Global market crisis

The US sub-prime crisis has sparked a plunge in stock markets around the world. Global stock markets took a hammering last week as a knock-on effect from the problems that started in the United States. The trend has carried on largely unabated in the last five days of trading. In the UK the FTSE 100 fell from 6,700 to 5,858 by Thursday close, losing 250 points on Thursday.

The roots of the problem lay back in 2003 when interest rates in the US were only 1% and Banks lent money to virtually anyone who asked for some. Mortgages were snapped up people living in Florida trailer parks or any other poor area in the States. Since then mortgage rates have crept back up and, now standing at 5.25% in the US, many of the people who took out those low rate mortgages can no longer afford the repayments on them. This has resulted in a large number of repossessions in the States and a crash in the housing market. In some areas to costs less to buy a property than to does to buy a car.

The reason the panic has spread to the rest of the world is because the American banks packaged their mortgages as saleable products and sold on them on to the global markets, where British and European fund managers and banks eagerly bought them. However, the funds have fallen in value and are full of virtually worthless property in the poorest areas of the US. Lat week the largest bank in France, BNP Paribas, had to suspend three funds which had large US debt exposure. The European Central Bank hoped that the injection of €95bn would prevent the US sub-prime mortgage problems from spreading into European banking systems, but it failed.

Banks have become concerned about the way they have been lending money; they may have gone too far with loans in the past. As they got nervous about the repercussions, they started to say no to loans to big business, thus halting many mergers, takeovers and new projects. The worry now is that the knock-on effects could make serious problems for economies round the world. Businesses, unable to develop in the way they would have liked, will tighten their belts, trying to cut expenses and will cut back on their workforce. The consequence of that may be an economic downturn as people have less spending money, especially as their housing expenses have soared recently on the back of rising base and mortgage rates. These worries have quickly spiralled on the stock market, which always seems to react fast and too far, and has led to the downturn.

In the UK a further £60bn was wiped off share values on Thursday, and the 100 companies in the FTSE 100 share index have lost a combined value of £128bn in seven trading days. The index has gone down 12.5% in the past month. The plunge will hit not only private investors, but also millions of people with money in pension funds invested in the stock market. Ironically, very of these people will have any say in the sale of shares in their investments, and probably wouldn’t sell given the choice.

A Treasury spokesman said: “The UK economy remains strong, against a background of a strong world economy. There will always be periods of uncertainty in the markets but the UK economy is currently experiencing its longest unbroken expansion since records began and is forecast to be the fastest-growing economy in the G7 this year.”

The problem is that the downturn in shares might trigger a full-scale downturn in consumer economy as confidence is shredded against a background of rising interest rates. Even the good news on inflation from earlier in the week brought only brief respite to the troubled City.

The UK’s 200 biggest final salary pension funds had accumulated a £9bn surplus by the middle of July, but, at a stroke, that has become a £21bn deficit, spelling further pension fund problems ahead.

It is certain the sub-prime borrowers will suffer as a result of the crisis. Banks that lend to this market have inevitably been hit hard, and will have to put up their rates to new and remortgaging customers.

The nightmare scenario is almost unfolding before us: markets are continuing their slide and next debts will be called in, leaving a trail of businesses going bust; consumer confidence will dwindle further. The result of that could be a housing price correction – maybe even a crash – in the UK. That will mean that the value of people’s houses will be on the way down, but the cost of their mortgage is still on the way up. The problems of negative equity may be just around the corner again. Markets stabilisation must come soon to prevent the nightmare becoming reality.