August 22, 2007 | posted by Pam Atherton in Banking, Investments |

Where the current sub prime crisis will end, is anybody’s guess.

These ‘liar loans,’ as they are known in the US, were dished out to all and sundry, at a time of historically low interest rates and on an adjustable rate basis, to people with poor credit records, and little or no income.

The brokers who sold these dodgy loans were incentivised by commission, while the banks had little interest in the risk sub prime homeowners posed of defaulting because they knew the loans would be parcelled up, sliced and diced, and doled out to anyone who was foolish enough to buy them.

Now that the chickens are coming home to roost, it seems that some of the banks and hedge funds who bought these asset backed securities, or collateralised debt obligations as they are known, had little idea of the creditworthiness of the underlying loans they were buying.

Otherwise, we wouldn’t be seeing banks and hedge funds in distress or near collapse. So the whole of the banking system is in a state of near paralysis because nobody knows where the sub prime bodies lie buried and, until we do, banks are looking suspiciously at each other and pointing the finger of blame at everyone else.

But as the experts never cease to tell us, it’s no good panicking now. If you wanted to liquidate your share portfolio, the time to do that was several months ago before the depth of the sub prime crisis became apparent.

For private investors who have a ‘buy and hold’ portfolio, it is probably best to sit tight and wait for the storm to blow over (although be prepared for a long one).

Professional investors may well find buying opportunities, but you need to be brave, highly knowledgeable or foolhardy to buy in these markets, as each day unearths new horrors.

While the Federal Reserve’s reduction in the discount rate last week restored a little temporary calm, equity and credit markets remain tense. In Europe the exposure of the German banks to the turmoil in the sub prime sector is particularly worrying. Are any nasty surprises lurking within UK banks, everyone is asking?

Banking expert, Ken Murray, who manages the Blue Planet Worldwide Financial’s Investment Trust, told me last week that two UK banks could be facing serious problems. Of course, he declined to name names for fear of starting a run on these banks.

But he made the point that many investors, who should have known better, did not understand the nature of some of the new-fangled products which investment banks have been peddling in recent years.

His words reminded me of the oft repeated, but little heeded, warning that “if you don’t understand an investment, leave well alone.“ The events of the last few weeks bear this out all too painfully. And that, dear reader, I am sure you will agree, is a lesson to us all.

Use our: Banking centre | Investment centre