Credit crisis not abating

The current global financial market crisis has caused much uncertainty across the world.

The current global financial market crisis has caused much uncertainty across the world.

The critical question is, what really went wrong and how long will this uncertainty continue?

People are concerned about the effects of the turmoil as well as its implications on investments.

Nic Andrew, head of Nedgroup Investments, says the world banking crisis broadly follows the following themes:

l Inappropriate and lax access to credit for those who should not have been allowed to borrow;

l The re-packaging of these poor quality loans by investment banks who sold them to investors in desperate search of yield;

l The excessive leverage of the investment banks;

l The credit agencies who rated these instruments incorrectly and without proper understanding; and,

l Poor transparency and regulation.

Andrew says falling US property prices was the catalyst that started to show the cracks. Property owners who could not afford repayments could no longer rely on rising property prices to bail them out.

What started as a sub-prime crisis (poor quality loans crisis), quickly spread into a general credit crisis - banks stopped trusting each other and refused to lend to one another.

Liquidity, the lifeblood of the capitalist system, was squeezed out of the system.

This had dire knock-on effects and central banks (the US Fed in particular), were forced to act decisively and materially to avert a complete meltdown.

Andrew says that while the latest proposed bail-outs and rulings, including banning short-selling, have provided some short-term relief and should restore some confidence, the bad news is not over and the global economy will not recover quickly.

But what is encouraging for South Africans is that local companies have relatively low direct exposure to sub-prime.

Andrew says local banks have remained relatively unscathed, partly as a result of exchange controls and partly as a result of the tougher monetary policy and legislation.

"The extent of the impact in all likelihood depends on how successfully the Fed is able to restrict the crisis to the financial sector."

The impact on assets has been severe with equity indices around the world dropping significantly (more than 20percent), with certain sectors (particularly financials) and countries (such as China) falling by more than 50percent. Property prices have also softened, particularly in the US and the UK.

Many commodities have also declined materially on fears of slower world economic growth.

"There has been very little place to hide as investors have been in a hurry to take risk off the table," says Andrew.

What should investors do?

Sensational headlines make it very difficult to remain calm.

"Investment decisions made in panic and without proper thought are generally destructive.

"It helps to have a clear, documented and sensible investment strategy."

His advice is, detail your objectives, time frames and a realistic assessment of the risk you are required to accept to achieve the objectives set.

To him, risk and return are closely related, and to have objectives of anything more than cash requires an acceptance of risk.

"It is important to acknowledge this risk before you invest to avoid incorrect action at the time of heightened emotion."