The last few weeks of hearing all bad news all around financial markets, made me think is the world is going to be destroyed pretty soon. Is this the Apocalypse? I mean, why is there so much of panic when a casual glance at the current situation doesn't seem to be bad, at all.
1. American households earn average of 75K/year and buy house at an average rate of $300K that is just 4 times the annual income, and in many rich neighborhoods that earn in 6 digits this ratio could be even less. So, is the house price sky-high? Is the ratio change too much in America's history? Are other countries better? Brits and Europeans whose average house price is like 10 times the annual house-hold salary seem to worry much less even at the back of a 3x price growth in 10 years. In Asian countries like India, this ratio could get even higher. I don't know about Africa and South America, but think that they wont be any better in owning houses than America.
2. Current America has a very healthy corporate cycle and unemployment rates are almost historically low. The last housing bust was at the back of big unemployment.
3. The subprime mortgages are still a small portion of total value of American housing assets and not all of them are defaulting and not all the defaulted properties have a value of 0.
4. By the very nature of the American economy, the risks are well spread out and markets are pretty deep and matured compared to almost any other country. Agreed that there is a lot of unnecessary froth at the top, but derivatives in essence builds a very strong foundation and links the stakeholders.
5. The world economy never looked so better and not all of it is based on cheap mortgage. There are quite a bit of fallbacks, unlike the previous times. Even taking the factors that are dependent on US consumption, the consumption of many Asian countries have increased sharply and Russia is back on its knees.
6. Most importantly, unlike in most other times of American history, there are a quite of bit of non-market entities that are extremely powerful and they would like to maintain status quo and have the means to do it. The foreign reserves of Japan, China, India and Korea alone are in the range of $3 trillion and each of them is much bigger than any institutional or individual player in the market and they understand the stakes. If US goes into recession or if there is a reduction in interest rates, there could be losses of hundreds of billions here alone. So, would it be stretch to assume that a couple of hundred billion dollars could get diverted by these power central banks into US mortgage and bonds to save American economy from collapsing, while making strategic buys with high yielding interests. For these central banks few billion dollars are pocket change and they have quite a bit of powers in their arms. They are silently watching and if there is a definite case of collapse, there could be a lot of invisible hands at work to clean the mess.
US is so crucial to the world economy that not many of the powerful hands will allow it to drop. And the fundamentals seem to be good – its not like inflation is going into double digits or corporate are throwing out people in mass numbers. Few hedge fund owners and a few greedy subprime buyers are fried, but I don't understand why the market value should drop by few trillion dollars.
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