Is this sub-prime or solvency crisis?

December 17th, 2007

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Today, news hit the Australian market of a very highly likely collapse of Centro Properties Group, one of the largest and most well-known Australian property trust. The result was a bloodbath in the stock market. As we read the mainstream news media, we caught hold of this article, Centro on the brink as shares collapse in the Sydney Morning Herald:

Centro Properties Group has become the biggest local victim of the US sub-prime mortgage crisis after higher funding costs forced it to downgrade of its distribution guidance, causing its shares to plunge by more than 70 per cent.

Pay attention to the phrase “US sub-prime mortgage crisis” in the above paragraph.

Sometimes, the problem with the mainstream media is that they often reduce their readers’ understanding of what is really going on in the financial market. As a result, we get to hear nonsense like this: “Oh, investment x is a fundamentally solid investment because it does not have sub-prime exposure.” People has come to believe that the sub-prime crisis is the source and root of the problem.


The root of this crisis is bad debts. Back in March this year, we mentioned in Marc Faber on why further correction is coming?Part 1,

Next, how is liquidity created? Traditionally, the money that is ?printed? by the central bank is the source of liquidity. But today, through the fractional reserve banking system (see 363 tons of US dollars to Iraq?how much money will eventually be multiplied into the economy? on how money and credit is created by the banks), the central bank is no longer in total control of liquidity because the creation of money and money substitutes is no longer in its hands. This situation has gone to the point whereby money substitutes (e.g. derivatives, securitised loans) supplanted the ?original? money created by the central bank as the vast bulk of global liquidity (see Prepare for asset repricing, warns Trichet on the extent of this supplantation).

The problem is that much of the economic boom that we enjoy over the past several years are financed by the explosion of credit (which is debt on the opposite side of the balance sheet). There is such a colossal amount of debt created and scattered throughout the globe that it does not take a genius to see that massive amount of bad debts have to accumulate and build up in the global financial system. Eventually, all bad debts will be exposed as what they truly are.

Hence, the sub-prime crisis is just a symptom and focal point of this systemic rot. In essence, the big picture is not merely about sub-prime mortgage debt. It is about the mass-solvency of the global financial system.