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Date Published : Wednesday, July 30, 2008
A year ago, terms like credit crunch and sub-prime were unfamiliar to most people, while Freddie Mac and Fannie Mae were strangers. Yet now it seems the news is full of references to them, usually as the harbingers of financial doom.
But what is the credit crunch, what caused it and what does it mean for Australians?
According to the Advertiser, the credit crunch has its roots in the US sub-prime loans crisis, which started to take hold in mid-2007.
Sub-prime mortgages are a type of home loan typically granted to people with poor credit or employment histories because they require little or no down-payment.
The loans also have low initial interest rates, which encouraged people to apply for them in the belief they could use the equity generated by the increasing value of their home to refinance the deal before the rates went up.
But when property values fell in 2006-07, refinancing sub-prime loans became harder. Borrowers began to default and according to RealyTrac, foreclosures increased by 79 per cent in 2007.
Mortgage firms started going under and the Federal Reserve had to step in with emergency loans to save the country's largest lenders, Freddie Mac and Fannie Mae.
Companies who had invested in the US mortgage market through shares in "bundled" mortgage packages took a hit. This started a chain reaction that weakened investor confidence, which saw more lenders hold onto their money.
The ripple effect spread and some firms, including Australian companies like Centro Properties, saw their shares slide because of difficulties refinancing their debt.
Banks with shares in the US mortgage bundles like the National Australian Bank also saw share prices dive after they had to allocate funds to cover bad debts from the collapse.
Furthermore, Australian home loan borrowers saw banks react to the increasing cost of debt by putting up their interest rates above the Reserve Bank of Australia's base level.
However, the newspaper said, while the waves from the sub-prime collapse have hit Australia and many other countries, the chances of a full-blown sub-prime crisis occurring here is low because similar mortgages make up around one per cent of the market.
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