Sub prime mortgage is the basket of lending done by financiers to people whose credit worthiness is sub standard or the credit rating is not up-to the mark.
Why did it happen?
During the course of competition and a dwindling rate of interest the net margins of the lenders in US fell from around 600 basis points to around 300 basis points. A reduced earning margin created pressure on the bottom lines. As a result of which the lending institutions like banks and Non banking financial institutions increased the volumes.
An increase in the volumes meant that one would have to conduct business with the non traditional customers also and venture into the uncharted territory. Although the pricing was done as per the risk assessment of sub standard lending, the situation became grim in the falling US home estate prices.
With an increasing real estate prices, the refinancing of the asset was quite easy since the equity participation increased by way of difference in the price between the two financing time points. But with the prices falling, refinancing became difficult.
How does it affect other financiers?
This basket of lending is bundled with other assets and sold to investors like hedge funds who are seeking higher returns. With the basket going wild, the investments done by the hedge funds go into the red thereby risking the capital – in other terms a loss of capital of the investors.
The severity of the sub prime mortgage seems to have been overblown. However it would take some time to rip off the layers and see how deep is the well. The investors worldwide stand to lose because of cross investments in other hedge funds which might have been affected by the sub-prime mortgage turmoil.