Last weeks big announcement came from the US Federal Reserve. They announced a cut in the lending rate by an amazing 0.50%.

All the analysts were predicting a quarter percent drop to match the previous announcement directed at the sub-prime market.

The big money was on 0.25 and I think everyone was taken aback by the big swing. I’m still getting mixed reviews from different economists. Some say that it had to be 0.50% or it wouldn’t be enough. Others who I tend to agree with think that this might be a panic situation to begin to resolve the whole sub-prime meltdown.

The interesting bit of news that hit my inbox this week was the analysis done on the sub-prime market. The result is, “We ain’t seen nothing yet.” Hold on to your hats folks. It seems the whole sub-prime market breakdown started 3 years ago when loans were given out to people who simply put, shouldn’t have been given a mortgage. The fun part is the first people were the borderline cases. It just got worse from there. We’re seeing the effects of these bad loans now, just wait until the next crop comes due in 2008.

Any body read a book by Robert Kiyosaki called Prophesy? In that book, he predicts that there will be a ma jor market correction. I had no doubt of that, but he thought it would be as a result of boomers retiring and drawing their funds out of the market. I think they may still do that, but I think the sub-prime market is going to be the bigger influence as far as a destabilizing factor.

Well it looks like late 2008 is going to be a fun time.

On the plus side, Canada seems relatively untouched by the sub-prime market. We do have a tiny bit of weakness, but not the same level of exposure as the US does. I think the Canadian dollar has reflected this as the theme seems to be to pull the investments out of the US. Canada seems to be riding the wave as far as a good place to invest. Hopefully the government is on board with this plan and working to continue this investment and ride out the wave. We can only hope that Mr. Flaherty is at least paying attention and is aware that this economic boom wont last forever. I’m sure the bank of Canada is aware of the rising dollar and the negative impact that will have on the manufacturing sector.

Just read an article about GM closing a plant in Canada. Seems it’s already begun.

Nothing like sitting in the middle of an economic flux and wondering what the heck is going to happen next. That ancient Chinese curse keeps coming to mind, “may you live in interesting times.”

In God we trust. All the rest pay cash.

I have a number of quotes that come to mind this week.

Call it a theme for the week given all that has transpired (or not in certain cases).

“You don’t know what you don’t know” – when I first heard this I had to stop in my tracks and think about this one for a minute. I certainly know what I know, but of the things I don’t know do I have any clue the depth and breadth of what that entails? A quick trip to wikipedia sure makes my knowledge feel limited.

“If you don’t know the rules of the game, you can’t win.” The corollary to this I guess might be “not everything is a competition”. It’s true though. How many times have we ever been in a situation where from our limited perspective, did we think that we were “ahead” or “winning” only to be hit by one of the rules and put right back to square one. The other half of the time you think there is a competition and you are working hard to “win”, only to find out either you are the only one OR there simply was no competition. I think of the story of the banana eating champion in college. Told there is a competition and is given a blind fold. Start eating bananas. The crowd starts telling him that the other guy is winning – “EAT FASTER”. He starts stuffing bananas in his face and they finally take the blind fold off. He’s the only one eating bananas. Good chuckle for everyone. Good life lesson as well.

“Knowledge is power” – this was my school motto. I agreed with this saying until one day I saw people with knowledge who did nothing. One can be educated and one can have knowledge, but if you don’t take action, what good is it?

I’ve updated the saying “Use of knowledge is power” or “Knowledgeable action is power”.

In my travels recently, I’ve come across someone who is seeking more knowledge. I tried to explain that what she seeks is all around her. My point was lost until someone explained it another way. There was a young entrepreneur in the crowd. “How many business books have you read?

One

How many business/marketing/accounting/real estate courses have you taken.

None.

Yet, you own a business and it makes a profit. The business knowledge you have gained is invaluable is it not?

Yes.

Would you say it’s fair to say that getting or paying for knowledge is not always the best action? Sometimes simply taking actions has it’s own rewards and education.
Yes”

We then came up with a plan of action for this person to gain direct knowledge and experience (via a job in a related industry) as well as paying for a “formal” education.

Along with knowledge, preparedness is also a key to success. The scouts motto “Be Prepared”. Hopefully knowledge will prepare you for certain situations. Eagle scouts seem to be prepared for anything in life and probably why many of them end up as captains of industry.
Sometimes being prepared can mean simple things. Like filling and paying your taxes. I’m still amazed at the number of people who contact me for a mortgage and one of the questions or documents I ask them for is the “blue piece of payper the federal government sends you every year with a cheque attached”. One customer said I haven’t filed taxes in 9 years. I then have to explain that no lender in the world will give him a mortgage until he does. Why? Here’s a quick scenario for you. Let’s say the tax man wants $10,000. You say you can’t pay. They say OK, we’ll take your house and sell it for you. The mortgage holder says “um, excuse me…” Tax man says “too bad, we get paid first. Period. Good luck with your client.”

The other type of client I see says, “well I haven’t started my taxes yet.” Ok, let me know when you do, I’ll get you a mortgage then. “But I have an accepted offer on a house!” Guess you’d better find an accountant quickly. I hear it takes 6 weeks to get that “blue piece of paper” from the government (notice of assessment for those not following me).
Hopefully I’ve parted some “knowledge” this week so you can be “prepared” in the future.

I’ve been reading several articles about what’s happening with the sub-prime market in the US. I was looking for an article that would explain what’s happening in easy to understand terms. I’ve found an excellent one posted below.

It should be noted that similar things happen in Canada, however due to the conservative nature of the Canadian lending institution, the impact is much less.

As all of our sub-prime lenders have been quick to point out in emails the last few weeks, it’s “business as usual”. No major layoffs and no closures.

—————

BOYD ERMAN

Globe and Mail Update

August 16, 2007 at 9:05 AM EDT

Q: What is a subprime mortgage?

A: It’s a mortgage given to a home-buyer with less than stellar credit, or who lacks the paperwork to prove an income that can support payments. While such mortgages may not seem like the greatest idea, lenders flush with money were making loans in the U.S. to almost anyone who asked and charging a little more in interest for riskier loans. The bet was that rising U.S. house prices would paper over any mistakes.

But when U.S. housing prices started to fall, and interest rates began to rise, many borrowers ended up in trouble and lenders started to become insolvent (at last count about 50 have been wound down).

Q: Who were those lenders?

A: There were specialty finance companies such as American Home Mortgage (which filed for bankruptcy earlier this month), as well as big well-known banks such as HSBC PLC (which is still standing, but weakened after its U.S. unit took a big profit hit on subprime loans).

Q: How did the problem spread from subprime lenders into the rest of the financial world?

A: Many of the companies that were making the subprime loans weren’t holding onto the loans, but instead sold them to other parties, including hedge funds and pension funds looking for higher returns. Often, the loans were packaged together (think of a mutual fund holding thousands of individual loans) and sold to investors.

When those loans started going bad, suddenly lots of people all across the financial world were affected. Concerned about losses, investors and lenders started demanding higher interest rates to make loans, or stopped doing so entirely. Thus began the credit crunch.

From consumers, who are finding mortgages have now become more expensive and tougher to get, to massive buyout funds such as Kohlberg Kravis Roberts & Co., which are having to pay more for loans to carry out takeovers, tougher credit terms are slowing purchases and that’s slowing the economy and hurting stocks. The latest problem has surfaced in the asset-backed commercial paper market.

Q: What is commercial paper?

A: Commercial paper is short-term debt issued by companies, usually coming due in under a year and often in as little as a month. Buyers tend to be institutional investors such as money-market mutual funds, low-returning funds where investors park cash in the belief that they are safe. As a result, only highly rated companies with strong balance sheets can generally issue commercial paper, limiting the size of the market.

Q: What is asset-backed commercial paper?

A: To feed the appetite of the growing fund industry for more commercial paper, financial companies such as Coventree and National Bank of Canada set up trusts that issue commercial paper backed by assets such as car loans, mortgages and credit-card receivables. Most of these trusts roll over a portion of their commercial paper every day.

Q: How big is the market?

A: It’s worth at least $120-billion in asset-backed commercial paper alone. About two-thirds of that paper is sold by trusts run by banks, and that segment of the market is holding up. About another third, or $40-billion, is issued by trusts created by non-bank financial companies such as Coventree, and those have suddenly gone “no-bid” — Bay Street lingo for “nobody will buy at any price.”

Q: What’s happening in the market?

A: Suddenly, portfolio managers at money-market mutual funds are asking whether they really want to be investing in commercial paper that is backed by assets such as mortgages when the housing market is going bust. As a result, the trusts can’t find buyers for their paper, leaving them short of money. They are turning to banks, such as Deutsche Bank AG, that had agreed to provide loans in a situation where the market flounders, but some of the banks are balking. The trusts could end up being wound up.

Q: What does it mean for my money-market mutual fund?

A: If a money market mutual fund is invested in a trust that is in trouble, it could spell losses in a fund that most investors probably bought precisely as a way to insure against losses. But, so far it’s only a small slice of the market that’s in trouble, and not every money market fund holds paper issued by the troubled trusts.