Monday, October 15, 2007

Subprime crisis fallout

Though we have noted elaborately on the subprime crisis in our blogs, we should not miss when great economists like Joseph Stiglitz write on the subject. It gives us a different perspective. Take a look at what he wrote in today’s ET on how the mortgage lending went wrong:

People have borrowed money to indulge in consumption. And Greenspan has encouraged it. He encouraged them to take variable rate mortgages, at a time when interest rates had nowhere to go but up. Predatory lenders went further and offered negative amortization loans. In these loans, the amount owed went up year after year – i.e., ballooning payments. Borrowers were wrongly advised by the financiers that when payments balloon, they need not worry as the house prices would rise faster, it is easy to refinance with another negative amortization loan. But the reality soon dawned on everybody, as people were left with mortgage payments which have far exceeded their entire income.

He further says that ‘securitization’ with all its advantages in sharing risk, has three problems that were not adequately anticipated:

· It meant that American banks would not be as hard hit as they would otherwise be; but their bad lending practices have had global effects.

· It contributed to bad lending. Banks that originated bad loans were able to pass them on to others.

· It had made debt restructuring difficult, if not impossible. Restructuring debt would have had a corrective effect on bad lending practices.

One fallout of this crisis that is right unfolding in the international banking circles is the setting up of a $80 bn fund to buy ailing mortgage securities and other assets, in a bid to prevent the credit crunch from further hurting the global economy. This fund is being setup by Citigroup along with other banks.

You may also be interested in reading the following on the subject:

The first casualty of the subprime crisis.

Why will India not be affected by the subprime crisis?

Some recommendations on handling the subprime crisis.

Can the the subprime crisis threaten the Indian economy?