Market crash, can someone shed a light?

[Siobhan]

Ok.. been reading about the market crash and now US are dropping interest rate and there is talk of recession.. what does it all mean to us? Are people going to lose their homes? will there be a higher rates on loan etc??

Can anyone explain in plain english what it means to us ordinary folks? Thanks

[Abigail]

Have you heard about the Sub-Prime mortgage problem in America? Bascially, Sub-Prime mortgages are for people on a very low income or who have little or no credit rating. They are very risky for the lender. Banks also lend each other money so when one bank is in trouble its likely that several will be.

People with SP mortgages are stuggling to pay them back at the moment so the US government yesterday wiped $147billion (£75billion) of public tax. Shares in SP sector and government sectors have decreased in price.

America is the biggest economy in the world. Whatever affects their stock markets affects every stock market in the world.

This Sub-Prime problem has been around a few months and the stock markets are slowly declining. The Nikkei in Japan has lost 18% of its value since the start of the year. That may not seem much but consider this: The FTSE-100 (our stock exchange) lost 5.5% yesterday, wiping £77billion off the stock exchange in 9 hours. I don't know the exact value of the Nikkei but by my calculation Japan has lost trillions of Yen in stocks in 22 days. Every country in the world has been affected by America.

The Federal Reserve in America had an emergency meeting today and has slashed interest rates from 4.25% to 3.5%. This is to ease the strain on the general public's purse in America.

America is heading for a recession and it's probably too late now to change that. A recession is where an economy that had previously been growing slows down. The level of production declines, unemployment rises and consumer spending dries up - in the worst case scenarios, as happened in the depressions of the 1930s and the 1980s, so few people are spending money that businesses sack staff to cut costs. The cost of borrowing becomes cheaper, which means that people who owe a lot of money (mortgage) have more cash in their pockets.

People were calling it Black Monday yesterday which isn't strictly true. You may remember Black Wednesday in the 1980s. The FTSE-100 crashed completely and the government had to step in three times to keep the market going. That didn't happen yesterday.

Anyway. The price of crude oil has fallen which is good news for motorists because the price of fuel looks set to come down. Price of gold has also fallen, you're probably not interested in that though.

People in this country won't lose their homes as long as homeowners can keep on top of the repayments. I think the interest rate may come down in this country but we will have to wait and see. The Bank of England who control interest rates meet on the first Thursday of each month so unless there is an urgent need to reconsider interest rates, the current rate will stay at 5.5%.

[Meh]

Abigails post was what the Govt would like you to hear.

Here's what's been going on:

Sub Prime is credit given to people who can't afford the repayments. They are offered a teaser rate, this resets to a higher rate, and the repayments shoot up. Its not just a problem in America, the UK has its sub prime problem as well, Northern Rock being a manisfestation. All the self certifiction mortgages, lack of regulation on mortgage advisors/brokers by the FSA have all contributed to sub prime in the UK.

The credit crunch has happened because all these sub prime mortgages were packaged as bonds and sold to investors (including other banks). Simplest way to explain it is imagine three baskets:

basket 1: AAA
basket 2: ABB
basket 3: CCC

AAA is the best bond rating and CCC the worst. All the bonds that weren't sub prime were in the AAA categeory (basket 1), and the worst ones in CCC (basket 3). These were then sold to investors to raise capital. All well and good so far as each investor knew the quality of the bonds they had bought.

The banks then invented new financial instruments. What they did was get basket 3, and a bit from basket 2 and 1, and then sell it on as a AAA rated bond. And then they repeated the cycle with the same bond. So imagine millions of bonds, some genuine AAA and some pakcaged as AAA but are worthless because they are really sub prime. The banks don't know who holds the good bonds and vice versa so they are not willing to lend to each other which has pushed the LIBOR (the rate that banks lend at - London Inter Banking Offer Rate) rate up. Banks like Northern Rock that depended on LIBOR to fund new mortgages suddenly found out noone was willing to lend to them. We all know what happened next.

With the credit crunch in place, the stock market now reacted. Investor confidence went down, the banks have tightened lending criteria. Essentially, all the money loaned during the boom is being called back. The Federal Reserve took drastic action by lowering IR by 0.75%. This is both good and bad. Good in the fact that it attempts to restore confidence and bad because the dollar becomes worthless and it shows that the Fed isn't really in control.

So what does it mean for us? The housing market in the US is crashing. If anyone recalls, they were saying it would be a 'soft landing'. The UK tends to be 12 - 18 months behind the US in the cycle. House prices are already dropping in the UK (http://www.propertysnake.co.uk - type in a postcode and see drops in your area) and we are heading for the same crash as being experienced by the US. Even if interest rates come down, they won't necessarily be passed onto the consumer because the banks need to counter the bad loans.

What people fail to realise is that high house prices are good for no one. Gordon Brown knew this when he said in his 1997 budget speech: "I will not allow house prices to get out of control and put at risk the sustainability of the recovery." He has done exactly the opposite and now it looks like there will be a recession.

The most important thing during a recession is that you have a job. Recessions are good in that they clear out the crap in the economy, but bad because people have to suffer. Best is to live frugal, save, and be in stable job.

[Siobhan]

The most important thing during a recession is that you have a job. Recessions are good in that they clear out the crap in the economy, but bad because people have to suffer. Best is to live frugal, save, and be in stable job.


Phew!! I have cleared all my loans and have been made permanent at work so I hope I can ride this one out... who stand to lose the most in this?

[Meh]

Phew!! I have cleared all my loans and have been made permanent at work so I hope I can ride this one out... who stand to lose the most in this?


The main losers will be those that have been excessively greedy in the boom years. All those that thought "property only ever goes up" and leveraged themselves highly with BTL will suddenly find they can't sell their BTL and that its dropped in price and left them in negative equity. A key indication of this is reposessions and bankruptcies shooting up (which is happening)

Companies that are based around housing will suffer most - so property funds, estate agents, B&Q type stores, builders etc

Everyone suffers really as people cut out unneccessary luxuries which cuts spending. But there is one big benefit: people will be able to afford a house at some point.