarded to finance these dodgy loans. And those that couldn't be financed were written off to the tune of billions. Anyone who needed short term credit were stuffed, with Northern Rock near the front of the queue. They had the long term assets but they just didn't have enough cash to function in the short term.

Companies that are due to join them are Bear Stearns and Irish Permanent. The most worrying aspect is that we are probably only half way through this ugly chapter in capitalism's history. Noone knows exactly what they are exposed to and just how deep the pain will be.

As an example, UBS Warburg had announced $10bn of losses in its mortgage-related securities during 2007. It was generally accepted that that was all there was. But January 2008 saw the investment bank announce a further $4bn of losses. These may be the Capitalist big boys, but it's not petty cash we're talking about here...

And that's where we are now, week by week more losses are announced, the FTSE and Dow Jones indices drop lower and lower, cash is pumped into the economy by the Fed and US interest rates are slashed. All to a relatively minor effect as there is just too much uncertaintly right now. So belts are tightened, cost control will be the watchwords of 2008 and you can bet your bottom much-coveted dollar that unemployment is going to bounce back up again.

Specific to the UK? Well, the housing market has stalled and mortgages are increasingly tougher to pay off with rising prices in power and food. I can't remember seeing so many Fixed Price homes for sale in the ESPC. And the Chancellor is powerless to do anything. Interest rates are controlled by the Bank of England and they can't relieve the pressure with lower rates as their decision is based on the rate of inflation, which is already dangerously high.

Meanwhile, Labour's popularity has dropped through the floor, chiefly based on the economic situation. An economic situation that they can do nothing about as it is almost solely due to these dodgy American mortgages and you can't shut the door once the billion dollar losses have bolted.

Chillingly, the Economics speaker left us with the message that what we have seen already, the Northern Rocks, the billion pound write-downs, is probably just the tip of the iceberg.

Basically, wrap up nice and warm cos America's sneezing fit is only going to get worse and the UK doesn't have any vaccine for the coming cold we're about to get.