Global stock markets are down, investors are on selling mode, and almost all of 2007’s stock gains have been wiped out. The culprit, analysts say, is the current US subprime lending problem.
The subprime… what? And if it’s supposed to be a problem in the US, why is it affecting markets in Europe and Asia?
What are Subprime Loans or Subprime Mortgages?
These are loans or mortgages made to homeowners with poor credit ratings. Loans made to these people are of considerable risk because these borrowers are more likely to default on their loans since they already had financial problems before taking on the loan.
After a subprime loan is issued to homeowners, issuing banks usually sell these loans to investors. To compensate for the high risk, subprime loans typically pay higher yields. Attracted by the higher yields, a number of mutual funds and hedge funds in the US invest in these loans.
What is the Subprime Lending Crisis?
Beginning in late 2006, many subprime mortgages have become delinquent as homeowners run into financial difficulty. In turn, lenders now suffer from lack of liquidity or profitability due to delinquent payments of borrowers.
In fact, more than two dozen subprime mortgage lending companies have already failed or filed for bankruptcy due to rising incidents of subprime foreclosures.
Of course, closures lead to layoffs and layoffs mean absence of income. You can imagine what its impact is to those employed by the lending firms.
How is this affecting the markets?
More importantly, the crisis causes volatility and panic in the US stock market because companies are closing down and creditors are not anymore getting money from borrowers. This consequently sent fears to European and Asian markets, fearing that the United States (US) is on the verge of an economic recession. These fears and uncertainties are responsible for driving world stock markets to their recent lows.
If you want to learn more about the US subprime lending problem, here are some other useful resources:
- Subprime Mortgage Problem 101: A funny Powerpoint
- BusinessWeek: A Primer for the Subprime Problem
- Oppenheimer Funds: FAQs on the Subprime Market
