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World Crisis scenarios for the 21st century – Worldwide economic depression.

Posted by Adrian on July 25, 2007

With all the potential long range and short range predications for a worldwide crisis in the 21st Century, the one crisis that could be closer on the horizon would be a worldwide economic depression, possible one that would be on a larger scale and far more destructive on worldwide financial markets than the 1929 crash or worldwide depression, otherwise known as the Great Depression.

World Crisis scenarios for the 21st century – Worldwide economic depression.

The world has currently gone through one of the longest and sustained financial growth spurts in history spurred by the insatiable and seemingly unstoppable growth of China and it’s consumption for raw materials from the West. In turn asset markets worldwide have expanded and inflated these asset classes that range from stocks, property, art and antiques. Although the majority of the asset bubble comes from Stocks and Property.

world-gdp.jpg

The property boom worldwide has been fueled by the easy availability of credit and excess liquidity. Borrowing rates, or interest rates have been low which has fueled a huge mortgage market worldwide. Undoubtedly the biggest mortgage market took place in the America, more specifically is the large growth of a mortgage market called Subprime. A dubious and over utilized mortgage market that targets people who have bad credit history, poor credit rating and generally high risk individuals. Various Subprime mortgage broker firms were set up to cater for that market. Hedge Funds also bought into these high risk markets to see if they could profit from risk based mortgages. The idea is to look at high risk groups, repackage the loans into a CDO (Collateralized Debt Obligation) then have a investment bank reassess credit ratings on borrowers (adding high risk with middle range risk) then bundling mortgages to together to form MBS (Mortgage Backed Securities), then sell them onto various hedge funds that attend to make profits, or bets on the premise that housing market will still boom and housing prices will still rise. This hasn’t happened, in fact the Subprime housing market collapsed almost completely overnight, metaphorically speaking. A recession is now in place in one of the largest housing booms to occur in the last century in America, which has effected various Subprime mortgage brokers (who sold the loans) have closed down and gone out of business. The Hedge Funds that bought high risk subprime CDO stand to lose millions as the housing market melts in America. Bear Stearns investment bank with it’s offshoot Hedge Fund has already informed investors that one of it’s Hedge Fund’s that backed Subprime CDO’s; of the real possibility that investors stand to lose all cash assets as the Bear Stearn Hedge Fund goes into liquidation from Business week

“Investors in a 10-month-old Bear Stearns (BSC) hedge fund are learning the hard way the danger of investing in risky bonds with borrowed money. The investment firm’s High-Grade Structured Credit Strategies Enhanced Leverage Fund, as of Apr. 30, was down a whopping 23% for the year. The situation is so bleak that Bear Stearns’ asset management group is suspending redemptions at the onetime $642 million fund—meaning investors have no choice but to sit on their losses. And that’s got some hopping mad. “At the end of the day, I’d like someone to be honest with me about what’s going on,” says one investor in the hedge fund, which bet heavily on bonds backed by subprime mortgages, or home loans to consumers with shaky credit histories. An investor in Europe, who didn’t want to be identified, says he’s been trying to get his money out of the hedge fund since February.”

Investors have already begun filing a lawsuit against Bear Stearns with the law firm Bernstein, Litowitz, Berger & Grossman,

“NEW YORK (Reuters) – Investors in Bear Stearns Cos. (BSC.N: Quote, Profile, Research) hedge funds that were virtually wiped out from large bets on risky mortgages are planning to sue the company as early as Monday, television channel CNBC reported on Friday. The lawsuit will be brought by the firm of Bernstein Litowitz Berger and Grossman LLP, which represented investors against WorldCom Inc. over a massive accounting fraud, CNBC said. According to CNBC, the lawsuit will allege Bear Stearns made material misrepresentations in offering documents, misrepresented risks of the hedge funds in those documents, and misrepresented its ability to control those risks.”

CDO’s are complicated financial instruments, working on high risk and with high leverage from Hedge Fund portfolios. By combing the high risk Subprime with the other mortgage backed securities, the idea is the risk could be manged. But Hedge Funds, like Private Equity companies don’t like using their own funds; usually, in the case of a Hedge Fund the money raised has been heavily leveraged from loans borrowed from other banks using the CDO as collateral. It is complex system to generating more income on investments, but ultimately it has proven to be problematic and in the Bear Stearns case potentially misleading investors.

The housing sector in America is receding very quickly and destroying any of the income possible generated by the hedge funds, again using Bear Stearns situation as an example (Businessweek article),

“In fact, things deteriorated rather quickly at the fund. The hedge fund got off to a good start, posting a cumulative 4.44% return over its first four months, according to a Bear Stearns investor letter. But early this year the fund’s performance began to suffer as the market for subprime mortgages began to implode. Coming into April, the fund was down 4% for the year.Then things really fell apart. In April, the hedge fund posted an 18.97% decline, according to the June 7 letter obtained by BusinessWeek. But even more shocking than that big loss: only weeks earlier, the company had said it lost just 6.5% for April, according to a May 15 letter the firm sent fund investors. It’s not clear what happened in those intervening weeks to force Bear Stearns to significantly revise upward its estimated April losses.

Bear Stearns isn’t the only big investment firm with a hedge fund that ran into trouble making bets on the Subprime market. In May, UBS (UBS), the Swiss-based banking giant, announced it was shutting down its Dillon Read Capital Management hedge fund after incurring a $123 million loss because of its exposure to the U.S. Subprime market. The hedge fund’s woes helped drag down first-quarter profit at UBS.”

So what does a severe deteriorating housing market and collapse of high leveraged hedge funds like Bear Stearns point too? World Depression? Of course that is a long call, but never the less, the fear of major depreciating markets (such as housing) could be the lead to a very quick spiraling downturn. Which could end up as a worldwide crash.

Recently the Bank for International Settlements has been quoted in saying that conditions that lead to the Great Depression in 1929 and Asian crisis in the 1990’s is now showing signs of a repeat in the present financial markets, from The Age Business Day article;

“The BIS, the ultimate bank of central bankers, pointed to a confluence of worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.”

The main concern is China, even if a down turn in the economy does occur in America, say a recession partly brought on by the housing sector collapsing. China could derail, which is a possibility, this will most certainty effect countries in the West like America as far as production in exporting raw material and the import of cheap goods from China – if production slows or stops, or import costs rise manufacturing could come to a halt to China. According to the BIS from the Businessday article;

“The BIS said China may have repeated the disastrous errors made by Japan in the 1980s when Tokyo let rip with excess liquidity. ‘The Chinese economy seems to be demonstrating very similar, disquieting symptoms,’ it said, citing ballooning credit, an asset boom and ‘massive investments’ in heavy industry.”

also from the BIS article,

“It said China’s growth was “unstable, unbalanced, uncoordinated and unsustainable”, borrowing a line from Chinese premier Wen Jiabao”

Can the federal banks save us from a possible crash that would lead to a worldwide global depression? During the the Great Depression that started in 1929 and lasted to 1933. Are all the worldwide banks tackling inflation yet acknowledging the growing dangers of the debt bubble?

From article on the great depression wikipedia,

“the 1920s, in the U.S. the widespread use of purchases of businesses and factories on credit and the use of home mortgages and credit purchases of automobiles, furniture and even some stocks boosted spending but created consumer and commercial debt. People and businesses who were deeply in debt when a price deflation occurred or demand for their product decreased were often in serious trouble—even if they kept their jobs, they risked default. Many drastically cut current spending to keep up time payments, thus lowering demand for new products. Businesses began to fail as construction work and factory orders plunged.”

So is huge worldwide debt going to be a precursor to a 2nd great Economic ‘Depression’? Margin lending, which is borrowing to invest into the stockmarket is at the highest peak sine the 1920’s. In the last 7 years there has been massive margin debt increases.

debt.gif

(graph from economist.com)

From the article on the Economist, regarding margin debt and the bubble it has created on the stockmarket,

“Margin Debt reaches it’s highest ratio since the 1920’s”

“MARGIN debt in the American stock market has reached a new record of $285bn. In other words, more borrowed money is being used to buy shares than ever before.”

“As David Rosenberg of Merrill Lynch observes, margin debt has jumped by $40bn in the past three months, a similar rate to early 2000, when the markets were in frenzy. As a proportion of market value, margin debt is now at its highest since the late 1920s, an era that was a by-word for speculation (and resulted in the crash of 1929-32).”

It is clear there is now correlation to the first great Depression that occurred in the 1920’s. It may be a matter of time when something does give, geopolitical crisis, the collapse of the hedge funds markets, the instability and inflation in China and the huge debt bubble that has swamped the World.

The financial markets, asset markets are now all at their peak and dangerously at the point of collapse.

Article reference links:

Business Day, The Age – Banks’ banker warns of Downturn

Telegraphy – BIS warns of Great Depression from credit spree

CNN money – The greateset economic boom ever

The Economist, Buy now, pay later article – Margin Debt Feb 25 2007

Wikipedia – The Great Depression 1929

How CDOs are created (in PDF)

CNNmoney – Bernanke Subprime could hit 100B in losses

Business Day, The Age – Subprime drives stockmarket down

Reuters – Bear Stearns to be sued over Subprime Funds

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17 Responses to “World Crisis scenarios for the 21st century – Worldwide economic depression.”

  1. […] Posted by zekukith on July 27th, 2007 World Crisis scenarios for the 21st century – Worldwide economic depression […]

  2. […] by zekukith on August 15th, 2007 World Crisis scenarios for the 21st century – Worldwide economic depression.(update […]

  3. […] World Crisis scenarios for the 21st century …With all the potential long range and short range predications for a worldwide crisis in the 21st Century, … that targets people who have bad credit history, poor credit rating and generally high risk individuals … is to look at high risk groups, repackage the loans into a CDO (Collateralized Debt Obligation […]

  4. […] Posted by zekukith on September 20th, 2007 World Crisis scenarios for the 21st century – Worldwide economic depression. […]

  5. […] World crisis scenarios for the 21st century – Worldwide economic depression (update 7) […]

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  7. […] by Adrian on January 11, 2008 World Crisis scenarios for the 21st century – Worldwide economic depression. (update […]

  8. […] by Adrian on January 29, 2008 World Crisis scenarios for the 21st century – Worldwide economic depression. (update […]

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  10. […] by Adrian on March 7, 2008 World Crisis scenarios for the 21st century – Worldwide economic depression.(update […]

  11. […] by Adrian on March 25, 2008 World Crisis scenarios for the 21st century – Worldwide economic depression. (update […]

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