24th June 2009

Dear Investor,

The Global Financial Crisis: what caused it?

Inevitably, in the years to come, much will be written about the causes of the current global financial crisis. What was first called a "sub-prime crisis", then later "financial turmoil", is now being called the "Global Financial Crisis". Dr Luci Ellis is the Head of Financial Stability Department at the Reserve Bank of Australia (RBA), and in a recent speech, she reviewed some of the causes, as well as the consequences and countermeasures.

Interestingly, she looked at the build-up of tensions that finally broke as this financial crisis. She noted that appetite for risk had been strong for some years; that risk was priced cheaply; and as a result, credit markets were booming and some measures of liquidity were rising. The RBA had identified the low price of risk as a potential source of vulnerability for the global financial system. One sector that took particular advantage of low long-term interest rates was the US mortgage market. American households traditionally took out fixed-rate mortgages, often guaranteed by the government sponsored enterprises Fannie Mae and Freddie Mac - the GSEs. As rates fell, households re-financed in large numbers, but this extra origination business dried up once rates started to rise again. Rather than shrink their business, US mortgage lenders pursued riskier segments of the market that the GSEs did not insure. This included not only the sub-prime segment, but also so-called "Alt-A" and other non-standard loans involving easier lending terms. At the time, this was considered a positive development, because it was thought that it allowed more people to become home owners. Products requiring low or no deposit, or with low introductory interest rates were know as "affordability products". They allowed households to pay the very high housing prices that their own strong demand was generating (a very circular proposition).

As the US housing market boom wore on, lending standards eased further. Up until 2006, the sub-prime market segment increasingly allowed mortgages with very high loan-to-valuation ratios: that is, borrowers did not need much of a deposit. Low-doc loans became more common across the board. Negative amortisation loans, sometimes called "Pay-option" loans became more common. These are mortgages where the borrower can pick a repayment level that is so low that the loan balance actually rises for a while - something that is essentially unheard of in other countries.

The result of all that mortgage borrowing was an increase in leverage, defined to be the ratio of home mortgage debt to the value of the housing stock. This measure had been quite stable in the United States for a number of years. But it increased in those last couple of years of the boom, reaching around 45% by the time prices peaked in 2006. In Australia, the equivalent ratio is below 30%. Since many home owners own their own homes outright, the US figure implies that many Americans had very little equity in their homes by the time the boom peaked. And, of course, this measure of leverage has increased a great deal since US house prices started to fall.

click graph below for larger view


But you can't borrow your way to a good time forever, and this recent example of a credit-fuelled boom was no exception. The first signs of trouble were in the US mortgage market. Lending standards had eased so far - and outright fraud had become such a problem - that arrears started to rise more than lenders and investors expected. The extraordinary thing was that, unlike in every other housing burst, arrears rates increased significantly before the labour market started to weaken - and are likely to increase substantially as unemployment rises.

click graph below for larger view


It seems reasonable to assert that the sub-prime crisis was indeed the initial cause of the Global Financial Crisis. But like the recent Victorian bushfires, the financial and economic environment was such that after the first match was struck, the fire took hold with devastating consequences.

In future editions of Investment News we will look at some of the other causes, consequences and countermeasures as discussed by Dr Ellis in her speech. A full copy of her speech can be obtained here.
Best regards,
Chris Andrews


> Home
> About Us
> PDS - Want to invest?
> FAQs
> Subscribe Free
> Independent Ratings
> Mortgage Shopping List

Chris Andrews
Head of Funds Management

t  +61 3 8610 2811
e  candrews@latrobefinancial.com.au

Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.

La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.

Copyright 2010 La Trobe Financial. All rights reserved. No portion of this may be reproduced, copied, or in any way reused without written permission from La Trobe Financial. Disclaimer

* La Trobe Financial Asset Management Limited ABN: 27 007 332 363 and AFSL No: 222213 is the issuer and manager of the La Trobe Australian Mortgage Fund. It is important for you to read the Product Disclosure Statement for the Fund before you make any investment decision. You can get a copy of the PDS by calling 1800 818 818. You should consider carefully whether or not investing in the Fund is appropriate for you.
(1) The rates of return from the Fund are not guaranteed and are determined by future revenue of the Fund, and may achieve lower than expected returns. Past performance is no guarantee of future performance. Investors risk losing some or all of their principal investment.
(2) Withdrawal rights are subject to liquidity and may be delayed or suspended.
(3) As at 30/11/10 the La Trobe Australian Mortgage Fund had received a Morningstar RatingTM of 5 stars. The Morningstar Rating is an assessment of a fund's past performance - based on both return and risk - which shows how similar investments compare with their competitors. A high rating alone is insufficient basis for an investment decision. © 2010 Morningstar, Inc. All rights reserved. Neither Morningstar, nor its affiliates nor their content providers guarantee the above data or content to be accurate, complete or timely nor will they have any liability for its use or distribution. Any general advice has been prepared by Morningstar Australasia Pty Ltd ABN: 95 090 665 544, AFSL: 240892 (a subsidiary of Morningstar, Inc.), without reference to your objectives, financial situation or needs. You should consider the advice in light of these matters and, if applicable, the relevant product disclosure statement, before making any decision. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/fsg.pdf
(4) 3.75 star rating out of a possible 5 star rating indicates that Adviser Edge believes that La Trobe has performed in line with its peers and exceeded its peers on some fronts.
(5) The Standard and Poors rating of 4 out of 5 stars indicates that S + P has high conviction that La Trobe Financial will consistently generate risk-adjusted fund returns in excess of its relevant investment objectives and relative to its peers.
(6) The award was given to the La Trobe Australian Mortgage Fund, Pooled Mortgages Option.
Research Ratings are subject to change. To view the latest research information please visit www.adviseredge.com.au or www.standardandpoors.com.au. Ratings issued by Adviser Edge Investment Research AFS Licence No. 236783 and Standard & Poors Information Services (Australia) Pty Ltd AFS Licence No. 258896 are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. The ratings are only one factor to be taken into account in deciding to invest. Research Houses receive a fee from La Trobe for rating the product. The Adviser Edge rating is generally a measure of the rated entity's capacity to meet its repayment obligations in all market circumstances.
IMPORTANT: This message, together with the La Trobe Financial website (www.latrobefinancial.com.au) and all its contents have been prepared for general information only and should not be taken as legal or financial advice, and as such the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore talk with their financial planner or advisor before acting on any information present on this message or the La Trobe website.