The Sub-Prime Mortgage Market

by Business Case Studies on Wednesday 17th October, 2007

The Sub Prime Mortgage Market

Adapted from a news item from Alex Chan (Year 13)

What is this sub prime mortgage market we keep hearing about in the news? Sub-prime mortgages are those sold to people with poor credit histories and thus a greater chance of defaulting. They are associated with higher interest rates. In the UK this type of mortgage lending is growing more quickly than the mainstream market (BBC, 10th July 2007). In the United States, a series of interest rate increases caused pressure on home owners, who had seen their monthly mortgage payments rise. This led to an increasing number of borrowers defaulting on their mortgage repayments:

'Proceedings for about 320,000 foreclosures – or repossessions – were begun in each of the first two quarters of 2007 he said, against an average of 225,000 per quarter in the past six years'. (BBC, 20th September 2007)

Whilst the US Federal Reserve has now cut interest rates, financial concerns about the US markets have impacted globally. In the UK a tightening control over lending between banks, known as the credit crunch, caused problems for Northern Rock. Having failed to raise funds in the money markets the bank was forced to ask the Bank of England for an emergency fund. (BBC, 13th September 2007). The move caused deep ripples in the financial marked and led to a fall in confidence in the bank and a tumbling share price (BBC, 24th September 2007).

Whilst the problems at Northern Rock have been most notable, other large financial institutions have also encountered difficulties. Investment bankers Merrill Lynch has reported a third-quarter loss after writing off about $5 billion (£2.45 billion) of sub-prime-related losses (The Times, 6th October 2007). The world's largest financial services group Citigroup, also stunned investors with a warning that turmoil in the mortgage markets would wipe as much as $3.3 billion off its t hird quarter profits (The Times, 1st October 2007). The Centre for Economics and Business Research (CEBR) has also warned that as many as 6,500 jobs may be lost in the city (BBC, 8th October 2007). The IMF warned in its global stability report that the 'global credit crunch' would result in an economic slowdown. It suggests that 'the potential consequences of this episode should not be underestimated and the adjustment process is likely to be protracted' (BBC, 24th September 2007).

However there are some signs that confidence in the business sector is growing. Lloyds TSB Corporate Markets Business Barometer for September has revealed that UK industry is holding its own. Trevor Williams, chief economist at Lloyds TSB Corporate Markets, suggests that in the UK, official data suggest that the majority of the corporate sector will perform strongly this year in terms of output growth and profit' (Fair Investment, 8th October 2007)

Sources:
The Times 100 Edition 12 McCain Case Study – How McCain Responds to Changes in the External Environment

BBC News – Sub-prime mortgages 'set to grow', 10 July 2007

BBC News – Mortgage woes 'exceed forecasts', 20 September 2007

BBC News – City 'to lose 6,500 jobs' in 2008, 8 October 2007

BBC News – Northern Rock gets bank bail out, 13 September 2007

BBC News – Turbulent ride for Northern Rock, 24 September 2007

TimesOnLine – Merrill Lynch crashes into loss after $5bn writedown, 6 October 2007

TimesOnLine – Citigroup Stuns Investors, 1 October 2007

BBC News –  Credit crunch 'hits world growth', 24 September 2007

Fair Investment Company – Lloyds TSB: UK firms tough out sub prime credit crisis, 8 October 2007

Potential Study Questions:

What is meant by the credit crunch
Why did the share value of Northern Rock fall after they borrowed funds from the Bank of England?
Evaluate the impact of the global credit crunch on the UK and global economy.

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