Saturday, 18 August, 2007

What is subprime problem?

What is happening in the mortgage market?

The riskiest segment of the US mortgage market, which serves borrowers with poor credit histories at high interest rates, has seen rising default rates in recent months.

The Mortgage Bankers Association said lenders began foreclosure against more than one of every 200 US mortgage borrowers in the fourth quarter, a record.

What types of loans are considered 'subprime'?

There are "no doc" loans. That's when you get a loan without giving the lender any documentation about your income. There are also "low doc" loans, or when you get a loan with just a little paperwork about your employment and income.

The number of non-traditional loans extended with low or no documentation jumped from 53.9 percent in 2003 to 65.7 percent in 2005, according to First American Loan Performance, which tallies home mortgage data.

How did this crisis come about?

While subprime mortgages have spread credit more widely and helped more people buy their own homes, critics contend a hot real estate market encouraged lenders to get more aggressive and offer increasingly complicated terms that borrowers did not always fully understand. These risks are being exposed as the housing market cools.

What's happening to the lenders ?

Waning demand from investors for home loans has toppled more than 70 mortgage companies and half a dozen hedge funds in the US since the start of last year. Concern over rising defaults has prompted bankers to reduce credit lines for home lenders.

Why is the meltdown among subprime lenders having an impact on the whole US stock market?

There is concern that the crisis could spread to more mainstream lenders and worsen the US housing slowdown. Delinquencies often foreshadow future loan failures and those bad credits could damage other mortgage-backed investments held by a wide range of investors.

Some economists worry that as house prices fall and lenders tighten credit terms, consumers will curb spending and drag down the US economy.

What would be the damages?

The US subprime mortgage crisis will cost credit investors about $150 billion in losses worldwide, according to Calyon, the investment banking unit of Credit Agricole SA, France's third-largest bank by market value.

Foreclosures may reach 20 percent of the $1.3 trillion of subprime mortgages outstanding, according to a research note. Assuming investors can recoup half their investments, losses would be $130 billion, it said.

A further $20 billion could also be lost from the $1 trillion of outstanding Alt-A mortgages offered to borrowers with better credit who fell just short of typical standards. Various other estimates for total subprime losses range from $50 billion to $200 billion, according to the report. Federal Reserve Chairman Ben S. Bernanke last month cited potential estimated losses of between $50 billion and $100 billion.

What's the outlook?

Some analysts believe the crisis in the subprime mortgage market could boost the chances of the Federal Reserve cutting its target for benchmark interest rates.

One of the factors driving the poor performance of subprime mortgages has been a series of interest rate increases by the Fed. From 2004 to last summer, benchmark rates rose 4.25 percentage points to 5.25 percent. That has led to a steep rise in payments on adjustable rate mortgages.

"The Fed is aware of the situation, and how raising rates might worsen the situation. " said John Kriz, managing director of real estate finance at Moody's Investors Service, a leading credit ratings agency. "Our view is that it is less likely that rates will rise and more likely they will fall."

The Fed may have done enough after adding $62 billion to the banking system on August 9 and 10 and pledging further funds as necessary, says Dominic Konstam, head of interest-rate strategy at Credit Suisse in New York. Stocks rallied worldwide on Wednesday, while the ECB said today it's optimistic that ``market conditions are normalising.''