Effects of the US home loan crisis

According to Shane Oliver, the Head of Investment Strategy and Chief Economist of AMP Capital Investors “the situation in the US sub-prime mortgage market seems to be going from bad to worse with several funds suffering large losses, investor nervousness impacting the broader US credit market and concerns this will affect the flow of funds available for merger and acquisition activity and profits, dragging down shares. ” The US economy expects the direct losses from defaulting loans to be substantial reaching between US$ 50 billion to US$ 100 billion according to estimates from US Federal Reserve Chairman Ben Bernanke.

These losses have caused underwriting on hedge funds and balance sheets of major investment banks like UBS, Citigroup, Northern Rock, and Merrill Lynch. Moreover, the impact of huge losses in the mortgage segment has spread intense fear of risk and potential losses among investors in the credit markets. This has led to higher cost of borrowing and reduced flow of corporate and private investment deals. The US economy is hit badly with stock markets taking a plunge and declining foreign exchange reserves that have eventually led to devaluation of the US dollar rate in the global market.

“Like a stone dropped into a very large pond, the crisis in the US home loans market is sending ripples throughout the world’s financial system. ” (BBC News, August 2007) The panic caused by this crisis in the global financial markets has led to sharp decline in share prices and crumbling of the stock markets. Impact of the Sub prime mortgage crisis on Australian economy The economies across the globe are facing tough times owing to the sub prime mortgage crisis in US. The US economy has floundered considerably with rising inflation and cheapening of the dollar in the currency market.

The question that comes foremost to the mind is whether this will cause a major recession in the global markets and the time duration of this crisis. Economists and market experts believe that this recession will not create much concern and economies across the globe will survive the impacts of this crisis without much damage. The US economy may have taken a battering and it might be witnessing slackened pace of growth but it will not prove disastrous in the long run. The Federal Reserve will adopt precautionary measures by cutting rates to bring inflation under control.

It is envisaged that the impact on the credit markets will not last very long and stock markets will take an upward plunge. The prime focus area in the Australian economy that is highly susceptible to the subprime mortgage crisis in US is the hedge funds and the international fixed interest funds. Some of the high yielding hedge funds are facing serious implications due to their exposure to sub prime backed collateralized debt obligations and their flow-on to collateralized loan obligations.

But besides this the direct impact on Australian investors has been minimal. Shane Oliver of AMP Capital Investors observes that “the main risk is contagion with sub prime problems affecting broader credit and equity markets. This is happening to some degree and it may be a rough ride over the next few months but is unlikely to last, particularly in equities, as it is unlikely to lead to serious economic problems in the US. ” The major impact on Australian economy is seen in the increased credit spreads and difficulty for companies to secure debt.

Credit spreads have continued to widen in the last few months that is witnessed in the depressing market movements and increased concern about the viability of investment products and structured products in the financial market. Spreads have taken an upward plunge in other related market segments too that includes securities backed by credit cards, auto loans, student loans, and commercial mortgages. This is a direct result of the increasing default rates and excessive leverage.

It is obvious that no economy can be entirely insulated from the global market movements and as observed by Glenn Stevens, the Governor of Australian Reserve Bank “ the closure of securitization markets for the time being has made life much more difficult for those lenders which relied heavily on that avenue of funding. The rise in the wholesale cost of term funding has meant that many non banks and some bank lenders have had to slow the growth of their businesses. ”

The increased credit tightening has got investors across Australia worried. They are increasingly speculating on the implications that this might have on the consumer spending. Moreover, this has directly affected the shares of financial services companies having direct exposure to the mortgage market. The banks are more reluctant to lend to each other in view of the looming market recession. All this has led to higher cost of borrowing for business ventures and higher rates of mortgages for households.