Over the last 12 months it seems as though Sub-Prime Mortgage Loans have never been out of the news, and by all accounts they are set to be in the headlines for a long time yet.  It was the problems within the Sub-Prime Mortgage Loans market which prompted the recent credit crunch, which has since evolved into a worldwide economic slowdown.  But how exactly did this occur?

The US economy has enjoyed substantial growth over the last few years, with home ownership increasing, stock market investments continuing to hit record highs and the employment market looking very strong.  However, it has been the property market which has led the economy higher and it will be the property market which will pull the market lower.  The problem with the housing market was the fact that it seemed impossible not to make money, whether you were a mortgage provider seeing record business walking though you door, or you were a home owner pouring the vast majority of your savings into a market which was far out performing other investment markets.  So what turned the market?

As business in the prime mortgage loans market became more competitive, many of the larger US business were starting to see a fall in profit margins.  This seemed to be the point at which many began to look at the Sub-Prime Mortgage Loans, the market which accommodated those who were not in a position to obtain a standard mortgage because of their financial history and were charged higher rates of interest.  As the property market moved higher it seemed easy money, bump up the rates for those in the Sub-Prime Mortgage Loans market, retain ownership of their homes until they paid off their debt and in the event of mortgage payment defaults just sell the property into an ever rising market.  All very good until the property market appeared to be hitting a natural peak with signs that investors were “taking a breather”.

This is what caused concern in the Sub-Prime Mortgage Loans market and while the default payment numbers had been growing during the market rise, it was only now that they began to hit the headlines.  This had been a correction waiting to happen!

As the economy began to falter it was the sub prime mortgage loans customers who began to default in ever increasing numbers until slowly some of the weaker players in the market began to suffer financial hardship.  When WMC Mortgage, a Sub-Prime Mortgage Loans provider owned by General Electric, hit trouble, the market simply collapsed.  As the number of defaulters increased so did the amount of property on the market, sold at knockdown prices to cover short falls.  This deluge of properties for sale pulled down the whole market and soon many people began to panic.

This was when financial markets around the world began to sit up and take notice, with many large financials around the world only just then realizing that they had exposure to the Sub-Prime Mortgage Loans market via the array of complicated financial instruments which were created in the 1990s.  Good loans, bad loans and every type of loan in between were stripped into interest payments, capital payments and bundled together to give financial conglomerates the perfect risk / reward ratio they were after.  As the sub-prime situation worsened it soon became apparent that many of these fashionable instruments were actually worthless, with many companies now reporting billion dollar losses.  When the risk / reward ration in the Sub-Prime Mortgage Loans market turned the wrong way, they all headed for the exit door, realizing their investments at any price.

Under pressure from a capital funding basis, many companies withdrew there funds from the money market, forcing a major hike in money market interest rates.  Businesses were starved of capital, takeovers and mergers were cancelled and indeed there are many who believe we have not yet seen the worst of the so called credit crunch.