The sub-prime crisis has rocked the United States, plunging it into an enormous financial crisis.
So what is the subprime home loan market?
It is aggregation of those individuals in the United States to whom, normal banks do not lend, for the simple reason that their credit histories are not good. Hence, there is a greater chance of the individual taking the loan defaulting. And no bank likes to take on customers who are likely to default.
Here is where institutions which have a good credit rating and are willing to take some amount of risk, come in. They borrow money from banks and lend it to the Americans who have a bad credit rating. They divide this loan, into a lot of small tranches and give it out as home loans to Americans who do not have a good credit rating and to whom the bank will not give a home loan directly.
They give out the loan at a rate of interest, which is obviously higher than the rate at which they had borrowed from the bank. This higher rate is referred to as the subprime rate and this home loan market is referred to as the subprime home loan market.
Since these borrowers, in any case, do have strong credit standing, the higher interest rate hits them hard.
As the EMIs on home loans go up, there is a great chance that subprime borrowers may not be able to pay them. If these EMIs are not paid, then investors who had bought the securitised paper will not get paid and hence suffer losses.
To cover their losses they may have to sell their investments in emerging markets like India, where there investments have been generating return.
And when they sell their investments in emerging markets, the markets are likely to fall, if there is less buying at that point of time.
Image: A sign is posted in front of a bank owned home that is for sale in Richmond, California. According to a report by RealtyTrac, home foreclosure filings surged 55 per cent this month compared to a year ago as borrowers continue to default on home loans. | Photograph: Justin Sullivan/Getty Images
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