Recent turmoil in the American sub prime mortgage markets has sent shockwaves through the world banking system but what exactly is this all about and what does it mean to the average man ? or woman, on the street?
To understand the consequences we must first understand the causes, what exactly is a ?sub prime mortgage market??
Unlike the banking system here in the UK the American system is far less legislated, there is no equivalent to our Financial Services Authority (FSA). This means that American lenders have had a much freer reign to lend to the sub prime market.
By this we mean people who have had a poor financial background and credit history and who represent a significantly higher risk to lenders. This is the sector of the market who, in the UK, will have traditionally found it difficult to get a mortgage.
This area of the market as well as being high risk can also be very profitable, which is why many American banks eager to spread the risk have sold many of these sub prime loans on to World, and in particular European banks, who were more than happy to take them on because of the possibility of higher profits.
This situation has been happening quite successfully for many years and was fine until a recent slowdown in the US economy meant that more and more people were finding it hard to meet their repayments on mortgages and loans etc.
This has resulted in unprecedented numbers of people defaulting on their mortgages and simply handing their house keys back to their mortgage lenders, a huge amount of which now being European banks. In turn this has led to a housing market slump in many parts of the US meaning that the market value of these ?handed back? properties is in many cases far less than the loans that are outstanding on them leaving the affected banks with less assets them they have debts in this particular market.
The main problem with this, and the reason so many banks have been caught out, is that no one seems to know the full extant of the problem. The banks themselves are still not sure, or are at least not letting on, how much of these bad debts they actually own.
This in turn has led to a breakdown in trust between major banking institutions as, until the full extent of the problem is out in the open, they cannot be certain of their own or other banks liabilities.
How does this affect me then??
What this actually means to the man on the street is that because the rate at which banks lend money to each other has risen (yes, as we now all know, even banks need to borrow money to make money) cheap credit at low interest rates is going to be increasingly difficult to find.
This is what is affectionately become known in the media as ?Credit Crunch?. With a lack of cheap credit available many of us will in turn not be able to afford to buy things that have been easily accessible in the past, a new car, put the holiday on the credit card and pay for it later etc.
More importantly, as most of us have seen in the media, cheap mortgage deals are, at the moment, a thing of the past. Most lenders have either increased rates or removed fixed rate deals altogether regardless of the Bank of England?s decision not to increase interest rates.
The worry for the Government is that with less ?cheap money? around there is almost certainly going to be a reduction in consumer spending leading to both manufacturers and retailer?s alike finding times very difficult and reporting significantly reduced profits in the future.
While it has not been widely mentioned so far, there is also an underlying worry for some economists that this is all to reminiscent of the late eighties and early nineties and we could be heading slowly towards a recession not seen since those times.
Whatever the future holds, many banks have no doubt learned a valuable lesson ? don?t lend money to people who obviously can?t afford to pay it back, regardless of how profitable it might be!
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