Submitted on Tuesday 21st August 2007
Sub prime fallout eases
World financial markets stabilised on Monday as the U.S. Federal Reserve decided last week to expand lending to banks. This had the desired effect of easing the credit crunch that had so unnerved investors.
Credit markets - the source of so much turmoil over the past two weeks - also reacted with optimism as buyers of corporate debt recovered an appetite for bonds that had dried up before the action taken by the Federal Reserve on Friday.
Signs that credit markets that had seized up were relaxing, allowing companies to finance their operations, comforted and heartened stock markets, which were looking for evidence that borrowing costs were regaining predictability.
Lack of confidence can be sourced back to the subprime mortgage financial crisis in the US. The growing practice of lenders raising funds by securitising debt parcels has been hit by the buyers of that debt beginning to doubt its integrity.
The subprime mortgage financial crisis refers to the sharp rise in foreclosures in the subprime mortgage market that began in the United States in 2006 and became a global financial crisis in July 2007. Rising interest rates increased newly-popular adjustable rate mortgage and property values suffered declines from the demise of the housing bubble, leaving home owners unable to meet financial commitments and lenders without a means to recoup their losses.
The sharp rise in foreclosures after the housing bubble caused several major subprime mortgage lenders, such as New Century Financial Corporation, to shut down or file for bankruptcy, with some accused of actively encouraging fraudulent income inflation on loan applications, leading to the collapse of stock prices for many in the subprime mortgage industry, and drops in prices for some large lenders like Countrywide Financial.
The butterfly effect of this has spread quickly in today’s highly leveraged and interconnected financial community.
The effects of the meltdown spread beyond housing and disrupted global financial markets investors largely deregulated foreign and domestic hedge funds, were forced to re-evaluate the risks they were taking and consumers lost the ability to finance further consumer spending, causing increased volatility in the fixed income, equity, and derivative markets.
It remains to be seen how deep the damage is and how this will impact on the future ability of UK institutions to lend money.
