It is a tale of desperate housewives and desperate stockbrokers. It has come as a surprise to many that there is such a close link between what goes on in middle America, and what goes on on the trading room floor. The culprit is the sub-prime mortgage, a type of loan made to someone with poor credit history and a patchy employment record. Since 2002 they have fuelled the US housing boom: As one US analyst said, “If you could fog a mirror and show a pulse you could get a loan.”
A rising property market and rock bottom interest rates meant just about anyone could get a mortgage. But the US central bank raised rates to beat inflation, and the rot set in. The chain of events works like this. Homeowners have trouble making mortgage repayments as interest rates rise. They default on their loans, and the lender buckles under the weight of bad debts.
Large international banks are then affected as these mortgage debts have been sliced up and sold off to financial investors around the world. Stock markets start to fall as it becomes clear that banks cannot accurately value their investment funds, and hedge funds have to sell shares in order to earn cash to honour terms and conditions on their loan contracts. The recent falls illustrate the globalised state of the financial markets.
And they have prompted the European Commission to open an inquiry into the credit ratings industry. Some suggest it was too slow to warn of the looming sub-prime mortgage crisis. EC spokeswoman Antonia Mochan: “There are a number of issues that we want to look at: governance of the agencies, their management of conflicts of interest, their resourcing, and their ratings perfomance”. The tumbling value of stock markets has an impact on everyone. Equities fall, pension funds slide, and the drop in consumer confidence exacerbates the problem as people feel less inclined to buy goods and services.