US housing market trouble - Consequences of going wild?

Well, though I don’t live in the US, but what happens there, economically and politically, affects almost everyone around the world, so got interested in finding out what’s going on. What’s all the fuss about Subprime Mortgages and trouble associated with it?

Well, lets start with subprime mortgage.
Basically, it’s the practice of giving loans to less credit-worthy borrowers at a higher rate (higher then currently going rate in the market). Now it’s a win-win and loose-loose proposition for both parties – lender as well as borrower.
Win-win, because it helps less credit worthy to afford a house (or any other asset) and helps the lender to earn higher return on their money.
Loose-loose, because its fraught with risks for both parties – one is lending to other who is not credit worthy, and one is borrowing from other at higher interest rate so repayment is going to be difficult.

Now all looked great while the interest rates in the US came to 1% (before June 2004), both parties were happy doing normal business i.e. lending, borrowing and repaying.
Trouble started when US Federal reserve started increasing interest rates to contain rising prices and today it has come from 1% to 5.25% and this has disturbed the borrowers ability to pay and hence lenders have started feeling the heat due to ever increasing the defaulters and going bankrupt. These lenders were given money by institutional investors and hence these big investors have also felt a big jolt. And this ultimately has to come the stock market, first to the US and then to all over the world.

Clearly, it’s a consequence of mortgage industry going wild and there are always consequences of going wild. This has a parallel to the IT crash of 2001, which was also a consequence of going wild. After all any start-up with a .com in the end could raise money. Even a start-up aiming to sell dog food on the net also got VC funding, despite the fact that cost of the dog food was miniscule in comparison to cost of delivering it to individual customers, but no-one was prepared to look into these minor details then!!

Now, the bigger question for those owning a house in the UK. Is UK housing market not following the US in subprime mortgages?
According to market analyst group Data monitor, mainstream mortgage lending grew by 4.1% last year, while sub-prime mortgage lending rose 9.1% for the period.
However, the big difference between US and UK is that while almost 35% of all mortgage securities issued last year in the US come under subprime category, this is only 5-6 % in the UK. And most of the major retail banks stay away from this market, there are only 2-3 major banks offering such mortgages.
So lets hope that UK housing market doesn’t go the US way and doesn’t add to the agony of the stock markets world over.