US Sub-Prime Mortgage Jitters Affecting The UK Stock Market

Sub-prime mortgage lenders in the USA are struggling to survive and their demise is impacting significantly on the world’s financial markets. In London, the FTSE has undergone a series of significant drops, suffering the biggest fall for seven years in one day alone on Friday, 10th August, wiping out most of this year’s gains. As a result there is now a real fear that the housing market crash in the US could be repeated here in the UK.

The panic selling and lack of confidence in the stock markets can be traced back to the collapse of the sub-prime mortgage market in the USA. Rising delinquencies and defaults amongst sub-prime mortgage borrowers in the USA have led to a reassessment of the value of such holdings by investment bankers who bought heavily in securities for the risk. They are watching the potential paper value of their investments virtually disappear overnight as US house prices collapse, provoking panic and attempts at consolidation in almost equal measures.

Sub-prime mortgages are usually given to those who can’t prove their income or have poor credit status, or maybe even both. In return for receiving higher interest rates from borrowers, lenders are willing to take a risk on this type of bad credit loan. When house prices are increasing, the risk is minimal because if the borrower defaults, the lender has a charge on the property and can therefore force the sale of the property recouping the initial investment, any interest due and recovery charges.

However, in a market where house prices are dropping, as it is in the US, the value of the property may become less than the outstanding liability leaving the lender with a significant loss. Because US sub-prime lenders have the least ability to absorb defaults as most of their borrowers take out 100% mortgages, they are most prone to collapse if it all goes wrong.

The largest sub-prime lender in the US New Century issued sub-prime loans amounting to $33.9 billion last year alone. It is now being investigated by federal investigators to establish whether impropriety featured in their business practices. It is the bad debts recorded by lenders such as New Century that are causing the extreme jitters in financial markets throughout the world, causing analysts to question whether the situation will be repeated in the UK. That has prompted many UK lenders to evaluate their most at-risk loans to determine their exposure and ensure that they have an adequate amount of capital to cover the potential losses. Thankfully, the UK market is thought to be less exposed to sub-prime lending than the US market. Plus, providing house prices in the UK continue to rise or remain stable then lenders that have issued such bad credit loans [] to homeowners will not be affected. Any threat will materialise if house values in the UK fall as the amount of equity in properties will also drop, and that could lead to the sort of financial chaos witnessed in the US.

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