The Bankwatch

Tracking the consumer evolution of financial services

America’s subprime lenders create a domino effect problem amongst lenders

 Some background on the subprime lender problem in the US.

The trouble started with New Century, which had become the nation’s second biggest lender to would-be homeowners with dodgy credit histories or little cash for a down payment.

Last month New Century said it would be restating its earnings, triggering investigations into how it has accounted for its bad loans.

Lenders have not only cut off all credit lines, many also demanded accelerated repayment of outstanding loans—which New Century says it cannot make. If the rest of its lenders demand their money back New Century will be on the hook for roughly $8.4 billion. The New York Stock Exchange has suspended trading in the firm’s shares and has started proceedings to delist its stock, which last changed hands at $1.66 (down from a peak of $51.97 last May)

Source: America’s subprime lenders | Shakedown | Economist.com

From reading this article, the lenders who were all too happy to make the loans to New Century during the booming housing market have gained cold feet. 

This has to be the most predictable problem that ever could have arisen.  When the lenders were happily throwing money at New Century, the markets have been mixing obligations within Collateralised Debt Obligations which go into the derivatives market.  The collaterised nature, and higher rates would have been attractive in those markets.  Now that the alarm is raised as a results of default on payments (not on the principal, yet, just the monthly payments), the derivatives market stands to drop next.

Its worth noting that this correction will generally create an impact on investment returns.  Principal should generally be safe unless there is a catastrophic drop in house prices, and in that case we would have an entirely different set of problems including the regular mortgage market too.

All in all, this series of events along with the Stock Market tumbles suggests that investors will have a rough time for the next few months, and will be seeking alternatives for their funds.

 

Written by Colin Henderson

March 14, 2007 at 16:09

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  1. […] am just a blogger, but I have been blogging consistently since March 07 about how the sub prime crisis will change everything in banking, and in the economy. For the full […]


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