I don't understand anything about markets, mortgages, and sub-prime lending. Can someone help me?

Question

I am a complete dolt about such things. I know the economy is troubled world wide because of sub prime mortatges, and that they are loans given to high risk people. That is it. How does it all relate to each other and what does this do to the economy? What exactly is the Federal Reserve Rate and what does it mean when they intervene? What does this mean to me, someone without investments that works and rents?

Sorry to be such an idiot, but I really want to understand...let's pretend I have been living in a cave for a long time and don't understand the lingo! I hate feeling like such an idiot when I hear about this and read about it. Thanks!!!

that really does help...but I'd love to hear more answers...esp. why someone would thumbs down!

Answer 1

Okay, a market is anywhere a buyer and seller meet to do business. If you want to buy shoes and the price is agreeable to you, then you buy them from a seller. You are better off because the shoes are more valuable to you than the money was. The seller is better off now because the money was more valuable to them than the shoes. Both parties are better off from the ability to freely trade.

A mortgage is a loan to purchase or improve a home. Sub-prime loans are made to people who would not ordinarily qualify but are offered them given a higher rate.

The Federal Reserve rate is actually two different rates, the Federal Funds rate and the Discount rate. The Federal Funds rate is the rate banks loan money to one another. The discount rate is the rate the Federal Reserve banks loan to their member banks in an emergency.

What it means to you, if it is functioning well, is that you should someday, if you save, be able to buy a home because the money is more valuable to you than it is to a lender and the home will be more valuable to you than the seller.

The economy is deeply interconnected. Your employment may very well be tied to this. For example, if you are a waitress and many of your lunch customers are from a nearby bank, what impacts them directly impacts you. If the mortgage market has enough problems they will lose their jobs. You will lose your tips, the restaurant its customers and may you will lose your job.

Likewise, if the market stress continues long enough, your landlord may see the interest rate on the loan to buy your apartment go up, your landlord may be required to raise your rent to cover the higher costs.

Answer 2

Most mortgages are no longer held by the bank that made the loan but are bundled and turned into securities and sold as investment vehicles. The problems arise when these securities are then bought by funds using borrowed money from investment banks. When an unusually large number of people can not make their loan payments the value of the securities fall and because the funds have borrowed more than their new value, the fund could be bankrupt and may not be able to pay the interest to the investment banks who then may not meet their obligations. Because of the uncertainty of who actually owns the troubled securities investors and financial institutions are selling everything so they can have cash to cope with possible problems. This is eating up the cash in the system. The fed is intervening, supplying cash by buying securities from banks and making it easier for the banks to get loans from them.
The effect on you will be minimal unless their is more trouble. Crashes in the financial system can cause a recession.
The fed fund rate is the interest rate for bank to bank loans and the discount rate is the rate the fed loans money to banks.

Answer 3

Lol, believe me, many people don't understand this..

First off, sub-prime mortgages are mortgages given to high risk people. They have a high rate associated with them, and if you start to rebunk on them, the interest rate will go astronomically high, usually causing foreclosure. The main reason that they do this is bc the banks or other lenders that are lending the money out need to do 2 things: 1) they need to be able to make money and 2) they have to cover themselves in the event a person stops paying.

The Federal Reserve Rate basically is the rate of interest that one can expect to recieve. Usually investments, such as CD's will have a rate that is slightly higher or lower than that of the Federal Reserve Rate. The FRR is a rate that is also adjusted for inflation or recessions. Usually when they intervene, its because there is inflation, which means the FRR rate will rise, as inflation and interest rates mirror each other.

As to what this all means to you as a renter... Basically, if you were to buy a house, you need to make sure that your morgtage is something that you can afford, as if you qualify as a sub-prime, and then don't pay, you will be over your head. Additionally, if you do so choose to invest money at any point and time, you should look at the rate of inflation, and where it's expected to go. If inflation is going to go up, don't lock into a long term investment that has a set return, as you will be losing money. Either go short term or stocks/mutual funds/bonds...

Hope this helps!

Answer 4

Commercial banks are experiencing losses due to falling asset prices, especially on loans related to real estate. If the investors in the banks lose confidence in the longer-term performance of the banks, they will sell their share holdings in that bank. This, in turn, forces banks to sell some of the portfolio, which further depresses the price of mortgages. Also, depositors in the bank can also become worried, which also forces the bank to shrink its assets.

The central bank can lend money to banks, which replaces the loss of bank capital and bank deposits, which allows the banks to temporarily hold onto their portfolio. This prevents further selling off of mortgages, and hopefully can limit the slide of both mortgage prices, stock prices, and bond prices.

The downside to all of this is that the central bank often lends public money to these banks at a lower rate than the banks would normally have to pay in a crisis. So, the taxpayer is indirectly subsidizing this type of lending activity. But, hopefully, the benefit is that it prevents a true calamity in the financial markets.