Credit Squeeze: What does it REALLY mean to you?
Hey guys,
I have had a lot of phone calls recently from clients wanting to know what they should make of the global credit squeeze! The short answer is:
Absolutely nothing.
For the average investor like you and I it really and truly means absolutely nothing. Now before you jump up and down quoting facts and figures and tell me I'm deluded, let me qualify my statement a little.
The one thing I learned early on in my investing career is that whatever is going on in the market someone will lend you money. So whatever happens you will be able to get a mortgage but lets look at where the money is coming from and what they are all talking about.
Mortgage backed securities are getting squeezed
This is where the squeeze is right now. Banks (like Northern Rock) borrow money from other financial institutions around the world through an investment vehicle called a bond. Now in this case the bond would be backed by mortgages and the investors receive a return on the investment through the interest payments from mortgages. Until recently, everything was great for these investors since people were paying their mortgages each month.
But as the US (where a large proportion of the funds come from) raised interest rates people began to fall behind in their payments. Investors naturally became less confident lending more money as they didn't know whether they were lending to people with poor credit (sub prime) who might subsequently fall behind in payments or stop altogether.
So, the entire reason for the credit squeeze is: large institutions with lots of money don't want to let out money for bonds because they don't know who their money will subsequently be lent to.
I believe that once they work it all out in about 3 months it will all blow over, everything will go back to normal and it will be business as usual.
The only difference you will notice is that maybe if you remortgage or purchase a new property, your interest rate or arrangement fee will be a little higher (about 0.25%-0.5% I predict).
So if I'm predicting slightly high rates, then why do I say the effect will be "absolutely nothing" for you and I? Well, if the rates go up, the amount we have to spend decreases, and with less money being spent the economy will slow down. As it slows down, inflation will drop and the Bank of England should decrease rates to keep inflation on target (at around 2%). And voila, this would return us back to exactly the same position as before.
So that's my reasoning on why I believe you have nothing to worry about. Obviously this is a massive simplification of a rather complex subject and yes, there are many more factors affecting the situation that I haven't mentioned.
I am more than happy to answer any more complex questions if you have any regarding the intricacies of all of this.
Live with passion,
Brett Wood