• U.S.

A Sub-Prime Primer

1 minute read
TIME

A wave of defaults on “subprime,” or high-risk, home mortgages has not only rocked the Dow; it also threatens to ripple through the economy. Here’s how

WHEN HOMEOWNERS CAN’T PAY …

Borrowers with poor credit and unusual loans have often taken on more debt than they can handle. And if rates rise, they are vulnerable to default and even foreclosure.

… MORTGAGE LENDERS GET HAMMERED …

Many lenders resell their high-risk mortgages to investment banks. If defaults rise, the lenders are often forced to buy back the bad loans, which hurts earnings and stock prices.

… INVESTMENT BANKS LOSE BUSINESS …

The firms that buy the loans usually repackage them and sell them as securities (for a profit, of course). As securities get riskier, there are fewer buyers. That means lower profits.

… INSTITUTIONAL INVESTORS ARE EXPOSED …

Banks, hedge funds, insurers and mutual funds have been buying the risky bonds because they promise high rates of return. As defaults spread, that promise evaporates.

… AND THEY FLEE THE STOCK MARKET

The mortgage storm plus slowing consumer spending lead investors to look for safer bets than stocks. Another fear: tighter credit further weakens the housing market.

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