In my Concrete Analysis piece in April, I clearly underestimated the impact of the subprime mortgage meltdown and its effects on the broader credit markets. Estimates of the expected credit losses attributable to the subprime mortgage market have grown appreciably in recent months.
A recent Goldman Sachs research note estimates the potential losses at US$400 billion, or three times the size of the savings and loan crisis in the United States in the 1980s. While the loss in absolute terms may not seem very large given the size of the US financial markets, the amount of leverage related to investors holding mortgage-backed securities should not be underestimated.
Goldman estimates that if leveraged investors write off US$200 billion to US$400 billion of aggregate credit losses, the reduction in overall lending could be as high US$2 trillion. In addition, the spillover impact of the credit markets is unprecedented.
In the past six months, the US asset-backed commercial paper market has shrunk nearly 25 per cent (more than US$400 billion) and several central banks including the Federal Reserve have injected billions of dollars to provide liquidity into the uncertain money market system. These factors all together are most likely to drag the US economy into a recession. The real question is how long the economic downturn will last.
In Hong Kong, the markets have been relatively immune from the global contagion, as the credit and mortgage markets continue to perform well. However, in September, interest rates in Hong Kong began to decline again with the best lending rate falling 75 basis points.
On the surface, this may be viewed as good news, but does Hong Kong really need lower interest rates at this point of its economic cycle? Hong Kong's economy has been very robust since the Sars epidemic. The economic facts are clear: GDP growth is strong, unemployment continues to fall, and the overall business confidence is high.
Most importantly, inflationary pressure is increasing with real interest rates expected to fall into negative territory, according to a UBS Global Economic Research report on Monday. Ultimately, most market professionals would agree that lower real interest rates would only further fuel an already strong property market (from January to September, property transactions rose more than 45 per cent year on year in terms of dollar volume.)