Sub-Prime Saga

Stock exchanges in emerging markets have turned bearish and extremely volatile in recent weeks, primarily because of the ripple effects of the subprime mortgage crisis in the US. Investors incurring losses in those markets are reordering their global portfolios to meet immediate commitments, resulting in a sell-off that is having global repercussions. This is not because all, or even most, of these investors are directly involved in mortgage financing. Rather, it is because they have invested in assets – derivatives or collateralised debt obligations – that are linked to sub-prime mortgages.

Sub-prime loans or loans for housing investments to borrowers with low credit ratings and high probability of default have increased sharply over the last few years, driven by supply-side factors such as easy liquidity and lower interest rates. Utilising these circumstances, mortgage brokers attracted clients by relaxing income documentation requirements or offering sweeteners like lower interest rates for an initial period, on the completion of which higher rates kick in. Estimates vary, but according to one by Inside Mortgage Finance quoted by the New York Times, sub-prime loans touched $ 600 billion in 2006, or 20 per cent of the total as compared with just 5 per cent in 2001.