Commercial insurance article archive
US credit squeeze threatens international liquidity
Interest rate rises to curb inflation have been putting the squeeze on debtors in the US just as in the UK, but a domino effect from America may affect the options for investors around the world.
To begin with, the collapse of the sub-prime mortgage market in the US was prompted by recent rises in interest rates. These forced up payments for mortgage holders which affected the most vulnerable sector of society the worst.
While higher interest rates always have a more striking effect on the lower-earning sectors of society, the problem was exacerbated in the US by the financial services industry offering this at-risk group tailored mortgage deals.
These sub-prime mortgages often let people balance the loan against their home's future price growth rather than be guaranteed by a risk assessed through income.
However, higher interest rates coupled with falling property prices, which were creating negative equity in some areas, meant large numbers of people had to default on their mortgage payments and risk losing their home.
Economics editor for the Guardian, Larry Elliott suggested that the greater use of sub-prime mortgages could be seen as a heroic attempt by lenders to get all parts of society into the property market or, more likely in his view, an attempt by "a bunch of snake-oil salesmen, hucksters and crooks" to gain more commission fees and pick up cheap property from foreclosures.
This view is shared in hindsight by Ben Bernanke, chairman of the US Federal Reserve, who declared lenders had engaged in an "outright fraud" and promised to toughen regulations to clamp down on "unfair or deceptive" mortgage deals.
The collapse of this system could cost the US mortgage industry £50 billion and the fallout has seen higher yields in the bond market.
This could lead to less flexibility or liquidity in the economic markets as money will be more likely to stay in one place as it has become harder to borrow money cheaply, which could reduce the opportunities for property trusts to raise capital to invest and so reduce market activity leading to prices falling.
But Mervyn King, the governor of the Bank of England, insisted recently that there would not be an international crisis following the sub-prime lending fiasco in the US, saying: "I don't think there is much evidence of major damage to loan performance in other markets."
However, Mr King's deputy Sir John Gieve said that as ever there were "uncertainties" in how the market would react to changes abroad.
Nevertheless, the sub-prime collapse was also seen as a warning to the British mortgage industry to check its practices.
Incoming Financial Services Authority chief executive Hector Sants cautioned banks and financial institutions to take care to protect themselves and their customers from an economic downturn due to the US sub-prime collapse.
In addition, Mr Sant's predecessor John Tiner warned in his final speech in the role that there was the possibility for a similar over-selling of sub-prime mortgages as "risk has been under-priced".
Such warnings may possibly be coming too late, however, as recent figures from MoneyExpert.com showed more than 7,716 loan repayments are skipped every day seeing 1,389,000 repayments missed in the last six months alone.
"This is yet another warning of real financial distress and a sign that finances are being stretched to the limit by recent interest rate rises," said Sean Gardner, chief executive of MoneyExpert.
And finances are set to be stretched even tighter as reports suggest interest rates could rise further to 6.25 per cent if inflation is to be brought down to the government's target of two per cent.
09 Aug 2007