The news coming out of America’s financial sector is becoming more unpleasant with every passing day. The US dollar is having a free fall, prompting the Iranian President (an American foe) to refer to the currency as a “worthless piece of paper”. Towards the end of 2002 the dollar had parity with the Euro but today, 5 years later, it is almost $1.5 to one Euro.

On the other hand, financial institutions both within the US and beyond are feeling the threatening ripples of a tremor with an epicenter in the US subprime mortgage sector.

Many ordinary citizens, especially those living outside the US barely understand what is happening, let alone guessing the impact of such crisis on them.

The principal reason is that any news from this sector is shrouded in financial jargon that does not make any sense to the rest of us.

In Order to understand a little bit of what is happening in the US (which is also hurting the rest of us), you need to know the meaning of some key words.

Mortgage: It is a loan that one borrows to pay for real estate (house and land). The common practice is that the borrower advances about 10% of the value of the property and the rest of the payment plus interest is spread over a period (say 10 to 30years) depending on the contract. The title of the property remains with the lender or what I call ‘middlemen banks’ that brokered the deal. You can start using the house but the title documents will only be given to you when you have completed payment. 

Foreclosure: The forced sale of real estate (usually by auction) to pay off a loan on which the borrower has defaulted.

Subprime Mortgage: It is a mortgage extended to borrowers with low credit ratings or without a credit history. These are considered more risky mortgages compared to the conventional mortgages and tend to attract higher interests. These mortgages are usually handled by ‘middlemen financial institutions’ that borrow money from bigger financial institutions like Citicorp to invest in this risky sector.

Historically, investors have always considered the US housing sector as fertile and stable ground. That is why many major banks within and outside the US easily made capital available to the risky US subprime mortgage sector. Easy money became available and the actors (both lenders and borrowers) became more reckless. People were enticed to ‘purchase’ homes that some could hardly respect the payment schedules without defaulting. The consequence of this indiscipline was not long to surface. As the house prices started slumping and mortgage interest rates were taking the opposite direction, ‘subprime house owners’ started defaulting on their loans in record numbers. The ‘middlemen financial institutions’ also started defaulting on their loans to the big banks. The value of real estate assets in the banks’ accounting books had to be revised downwards. The ensuing adjustments prompted some major banks to announce fall in profits and modify upwards their provisions for bad debts. The financial crisis has already cost the jobs of prominent CEO’s like Stan O’Neal of Merrill Lynch and Citicorp’s Chuck Prince. The first oversea casualty (institution) was UK’s Northern Rock that had to be bailed out by the Bank of England with a $ 25.5 billion credit as jittery depositors queued up to withdraw their savings.

To understand the extent of the problem, consider the following developments. As stated earlier, the crisis has already prompted write-downs (reduction in the value of assets in accounting books) of more than $45 billion at the world’s biggest banks. According to Credit Suisse Group (a global financial service company), at the end of August 2007, mortgage loan default in the subprime market amounted to $46 billion, representing 225,000 homes. It predicted that the number will hit $270 billion, or 1.5million homes by 2010 or later.

Goldman Sachs, one of the gurus of the financial world, forecasts that, Citigroup, for example, will write down $22 billion between now and the end of 2008.

The unfortunate part of the story is that the crisis is seemingly contagious. Insurers, Credit Card and Car loan sectors are already feeling the symptoms of the ‘financial flu’. In response to apprehensions about the possible impact of the problem on the credit card sector, former US treasury secretary Larry Summers told a gathering in Dubai recently that; “I would be surprised if we did not hear more about the credit card issue in the next three months”. Already, some desperate people are now using credit cards to make mortgage payments—thereby compounding their debt problems.

It is easy for people living outside America to shrug their shoulders and say; “That’s their problem”. No. It is not just their problem. It affects just about everybody globally. Many countries with foreign reserves in US Dollars are getting poorer by a factor related to the decline of the dollar. Foreign- based companies like Airbus (based in the Euro zone) that negotiated long-term contracts for the prices of her aircrafts in US dollars are heading for big trouble as the declining dollar continues to reduce the prices of their products and adversely affects their profits and competitiveness. Millions of people around the world depend on remittances from relatives resident in the US to run their lives. If a US-based breadwinner is trapped in the mortgage mess, his (her) ability to continue to support others financially will be compromised. Besides, as the value of the dollar continues to drop, the recipients will continue to receive smaller and smaller amounts.

It is predicted that the US mortgage crisis may last long, spread wider and bite deeper. AS Michael Mayo of Deutsche Bank said; "This is one of the slowest moving train wrecks we've seen”.

As we continue to ride that train, we ask whether it is not about time to reform America’s pervasive culture of living on borrowed money?

N.B. This article reflects the understanding of a layman on a complicated topic. It is intended to serve as a stimulus for other people in the author’s position to make more research and obtain more complete information from experts. Too many people are lost in the maze of financial jargon.