US Subprime Market - Is the worst yet to come?
by Althaf Ahmed
With the bubble bursting on subprime mortgages, analysts expect a significant fall in growth in the second half of 2007, with the worst yet to come
The first signs that the bubble was about to burst on the United States housing bubble of the last decade or so was the sharp fall of the US stock market. It fell sharply as the subprime mortgage crisis began its inevitable spill into the broad financial markets.
Two hedge funds run by a leading New York broker began to shows signs of serious trouble as a result of their heavy exposure to subprime mortgages. Eventually the company had simply no option but to prop up the funds from their own capital. The feelings in capital markets were that the possibility of write-downs of securities backed by subprime mortgages at other institutions would become a very strong reality which would in turn become a genuine threat to other parts of the economy.
The cost of borrowing is beginning to rise steadily and consumers are caught in a difficult position as their one major asset in their lives;their home, is making the steady slip between being an asset to a liability.
Analysts generally concur that for a long time house prices have raised to a level where they far outstrip any logical relationship to what people earn or what they will return in rental income. Nowadays the average rental cost per square foot is half what it takes to repay a mortgage.
In the glory days of the property boom, consumers were encouraged to buy properties and borrow too much money. Mortgage banks were happy to lend money and asked for very little equity in the property as security. Sometimes as low as 10%.
Ask yourself what kind of banker would do such as thing? One who could then sell on these mortgages in a block to hedge funds, where the securities were backed by these shaky mortgages. It was a win/win situation then.
The consumer enjoyed the security of “owning “their own property, the mortgage banks earned a nice commission on selling the mortgage and the hedge funds were able to sit on blocks loans on secured assets.
Now that the dust has begun to settle on this fiasco, analysts fear that a trillion dollars in mortgage loans out there will not be repaid. This means foreclosures, and a glut of property on the market, Mortgage banks are now battening down the hatches, demanding equity of 30-40% and considerably higher and fixed interest rates for new borrowers. This trend is expected to continue for at least the next five years.
In the short term, financial forecasters predict that the US economy will face a major uphill struggle to achieve the 2-1/2 to 3 percent growth rate had aimed for in the second half of 2007. The new forecast is a growth rate of less than two percent for that period, largely as a result of a major fall in consumer spending.
With an election year in the offing, democratic congressmen are pushing a proposal to” bail out” subprime borrowers on humane grounds. Many of these home owners are now approaching retirement age. Statistics show that around a third of them have no form of pension and were dependent on the “profits” from the sale of their property, as it would allow them to take care of themselves in their golden years. Now they are faced with the reality of having lost their equity, and may be both homeless and on the poverty line.
Whether the US government can turn their back on these people remains to be seen. If Congress decides to step in and underwrite the bulk of the projected bad debt, then austere times indeed are expected for the US economy.
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