The United States Banks and Trading Houses re-packaged sub-prime debts into attractive-looking securities and/or investment vehicles, which were then picked up in European and Asian markets by Traders and Banks.
Sub-prime basically refers to those loans being given at a higher rate than the prime rate (i.e. the interest rate that Banks generally use as an index in calculating rate changes to adjustable rate mortgages (A.R.M.'s), and other variable short term loans); according to data published by the Wall Street Journal On-Line, the prime rate in the United States is currently 5%.
Sub-prime lending is also known as B-Paper lending. Borrowers generally tend to have compromised credit histories.
Sub-prime loans incur a higher interest rate than an A-Paper loan due to the perceived increase of the Borrower being more of a risk.
Along, with sub-prime mortgages, the term encompasses sub-prime car loans, sub-prime credit cards, and the most abusive sub-prime lending practice of all, short-term "payday" loans.
The controversy surrounding sub-prime lending is high. It is alleged that sub-prime lenders engage in predatory lending practices, deliberately targeting the less-educated, racial minorities, and the elderly; those who may not understand exactly what they are signing, and/or could never hope to honor the terms of their loans.
Sub-prime loans are usually covered by collateral such as a car or house. As many of these loans include hidden terms and conditions, not to mention, exorbitant fees, Borrowers usually end up in default; their collateral is seized; or the property ends up in foreclosure.
As the United States is considered a powerful nation, extending it's control and influence over nations that may not be as economically fortunate, it can be better understood why the ongoing sub-prime lending and credit crisis in the United States has progressed to a restriction on the availability of credit in world financial markets.
Unfortunately, when the United States sub-prime mortgage crisis hit in 2006, Investors found their investments near valueless, or difficult to ascertain value; the inability to assess the value of an asset generally leads to market paranoia.
As a result, Banks tightened their lending policies, which led to higher interest rates, and difficulty in maintaining credit lines. Thus, overseas businesses with no direct connection to the United States' sub-prime mess suddenly began to find difficulty in maintaining credit lines; Banks stopped lending to each other and to businesses.
Don't be misguided though; sub-prime woes are now spreading into the prime market. Borrowers with good credit are experiencing sudden changes in financial security, causing them to fall 60 days or more delinquent on their loans, and foreclosures are climbing rapidly.
House prices continue to collapse and prime loan Borrowers are shocked to discover that they owe more money than their houses are worth!
Rate increases continue to rise making it more difficult to keep up with monthly mortgage payments.
The U.S. Government is stuck between a rock and a hard place. If they offer funding to assist troubled Borrowers avoid losing their homes will the effect cause more defaults or encourage riskier lending?