Tuesday, November 25, 2008

How the world is deleveraging itself

I read an article recently which gives an addition perspective on the current financial crisis.

It started in the bull market in around 2003
  • Funds took in money from the common people
  • Using this money as collateral ( something like mortgage) , they went to the Japan banks to borrow even more money, up to 30 times for investment. This is becaue Japan has a very low interest rate for borrowing money.
  • Using this money they invested in many risky products
Now, the bear market
  • Started with HSBC writing off $10 billion of sub prime mortgage and the fall of companies like Lehman Bros etc.
  • This cause investors to lose confidence and pull out their cash from these funds.
  • Hence, because the funds have to pay back these people, they are selling their bad investments at a loss ( their losses is up to 30 times what they invested, because of the leveraging they used in the bull market)
  • And they are trying to minimize their leverage by trying to change their investment back to cash.
  • This process is then what we call deleveraging.
  • In the process, the funds have to return the $$ they borrowed from the Japan banks.
  • Hence they have to buy the Yen, in order to return Yen to the bank
  • This cause the Yen to strength significantly, which is what is happening at the moment.

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