A listener in China named Turbo wonders why problems with subprime home loans in America can influence world markets.
Subprime mortgages are loans to people who may not have enough money to repay them. These and other risky housing loans are often grouped with other mortgages and sold as debt investments.
Investors all over the world have bought bonds and other securities based on subprime mortgages as a way to earn higher returns.
Sometimes, the investors are banks that want to spread their risk by investing in several different countries. What happened in late July to a German bank, however, is an example of spreading risk with bad results.
IKB Deutsche Industriebank had put money into American debt securities, including some based on subprime loans. Some of those loans started to fail.
The bank was in danger of not being able to pay its short-term debts. Other German banks, led by the government-owned KfW Group, agreed to provide almost five billion dollars to aid IKB.
In early August, the French bank BNP Paribas had to temporarily bar investors from withdrawing money from three investment funds. Their value dropped by twenty percent in less than two weeks. The bank blamed difficulties in valuing its holdings in the subprime market.
Worries over subprime loans have hurt even some of the biggest lenders in the United States. On August sixteenth, the nation's biggest housing lender, Countrywide Financial, had to turn to banks to finance its short-term debt. Normally the company would raise the money in financial markets.
Many took this as a sign that investors were becoming unwilling to provide short-term loans to companies. Especially companies involved with subprime loans.
A shrinking debt market, a credit crunch, can affect stock markets. Not only have subprime losses hurt financial stocks. Many companies depend on credit. Private equity groups often use borrowed money to finance buyouts of publicly traded companies. Hedge funds also use borrowed money for their investment activities.
In an effort to calm financial markets, the Federal Reserve two weeks ago cut the rate it charges banks to borrow money. Many investors hope the central bank will cut its main short-term interest rate when policymakers meet on September eighteenth.
And that's the VOA Special English Economics Report, written by Mario Ritter. I'm Steve Ember.
