More clarity needed to fathom the effects of the sub-prime debacle

19 September 2007
More information is required in order to effectively evaluate the impact of the sub-prime mortgage affair on the economy, according to an analysis of the events leading up to the current ‘credit crunch’, carried out by the Alliance Trust.

“There has been a role reversal between the world’s financial markets and the economy,” said head of Alliance Trust Research Centre, Shona Dobbie.

“Before this summer’s credit crisis, it seemed to be the economy that was driving markets forward, and now it is the markets, and how well they can weather this crisis, that appear to hold the key to the future direction of the economy,” she explained.

The Trust found that, while lending to ‘sub-prime’ borrowers with unfounded credit histories has traditionally accounted for less than ten per cent of the US mortgage market, sub-prime accounted for a fifth of new American mortgages by 2006. It found that the total value of sub-prime mortgages is approximately $600 billion, a relatively small amount considering the $1.3 trillion US economy.

However, the research also showed that mortgage-backed securities (MBSs) – products based on the expected income stream from mortgages –represented 25 per cent of the total asset-backed securities market. This has rapidly exceeded the market share of securities backed by credit cards, cars and student loans.

According to Alliance, the impact on financial markets has been magnified by up to 100 times the value of the original loans as a result of various structured finance deals that have been repackaged and resold to other institutions.

Ms Dobbie said: “We have uncovered a lot of astonishing facts and figures in our research into the causes of the credit crisis, but what is most surprising is how little we can unravel about where these enormous liabilities have ended up. It is now up to institutions to untangle this web because trust among them can only be rebuilt when we get more clarity.”

Find out more about sub-prime mortgages