The Home Loan Crisis in the USA and Its Impact on the Australia Financial System - Coursework Example

impacts of home loan crisis of USA on Australia financial system The impact of home loan crisis of the USA, is giving the world as a whole a great shake. The markets are regularly facing anxious days. The crisis in the US home loans market is sending ripples throughout the world's financial system 1(bbc.com). US home loan woes caused tremendous effect on world markets on August 3, 2007; despite the tens of billions of dollars released by central banks to stop the problem resulted into a huge global economic crisis2. There are few mishaps already. The effects over the Australian finance market too were very strong. It was in September 2007, that the true cost of the credit fell very heavily over some of the richest companies of Australia, especially companies from the banking sector. Though there are variations to this assessment. According to Fitch Ratings the US subprime issues have not caused any material problems to the larger Australian banks. In its semi-annual review on these banks, the agency noted that this is to the limited exposure of Australian business scene to the US subprime market. It was no doubt of getting effected, either directly or through structured credit products, but with hardly any losses to the earnings event. 'Australian banks in general have come to rely more heavily on wholesale funding in the last decade as loans have consistently outgrown retail deposits. With a global repricing of risk under way, wholesale funding will become more expensive…Where this is most likely to impact the Australian banks is in their cost of funding ' Fitch said (Forbes; 2007)3. There are of course the declarations that this crisis has got greater impact on smaller financial institutions of Australia. The reason is that these institutions rely heavily on the wholesale and structured markets for their funding rather than the larger and more diversified banks. During 1980s there was the repetitive disorderliness in the financial upheavals of banks, affecting some of the establishing leading market positions and simultaneously being absorbed by the larger banks. 1990s came up with the privatisation of the Commonwealth Bank. This again increased the competition from non-bank lenders, such as providers of securitised home loans. The Reserve Bank of Australia, states about the Australian financial system as, "The financial system is the term used to comprehend the set of arrangements covering the borrowing and lending of funds and the transfer of ownership of financial claims."4 (Brooks & Simon, 2007) The actual crux is in the facilities led by the subprime mortgages that get arranged for those borrowers who lack legal immigration status in the United States.The fact is that, the subprime mortgage loans are riskier loans. Added to this it has been made to borrowers with a limited or blemished credit history. In general, a subprime borrower is defined as someone with limited income. It is someone with the FICO credit scores below 620 on a scale that ranges from 300 to 850. The category of subprime mortgage loans is priced based on the risk assumed by the lender. As opposed to all the prevailing situations the lenders in the subprime market have been battered by rising defaults and increasing demands by their own lenders. The idea was to take back soured loans at a loss. The estimation shows that more than two dozen of lenders have quit the industry the last year. In most cases the home loans do not belong to this category. However subprime mortgages flourished in the early part of the 21st Century, especially in the countries like USA. It is during this period that almost 21 percent of all mort­gage originations from 2004 through 2006 were subprime. According to John Lonski, the chief economist for Moody's In­vestors Servic; ‘they were all in the business along with an up from 9 percent from 1996 through 2004. It increased to a total of $600 billion in 2006, accounting for one-fifth of the U.S. home loan market5 (a b c Study, 2007). It has been estimated by the credit rating agency Standard & Poor's that investment banking revenues could fall by nearly 50% in the second half of this year because of exposure to non-performing mortgages and loans. Pic. 1 The markets could face many more anxious days yetSource - http://news.bbc.co.uk/1/hi/business/6970287.stm The gigantic problems in the US housing sector have rippled the banks who were involved in lending all around the world. The responsibility is on these banks in all respect. They were more liberal and got involved in the actual business of providing mortgages to poor Americans with no jobs and no money. With the increase of US interest rates, those borrowers started defaulting on their loans. The whole bunch was of sub-prime lenders in states such as California. The sub-prime loans eventually got parcelled out to the markets as investments; in the form of complex debt vehicles with odd names like "Collateralised Debt Obligations" and "SIV Lites". Most of these were bundles of American mortgages that anybody can buy like a share or a bond. The poorest part is that now there is none to pay any attention to buy them. In the last few weeks these investments have bombed in value, leaving some cases they are kept away from any kind of deal, resulting losses running into billions of pounds. Pic. 2 Problems in the US housing sector have rippled around the world Source - http://news.bbc.co.uk/1/hi/business/6970287.stmUS stocks are reported to plunge overnight in their second-worst sell-off of the year as the impact of losses in the subprime mortgage group cascaded across the financial sector. There were tremendous fall in the shares of investment banks and traditional lenders, associated with the whole crisis. The Australian share market thrushed due to the crisis in the US home loans industry. There are all assuring signals that it is going to engross the financial sector of Australia. It all started in March 14, 2007, when at10.15am, the benchmark S&P/ASX200 index was 99.2 points weaker at 5,765.80, while the All Ordinaries had fallen 97.2 points to 5,746.806. The fall was estimated as a huge loss of $25 billion in market value. However the strangest reactions were from the local analysts, who saw little cause for concern at this stage. According to the analysis of the Austock Brokers senior client adviser Michael Heffernan, ‘it was a great time to buy with some good value on the market’. "We were going to open down, and we have with a great flourish…'' The US Mortgage Bankers Association reported that the proportion of mortgages in initial stages of foreclosure rose to the highest rate on record. On the contrary to this the chief executive of the largest US home lender said that the subprime mortgage industry is now in a "liquidity crisis" and randomly caters to borrowers with weak credit. The whole structure of trading got heavier on the NYSE, with about 1.97 billion shares changing hands, as compared to last year's estimated daily average of 1.84 billion. In case on Nasdaq, it was about 2.24 billion shares that gat traded. An estimation of above last year's daily average of 2.02 billion. The deeclining stocks seems to outnumbered advancing ones by a ratio of about 9 to 2 on the NYSE and by 5 to 1 on Nasdaq. The reports add that the tech-rich Nasdaq composite fell 11.60 points or 0.45 per cent to 2,544.897. The continuously growing home loan crisis of US has caused the price of oil to fall for the third straight day after the burst. The speculators rushed to bank profits and found that the subprime loans got the cause of the weaken energy demand. On Aug 10, 2007, the Australian market lost a huge amount of $53 billion. It has been rated as its biggest one-day percentage fall since September 2001. The whole gamut of Central banks across the world has responded by pumping tens of billions of dollars into the banking system; especially in Australian financial sector. They were active in the act of offering loans at lower rates to commercial banks to forestall a credit crunch that could damage economic growth. Morgan Stanley, a US investment analyst commented over the situation more appropriately, "The European financial system is facing a serious but not catastrophic crisis…it may take weeks before the true depth of the credit problem is revealed". Investors have lost billions of dollars in investments. All these investors were those who were tied to sub-prime mortgage assets. As a result the disturbances in the global markets, including Australia got to the zenith. The worst part to the whole fall is that, the housing market slump in the U.S. could cause interest rates to rise further in Australia. It went so far in stretching home owners to their limits, that the margins became unlimited. Aussie interest charges are rated as one, among the highest in the world. The crisis of USA home loan market hits Australia market in a very devastating way. Consequently all Australia mortgage borrowers have started suffering from increased interest rate. A high value payment is typical to the Australian financial sector and is getting more time critical and for large sums. The main high value payment systems in Australia is the SWIFT Payment Delivery System (SWIFT PDS) and Clearing House Electronic Subregister System (CHESS8). The affects were going to be equally drastic. If a CHESS transaction is selected for RTGS settlement, then an interbank request is sent to RITS via the SWIFT FIN service, might get some support. Some assessments are that the crisis is yet to affect Australia, to the same extent as it has affected the U.S. In the country itself, the estimations show a small portion of all loans. A minimal was found to be of the sub prime variety. As a result a local meltdown is far less likely to occur. The Australian share market has remained relatively strong despite declining U.S. stocks. The economy to some extend has remained steady. Property values are still on the rise, despite interest rate hikes. The demand for property is increasing consequently. It has been assumed that with the upcoming election time, towards the end of 2007, some may be tempted to hold off on any major financial commitments. However, the expectations of US interest rates were thought to remain relatively stable in the current economic climate. The Australian stock market hits 2008 low on US home loan crisis consequences, while local banks plunged. The report states that the benchmark S&P/ASX 200 index had fallen 82.7 points to 5181.3 by 12.13pm AEDT, which is a clear down of 1.6 per cent, as compared to S&P/ASX 200 index fell 99.4 points to 5164.6,in earlier estimations9. The 2008 low of 5186.8 was set on January 22. As the fall continues, all the banks were lower at 12.15pm AEDT, plunging to shock new low levels. National Australia Bank had lost 58 cents to $26.35 or 2.1 per cent. By 12.21pm AEDT, Babcock & Brown rose 0.7 per cent to A$13.97 after falling as much as 7.6 per cent during the initial stages of trading. The investment bank and asset manager of Australia are of the view that it had retired over $250 million of short-term margin loans and has received commitments to refinance all other outstanding margin loans, reaffirming at the same time its 2008 group net profit forecast of $750 million. US crisis leads sell-off in the whole scenario of Australian financial system. The Australian dollar has also faced the consequences. It has got dumped on financial markets. By 9.34am AEDT, the Aussie was quoted at $US0.9271/74, down from $US0.9288. The result is a fall of a low 0.9247 in offshore trade as high yielding currencies and riskier assets were dumped by investors. Aussie Home Loans boss John Symond, is of the view that the increases in the cost of borrowing on international credit markets could force Australian home lenders to charge higher interest rates, regardless of moves by the Reserve Bank of Australia (RBA)10. In his own words, as told to The Daily Telegraph "You are going to find housing loan interest rates will creep up regardless of the Reserve Bank….This means interest rates are going to go up slightly. It could be anything up to another quarter of a per cent." To conclude the whole story, the sub-prime mortgage crisis in the United States has had a flow-on effect to international credit markets for sure, but has became more expensive for Australian financial institutions, including banks, to borrow money from overseas, they would have to pass on the cost to consumers. The cost of money has not increased enough to push us and banks and others to increase the Australian interest rates on normal mortgages resulting to the brewing thunderstorm that could turn out to be quite aggressive by any moment. Thus, there is a chance that interest rates could trickle up a little bit and that's beyond what the reserve bank can ever hold of the higher cost of borrowing money from overseas. The consequence is such that the non-traditional lenders would be among the companies hardest hit by a credit squeeze. They are more into the plan of raising capital because they're into loans that aren't prime, aren't straight up and down. No doubt that some of those will struggle because they might not be able to raise money to fund their mortgages. Situation has already turned for the non-bank lender Bluestone, which specialises in low-documentation loans to lift its borrowing rates in addition to last week's official RBA increase because of the US subprime mess. If this trend continues across other non-bank lenders there may be a possibility of an increase in variable rate mortgages even if there is no rate rise. With the recent interest rate rise and the issue of mortgage funding in Australian financial scene, the consumers however can stay away from the worry about rates, added to which a fixed rate could be an option. References 1. Australian stock market hits 2008 low on US fears, http://www.news.com.au/perthnow/story/0,21598,23348883-951,00.html 2. ‘Counting the cost of the home loan crisis’ By Greg http://news.bbc.co.uk/1/hi/business/6970287.stm [ accessed on 03.05.08] 3. ‘Larger Australian banks seen materially unaffected by US subprime issues’; Fitch http://www.forbes.com/markets/feeds/afx/2007/08/23/afx4046469.html [accessed on 03.05.08] 4. Loans crisis could lift interest rates,http://www.news.com.au/adelaidenow/story/0,22606,22247869-37037,00.html [accessed on 03.05.08] 5. ‘Market hit by US home loan crisis’, http://www.smh.com.au/news/business/market-hit-by-us-home-loan-crisis/2007/03/14/1173722507479.html [accessed on 03.05.08] 6. Rick Brooks & Ruth Simon, Subprime Debacle Traps Even Very Credit-Worthy: As Housing Boomed,Industry Pushed Loans To a Broader Market, Wall Street Journal, Dec. 3, 2007 7. Submission to the Committee of Inquiry into the Australian Financial System ("the Campbell Committee"), Reserve Bank of Australia Occasional Paper No 7, December 1979 8. ‘US home loan crisis causes more global turbulence’, By Rory Mulholland, http://www.busrep.co.za/index.php?fArticleId=5019438[ accessed on 03.05.08] 9. ‘US loan crisis sparks more global turmoil’, http://www.abc.net.au/news/stories/2007/08/11/2002502.htm [ accessed on 03.05.08] 10. What Caused The Sub-Prime Crisis?- ‘A look at the history of the sub prime crisis, and how to plan today for the uncertainties of tomorrow’, http://www.ratecity.com.au/home-loans/info/what-caused-the-sub-prime-crisis/ Read More