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Sub-prime Crisis Affects Global Markets

It seems that the problems in the US with sub-prime markets may be reverberating around the world. These days it is virtually to limit a large financial crisis to one country.

Yesterday the London stock market fell like a stone as signs of the worsening crisis in credit market caused a jittery sell-off. There were signs of panic as the FTSE 100 Index plunged more than 150 points following news that the European Central Bank (ECB) had called upon emergency liquidity (a record £64.6bn) into credit markets. This has not happened since the 9/11 terrorist attacks in 2001.

European and American stock markets experienced large drops, with Wall Street falling by 387 points (2.8%) on Thursday.

Investors grew even more nervous at rumours that the US Federal Reserve was considering cutting interest rates – maybe even on Friday – to try and prevent further sell-offs.

The ECB hoped that the injection of €95bn would prevent the US sub-prime mortgage problems from spreading like wildfire into the banking systems of Europe. It had emerged early on Thursday that the largest bank in France, BNP Paribas, had had to suspend three funds which had large US debt exposure. By the middle of the afternoon shares in Paris, Frankfurt and London were all down by over 2%.

The bank itself lost 5.5% after it has suspended redemptions of the three funds after a ‘complete evaporation of liquidity’. Net asset value for the funds had become impossible to calculate after recent market nerves.

The Royal Bank of Scotland in the UK announced that it had had to abandon the sale of £1.1bn worth of hotel stock for the second time in three months owing to the credit crunch. The deal would have meant syndicating £900m of debt. Normally this would be manageable, but the fears in the marketplace following soaring default rates in America’s high risk mortgage market have made it impossible for now.

The US sub-prime crisis has been in the news for some time now, following the collapse of two funds at Bear Stearns, a huge US investment bank. That such an institution had to come clean about the loss of value of two such funds caused a stir in the US which is now threatening to cause more than a ripple in worldwide financial markets. Huge sums of money had been lent to homebuyers with poor credit history and the chances of recovering are now virtually zero. The funds once had combined values of $20bn.

The crisis deepened on Monday when US sub-prime lender American Home Mortgages had to file for bankruptcy, and then on Tuesday one of the biggest providers in the US, Impac Mortgage Holdings, announced that it was halting all funds to risky loans. On Thursday DB mortgages, part of the German Deutsche Bank, pulled its UK sub-prime mortgages out of the UK market, with the line to brokers that it wanted to reconsider its level of interest rates.

Thursday saw the London FTSE 100 close down 122.7 points at 6271 – a fall of 2%. It recovered from an earlier position of 150 points off.

Tom Smith
20th August 2007

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