How will the subprime crisis ultimately affect our country?

[ThaSaltCracka]

Can some of you more familiar with the topic describe what you think will be the lasting impact of this crisis on America and the rest of the world.

In particular, how will this affect the US within the next six months, year, and five years.

[iron81]

I suppose the number one effect will be to lower housing prices. Fewer people qualifying for mortgages lowers demand and more foreclosures due to increasing interest rates increases supply. Also, housing construction comprises a huge percentage of our economy. My dad works residential construction and he said business is off by a third over the past year.

[ThaSaltCracka]

Iron, glad to see there wasn't a thread about this already [img]/images/graemlins/smile.gif[/img]

You mention that it should lower the value of houses in this country, which it should. But what about all those people who took out equity loans on their mortgage because their house appreciated so much. There could be people who owe more than what their house is worth.


I think this is going to have massive repercussions in many job sectors as well.

[Ron Burgundy]

TSC,

What's up with you getting so passionate about political issues all of a sudden? I think that's great, but I'm just curious.

[ThaSaltCracka]

I use to post here a lot, way back in the day. I was put off by this place because of what I would consider uber partisan [censored].

I love politics and passionate about my beliefs. For some reason I am want to learn more about the recent events as I am deeply concerned about where our country is heading.

[PLOlover]

subprime isonly aa symptom of the larger problem, which ultimately will lead to national captivity.

[DcifrThs]

[ QUOTE ]
Can some of you more familiar with the topic describe what you think will be the lasting impact of this crisis on America and the rest of the world.

In particular, how will this affect the US within the next six months, year, and five years.

[/ QUOTE ]

this is more a finance question so it is more up my ally...and i'll give it my best shot.

there are many areas where the impact of hte "subprime crisis" can be felt.

first and foremost, as mentioned, defaults and housing prices. in the near term, there is a mass of existing homes in the supply chain that need to be sold down to sustinance level before growth from construction and rebound. the subprime mortgage lenders took advantage of low borrowing rates as the result of falling interest rates after the stock bubble in 99 to push new financing methods on riskier borrowers.

further, by loaning to higher risk groups, they could make more money since hte yields they could demand were higher. this was encouraged by financial market innovation.

mortgage backed securities first appeared in 1980s and were analyzed to death (to price) and came into huge vogue as of late (in terms of massive demand). the demand for these securities, which were given AAA ratings on the top tranche even when the underlying securities were backed by subprime mortgages, soared as interest rates fell.

ratings agencies made money by rating these securities and the demand for that obviously soared. some conflict of interest here may have arisen as can be seen by the following: above i noted the demand for these increased as interest rates fell...one component of that was that AAA rated subprime backed residential mortgage backed securities (RMBS) were priced to yield more than similarly rated corporate bonds or other fixed income securities (this should be a flag as there is no such thing as a free lunch so to speak).

anyways, once defaults started coming in at above expectations, and more were expected in the future, these securities came under immense pressue. a few months back, bear stearns hedge funds (one leveraged 10:1 and one not so leveraged) basically became worthless because of the price pressure on these securities (everybody wanted out of them and trading wasn't even happening. these bets were "marked to model" since there was no market for them)

so shops like bear were in bad spots because they would have to sell to liquidate money for their investors who wanted out, but selling would push the price of their securities down even more further reducing the value of the funds. this shouldn't have happened if some of these securities were actually going to default at the AAA level (rather than at the level implied by their yield, which was probably still understated).

this was the first real sign of crisis.

time passed and everything started looking ok, but then a few weeks back in early august, there were serious issues arising as risk aversion shot up and nobody wanted to hold these types of securities...or even other less risky securities ... some not even related to subprime.

so volatility spiked up a ton as banks and hedge funds were forced to sell some other more liquid positions for funding because money markets were just not functioning and nobody wanted to buy any kind of risky fixed income security at "reasonable" prices.

demand for safe assets like Bunds, Gilts, and especially US 2 years soared.

this caused a massive near term inversion and long term steepening of th eyield curve.

finally the ECB, the FED, and later the BOJ had to step in and provide tons of money to markets, reduce the discount window rate, and basically keep the money market moving to prevent financial markets from siezing up.

equity prices fell 10% and then rebounded after "calm" was (and is) tentatively restored.

so that, sloppily, brings us to today.

the future can play out in a few ways.

imo, the most likely is that US and EU growth slows substantially relative to prior expectations in the coming year as personal consumption falls off a bit. i don't think we'll hit a major recession or anything like that unless some real bad data come in and the fed doesn't reduce the borrowing rate accordingly.

further, companies now have to pay higher prices to roll their commercial paper (short term loans typically for 1 or 3 months). in the past weeks though, this market almost entirely shut down forcing companies to borrow outright or sell some securities to produce funds ...it has since become better but nowhere near normalcy.

so if consumer demand falls, and corporate costs rise, layoffs can ensue (which they have substantially in the mortgage area) and aggregate demand falls further, then slower growth will ensue.

home prices are falling now while the cost of borrowing to buy homes has spiked a ton. nobody wants exposure to the mortgage market now. this is bad for risky borrowers' spending habits they've grown accustomed to these past few years.

further, this could only be round 1. what happens when ARMs reset in the next years? this will increase borrowing costs as prices fall and some borrowers may end up owing more than the value of their home. that is a bad spot to be in and could push aggregate demand down even further. this effect shouldn't be big though.

so, slowing growth could push housing commodity prices down, reduce corporate profitability, increase layoffs, increase the slack in capacity utilization (a good thing for policy makers), and lower risky asset prices over the near term.

on the other hand, the economy has so far remained robust in july due to massive corporate demand (490% above expectations for durable godos orders). prices are coming into line, CA deficit has shrunk (due to dollar fall an increased import prices). this is all good news. the problem is that the future likely holds bleaker news.

finally, the fed is driving this economic car through the rear view mirror. hard to do and their choices will certainly affect the future. i think a 25bp cut will likely happen on sept. 18th unless even better news for the economy comes out this week (we have personal expenditures, consumer sentiment, and a few other notables coming out).

another problem here is that the fed should NOT be "bailing out" anybody who took excessive risks. if the economy is thought to be slowing while inflation is down, then sure, give us a cut.

but do NOT cut rates because equity prices are off their highs or people who took excessive risks are going bankrupt.

hope this post helps some people out as i think it helped me at least give some order to my thoughts, though it probably didn't come accross in this unedited, unrised, slackjawed rambling mess.

Barron

[DcifrThs]

[ QUOTE ]
subprime isonly aa symptom of the larger problem, which ultimately will lead to national captivity.

[/ QUOTE ]

lol...is that like the captivity in which panda bears live in our national zoos?

seriously though, can you state more clearly what your'e trying to say?

thanks,
Barron

[T50_Omaha8]

[ QUOTE ]
subprime isonly aa symptom of the larger problem, which ultimately will lead to national captivity.

[/ QUOTE ]There is a subtle pun in this post. Can anybody else find it?

[ThaSaltCracka]

Barron, so you don't think this will have a major effect on our economy? At least that is what I gathered from your post.

I use to work for a firm who did foreclosures, so I somewhat understand the process.

If these ARM's are causing more and more people to default, and consequently have their houses foreclosed, I want to know who is going to buy all these houses. I mean, prices are falling, but that has more to do with the demand decreasing and the supply increasing.

These lenders generally don't care if a house is foreclosed. They can turn around and sell it at auction to reclaim their money. But if no one can get loans, who is going to buy these houses??