US subprime mortgage lenders are struggling to survive and their demise is having a profound impact on global financial markets. In London, the FTSE has suffered a series of significant falls, taking its biggest single-day drop in seven years on Friday 10th August alone, erasing most of this year’s gains. As a result, there is now a real fear that the US housing market crash could be repeated here in the UK.
The panic selling and lack of confidence in stock markets stemmed from the collapse of the US subprime mortgage market. Increasing defaults and defaults by subprime mortgage lenders in the US have prompted a reassessment of the value of such holdings by investment bankers who have bought securities in bulk for risk reasons. They watch the potential paper value of their investments vanish virtually overnight as US home prices plummet, provoking panic and consolidation attempts in almost equal measure.
Subprime mortgages are usually given to those who cannot prove their income or have bad credit, or maybe both. In exchange for higher interest rates from borrowers, lenders are willing to take a risk on these types of bad credit loans. When real estate prices rise, the risk is minimal because if the borrower defaults, the lender has an encumbrance on the property and can therefore force the property to be sold to recover the initial investment, any interest due and collection costs.
However, in a market where house prices are falling, as in the United States, the value of the property can fall below the outstanding liability, causing the lender to incur a significant loss. Because US subprime lenders are the least able to absorb defaults as most of their borrowers are 100% mortgages, they are the most vulnerable to a collapse if everything goes wrong.
The largest subprime lender in the US, New Century, issued subprime loans totaling $33.9 billion last year alone. It is now being investigated by federal investigators to determine if there is any impropriety in their business practices. It is the bad debts recorded by lenders such as New Century that are causing extreme concern in financial markets around the world, leading analysts to wonder if the situation in the UK will repeat itself. This has prompted many UK lenders to rate their most vulnerable loans to determine their risk and ensure they have an adequate amount of capital to cover potential losses. Fortunately, the UK market is considered less vulnerable to subprime lending than the US market. And provided house prices in the UK continue to rise or remain stable, lenders who have made such loans to homeowners with bad credit will not be affected. Any threat will materialize when UK property values fall as the level of equity in property falls too and this could lead to the kind of financial chaos seen in the US.[tohomeownerswillnotbeaffectedAnythreatwillmaterialiseifhousevaluesintheUKfallastheamountofequityinpropertieswillalsodropandthatcouldleadtothesortoffinancialchaoswitnessedintheUS[tohomeownerswillnotbeaffectedAnythreatwillmaterialiseifhousevaluesintheUKfallastheamountofequityinpropertieswillalsodropandthatcouldleadtothesortoffinancialchaoswitnessedintheUS