The ‘US Subprime Lending Problem’ — explained in simple terms
August 17, 2007
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?
Read below to view a simplified explanation of the US subprime lending problem.
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 current Subprime Lending Crisis?
Beginning in late 2006, many subprime mortgages have become delinquent as homeowners run into financial difficulty. More than two dozen subprime mortgage lenders have already failed or filed for bankruptcy due to rising incidents of subprime foreclosures.
How is this affecting the markets?
A number of hedge fund companies and investment banks that invested in subprime loans incurred millions of losses or even went bankrupt due to the subprime lending problem. The possibility of tightening credit conditions also caused volatility and panic in the US stock market, which consequently sent fears to European and Asian markets that the US, one of their major trading partners, is on the verge of an economic recession. These fears and uncertainties are responsible for driving world stock markets to their recent lows.
References where you can learn more about the US subprime lending problem:
- BusinessWeek: A Primer for the Subprime Problem
- Wikipedia: Subprime Mortgage Financial Crisis
- Oppenheimer Funds: FAQs on the Subprime Market
Photo Credit: Joe Raedle | Getty Images
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March 16th, 2008 at 12:17 am
[...] the housing boom from 2003 to 2006. Then two of its hedge funds which were heavily hit by the subprime mortgage crisis collapsed and it was all downhill from [...]