Till the end of 2005 investors in real estate had never had it so good. Bankers were only too happy to lend whatever a borrower needed. They did not go into the details like the person's credit history, whether he had a steady income or not and also if he had any other assets. Most of the time they were not even asking for a down payment. Banks were able to get away with it because they simply sold the loan to Fannie Mae or to buyers of mortgage backed securities. Buyers saw their investments appreciating by double digit figures annually. The resultant feel good factor made them go out and splurge on their credit cards.
But such good times don't last forever. With an overheating economy Bernanke was forced to raise interest rates steadily and given the fears of inflation he is likely to keep them there in the near future. The results of continuously high interest rates on the housing market have been devastating. Real Estate prices started declining since the end of 2005 and continue to decline. This decline in asset prices coupled with high interest rates and a slowing economy has hit the sub-prime market real hard. Lenders have suddenly woken up to the fact that up to 25% of the loans given by them are at risk of defaultl.What is worse is that there are no prospects of recovery in the near future.
Although the US Treasury Secretary has come out and said that sub-prime mortgages do not pose any threat to the overall economy, most investors are not so sure. Some have gone so far as to predict another depression. Although a global meltdown is not likely the risks are growing. All it needs is perhaps a couple of large hedge funds to go under and the world financial system could go into a tailspin.
With October, which is historically the worst month for the US markets, not far away every body will do well to keep his fingers crossed.