| Stock markets have tumbled, redemptions in massive investment funds have been frozen and central banks have been pumping in billions of dollars. All because about 20 per cent of high-risk mortgages in the United States are in default. Here's a look at the major roles of the major players. Homes It all starts with the US housing market, where easy credit and soaring prices have been the norm. But sales of existing homes have tumbled by 6.8 per cent over last year, and as many as 20 per cent of high-risk mortgages are behind in payments. [Any person can buy a big house for as long as that person is willing to carry a big mortgage. It's a matter of choice.] Mortgage Lenders No money? No problem. Mortgage brokers and banks in the United States let people with tiny down payments and poor credit buy houses. People who missed payments had little trouble refinancing. Small wonder defaults soared as housing prices tumbled. What the Fed did Low interest rates and easy money fuelled the home-buying binge. Former US Central Bank chief Alan Greenspan and his successor, Ben Bernanke, focused on priming the economic pump through low borrowing costs. The Fed has resisted raising rates, citing inflation. Wall Street Hedge funds and investment banks found ways to bundle pools of high-risk mortgages and sell them to investors. But mortgage defaults have made valuing some of these assets impossible. And the shared profits in the funds have become widespread losses, triggering panic. ____________________________________________________________ How the liquidity tide turned It was just a few weeks ago when all the talk was about the global liquidity glut --- too much investment capital chasing too few assets, driving down yields even on high-risk debt. Anyone could borrow money, even American home buyers with lousy credit ratings. But all of a sudden the global liquidity glut is no more. It has unwound so quickly that in a space of a few weeks central banks around the world have gone from warning markets about the excesses of low yields and too much cash, to injecting hundreds of billions of dollars of cash into those very markets. The liquidity glut has served as backdrop for monetary and economic policy and for investment decisions implicating economies around the world. Now, amid the turbulence of the markets and the overwhelming concerted action by central banks, analysts are reviewing how this ample liquidity could evaporate so quickly, in the hopes of determining the long-run repercussions of the reversal of fortune. Goldman Sachs has broken it down into five stages: Stage One: Money was too cheap for too long. Fuelled by low interest rates, liquidity and leverage have been getting ever cheaper since 2001. Stage Two: In search of higher returns, investors took on riskier assets, driving down the yields of those assets. At the same time, financial innovations helped spread the risk around. High-risk investments were made to look safer than they actually were. Stage Three: Enter the subprime monster. The US housing market turned. Holders of subprime mortgages found all of their intricately connected but widespread holdings contaminated. Markets started to worry. Stage Four: That brings us to the present. Investors and markets have second thoughts about the true value of many assets. Without knowing the "true" price of credit, leverage is no longer acceptable. Lending seizes up. Positions dependent on leverage try to unwind. They've reached a point now where they don't know how to price things. So if you don't know the value of things, the value is zero. Stage Five: The future. It can be summed up with a big question mark. Either markets reprice risks quickly and settle down, or they don't, and the volatility drags on, spilling over into the broader economy. Economists who feel comfortable predicting how the credit crunch will play out are few and far between. The liquidity glut dried up quickly mainly because of a rapid change in market psychology, and psychology doesn't fit well into forecasting models. ____________________________________________________________ U.K.'s Subprime Crisis May Be Worse Than U.S.'s: Matthew Lynn Aug. 8 (Bloomberg) -- We are now all familiar with the damage that can be done to financial markets by a subprime lending crisis. Global equity markets have taken a battering recently because of concerns about U.S. home mortgages. So which country is next? The U.K. has had a property bubble every bit as crazy as the U.S.'s. Valuations were stretched, and lending criteria loosened. And now arrears are starting to rocket, even while the economy remains healthy. Not only does the U.K. face its own subprime crisis, it could be far worse than in the U.S. The latest figures on debts and mortgage arrears in the U.K. certainly make grim reading. Households ``are getting into more trouble when it comes to their mortgages,'' London-based consulting firm Capital Economics Ltd. said in a note to investors. ``With higher interest rates yet to have their full effect, mortgage arrears are likely to rise further, while unsecured bad debt might start to rise again too.'' The signs of trouble ahead can be seen in the number of homes now being repossessed because their owners can't keep up the payments. According to the Council of Mortgage Lenders, lenders foreclosed on 14,000 properties in the first six months of the year, 30 percent more than in the year-earlier period. That reflected ``the impact of an increasing amount of subprime lending within the overall market,'' the council said in a statement on the figures. Britons in Debt Arrears aren't in great shape either. An estimated 125,100 households are behind with their mortgage payments, about 1 percent of the total, according to the council. Home owners behind with the payments will have their homes repossessed a few months down the line, unless their finances improve. The wider picture of indebtedness isn't much more comforting. The British are deeper in the red than any other major economy. According to data from the National Institute of Economic and Social Research in London, the ratio of household debt to personal income is 1.62 in the U.K., compared with 1.42 in the U.S., 1.36 in Japan, 1.16 in Canada and 1.09 in Germany. The U.K. is now facing a subprime crisis on a similar scale to the U.S. As anyone who has taken out a mortgage in Britain will know, banks shovel out money without asking many questions. A review by the U.K.'s Financial Services Authority last month criticized reckless lending in the subprime sector, which has, it said, ``resulted in the approval of potentially unaffordable mortgages.'' No Proof of Income The British market doesn't fall neatly into ``prime'' and ``subprime'' categories. Most of the mainstream lenders offer so- called self-certified mortgages, which require no proof of income. Plenty of prime borrowers -- meaning people who haven't defaulted on a loan yet -- are likely to take out mortgages that will be hard to make the payments on. The U.K.subprime crisis may be a lot nastier than the U.S one. Here's why. First, despite the mounting evidence that people can't afford them, house prices continue to soar. The National Housing Federation predicted this week that British house prices will rise 40 percent in the next five years, taking the average value of a home to 302,400 pounds ($618,000) by 2012. The average British home already costs 11 times the average local salary, and that figure continues to increase. It is driven mainly by the U.K.'s small geographic size, high levels of immigration, and very low levels of house building. People have to live somewhere -- a home, after all, isn't an optional item for most of us. The net result is that even as payment problems mount, people will carry on taking out bigger mortgages. What choice do they have? Rate Differences Next, U.S. interest rates may have reached their peak and could soon fall. In the U.K., that isn't the case. The Bank of England is likely to raise borrowing costs at least once more to 6 percent. If the housing market and general inflation don't show any sign of responding to that treatment, interest rates could go higher still. That won't help borrowers already hard-pressed to make their payments. There should be two self-correcting mechanisms for fixing a subprime crisis in the housing market. House prices should gently fall, making properties more affordable, and reducing the size of loans. And interest rates should stabilize or fall, making the payments on those loans easier to maintain. Neither seems to apply in the U.K. Instead, interest rates are rising and so are house prices. The result is that thousands of families are left in a vulnerable position -- and so are the banks that have lent them money (not to mention the investors who have bought those loans as they have been sold on). Just Walk Away While the property market rises, everyone will be safe. If your house is worth more than your mortgage, you will be desperate to hold on to it. If you get into trouble, you can always sell it, repay the loan, and move somewhere cheaper. Yet, as the U.S. has discovered, if house prices start to fall, that arithmetic changes. If you are in trouble with your mortgage, you can't pay it off by selling. There is little incentive to keep up the payments. Why not just walk away, and hand the keys and the problems over to the mortgage company? Britain hasn't reached that point yet. But if it does, the mess could be even worse than in the U.S. Last Updated: August 7, 2007 19:17 EDT |
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| The subprime crisis: Who did what ___________________ |
| 08/07/2007 The Globe and Mail |