US Sub Prime Mortgage Debacle ripples across the world!
U S Sub Prime Mortgage Debacle sends ripples around the world!
Dear forum friends,
By now you must have heard about the problem with the Sub Prime Mortgages. What
then is a mortgage. It is a document, that secures a debt with an asset, in this
case a house. In a usual mortgage the amount secured does not exceed 75 % of the appraised value of the house. Some mortgage companies were able to lend up to
95% of the market value of a house, but these mortgages cost more interest and were additionally secured by a mortgage insurance company. This insurance had to
be paid by the borrower and was often added to the total debt. In any way no mortgage would be given, if the borrower did not have enough income to make the payments. The payments are usually made monthly and include both interest and principle (the debt). These mortgages would be standard or 揚rime?
Now what is Prime? We have 揚rime Ribs of Beef?a tasty and expensive dish. Prime rates and ?Prime denotes Quality. In bonds it denotes security. Now we can consider ?Sub Prime?It is a term coined by ingenious Yankee Bond traders. A Sub
Prime mortgage is really a sub standard mortgage. Would you buy a sub standard car? Never, but a sub prime car, perhaps it seems more like the economy version.
You can see why the term Sub Prime was invented. Companies were formed in the US
to sign people up for these mortgages. These were given without deposits by the
house buyer, who usually would not qualify for a mortgage, because of insufficient income. These mortgages were arranged by mortgage brokers who received fees
for their effort. All these fees were added to the mortgage. The interest charged was often low, so that the payments were low and people would then qualify to
buy a house. There would be a provision, that the interest would go up 2 or 3 points after two years. The usual mortgage repayment term in the US is 25 to 30 years. In the beginning the payments are almost all interest with only very little repayment of the debt. Raising the interest rate will the greatly increase the
monthly payment in some case it will double. Why did people go for it. Well the house prices in the US for the last 20 years had increased every year, and every one thought they could make a profit and sell.
The truth however is, that about 20 % of the mortgages are in foreclosure. That
means the buyer is loosing the house and the mortgage company will force a sale.
This has a downturn effect on house prices. Since there was no equity in the house, and it will be sold at a loss, the mortgage company will loose. The clever
brokers had earlier put together bundles of these mortgage with a few better mortgages as an investment packet at a return better than short term rates. It was
assumed by banks around the world, that these packets were good. The truth was otherwise. Bankers all around the world had taken these debt instruments and are
now having to make provisions for large losses. German banks, French banks and Canadian banks have declared the reserves, but nobody really knows the real extend of the losses, it will come out only in future years. However it looks that at
least half the money is gone. Even two large Chinese banks have exposure. I will not say here how much, but sadly it is a lot.
Could you say, that the bond brokers dealt criminally? I would have to think so,
because if they knew what was coming, then they were dishonest. If they did not
, then they would be totally incompetent.
What are the results of all this? The economy all over the world will be impacted. General Motors in Canada is laying off a whole shift in their truck plant affecting 1,200 men. The auto parts plants feeding GM will lay off another 4,500.
This is only one instance. In the US were people would borrow on the equity in
their houses, they can no longer do this and they must curtail their spending. Less being bought translates to less needed to be made. Thank God China has a strong developing middle class to take up the slack.
I hope you understand the Sub Prime Mortgage Debacle a little better now.
Best Wishes, Uncle Ben
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