Yet another subprime crisis in the making

Thu, 29 Jan Pre-Open

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Subprime - the word reminds us of the dark times in the global economy, the shadows of which continue to haunt till today. The term signifies the period when fancy and risky products such as subprime mortgages and readjust able rate mortgages flooded the US economy almost seven to eight years back. As the housing prices declined post mid 2006, these securities lost their value as well, with investors failing to pay back at higher rates. What resulted was tightness in the credit and slowdown in the economic growth. In fact, subprime crisis was the catalyst that led to a domino effect. The major global financial institutions that had invested in such securities incurred losses, expanding the crisis from the housing market to other parts of the economy. The following years saw some of the US largest banks go bankrupt. The much criticized Quantitative Easing was also a derivative of these dark times.

However, it seems that no lessons have been learnt from one of the biggest financial crisis in the global economy. In the quest for higher returns in a low interest scenario, some financials firms and hedge funds are back into the business of buying loans for the investors whose credentials are not upto the mark. These mortgages will again be bundled into securities of varying risks. If current industry estimates are anything to go by, the worth of such deals could lie anywhere in the range of US$ 1 billion to US$2 billion.

Interestingly, these firms have called such lending "non prime" . These firms are convinced that this time it will be different, for the fact that these securities will not be backed by the Government and the riskiest deals will be retained by these firms, unlike in the subprime crisis when all risks were shifted.

However, one must note that loans that are being considered have credit scores lower than the cut off for subprime. Again, as highlighted in an article in Bloomberg, issues like conflict of interest and transparency still remain. If the trend catches on, more loans could lead to more defaults. And over a period of time, we will not be surprised to witness a major crisis ahead, similar in nature, just with a different name.

Indian investors cannot remain oblivious to such risks as a second subprime crisis could have farther reaching impact on stocks than was witnessed in 2008.