How will the subprime crisis ultimately affect our country?

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I don't understand how this hurts the entire economy and not just the banking industry?

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two main reasons, one direct, one indirect:

1) directly, consumers account for about 60-70% of GDP. consumers, until Q2 2007 have supported growth (Q2 2007 we saw businesses stepping in to increase inventory & orders). if consumers choose to save rather than spend, growth will be directly hit. the issues here are to what extent are consumers spending habits going to be affected. while subprime borrowers are not a huge portion of the market, the knock on effects to other mortgage holders can be significant (higher rates due to less demand for mortgages from security issues who have gobbled up all types of mortgages to securitize & sellt hem).


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I'm not sure if it's still correct to characterize this as a subprime crisis - it's more of a genuine housing crisis. There are going to be a lot of defaults over the entire credit spectrum, though it's possible that at this point, the market's gone too far in the other direction.


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i have a question for the forum that maybe deserves its own post?? (ahnuld or evan, lemme know if i should decouple this)

right now, there is a mad scramble for liquidity in the london interbank community. asset backed commercial paper markets have pretty well frozen up as some trades can't be executed. this has resulted in strange occurrances like the 6mo USD libor rate being lower than the 3mo USD libor rate (and you can't take advantage of it since trading is so slim...that's actually besides the point since if you wanted to take advantage of it, you'd have to be a bank with money to lend right now and no bank seems very willing to do that relatively speaking).

banks are both trying to hoard cash themselves AND get as much of it as possible which leads to way higher libor rates. libor rates typically hover right around fed funds, ECB, & BOE rates. right now, they are about 5.75%, 5%, and 6.75% respectively (that is 50, 75, and 100bps above stated rates).

my question is how do things priced off of libor respond to these anomolies. for instance, almost every swap transaction is based off of LIBOR + x for the floating rate part.

similarly, many derivative transactions are also based off of LIBOR.

what does this mean for these instruments. in terms of funding, it seems the fixed payer is making out like a bandit since nobody could have forseen libor rates spiking like they have. this would obviously be at the expense of the floating payer who now has obligations far beyond what may have been budgeted for.

how could all that play out?

thanks,
Barron

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Well, these things are usually for hedging and marked to market and the swap rates actually have gone down on the long end, so it's just negative carry and the contract may have gained value. Doubt that big players are worried about this - they are probably much more concerned about the counterparty risk right now. Anyone else with a loan indexed to 1m libor is just getting what they bargained for.