Impact of sub-prime crisis uncertain

The fallout from the sub-prime loan event looks set to continue for some time yet, with investors and markets around the world still trying to anticipate the future direction of interest rates.

After being stung by the recent rate increase, home-owners and other borrowers took some heart the Federal Reserve's decision to cut official interest rates by 0.5%, in an attempt to settle markets that fell rapidly as the crisis unfolded.

Many U.S. Adjustable Rate Mortgages (ARM's), or mortgages with a low 'honey-moon rate', have begun to reset from their low initial interest rate to the prevailing market rate. Some borrowers, seduced by the low initial rates have found themselves unable to make the new repayments and have been forced to sell, further depressing some sectors of the $1.2 trillion industry.

The situation could possibly lead to a rise in the cost of debt for financial institutions in Australia, which would likely be passed on to Australian consumers.

This is not, however a situation the banks envision in the near future, according to Commonwealth Bank CEO, Ralph Norris. 'At this stage we haven't seen any significant impact on our cost of funds at this point', Mr. Norris said on Monday. 'But that is something we will be looking at on a day-by-day, week-by-week basis'.

At the same time, the jitters affecting US stock markets appear unlikely to prompt any change in interest-rate policy by the RBA. In the central Bank's recent quarterly report, commentary centred upon the continuing strong performance of the global economy and its impact on Australian economic growth; 'The evidence continues to point to strong growth in the global economy overall'.

Experts are predicting that the subprime loans affair will continue for some time, with the value of loan 'resets' expected to increase above current levels. Previous resets have been the precursor for increased loan defaults which were the catalyst for last week's market plunge.

The million-dollar question is how Australian markets will price these resets and their impact on Australian economic activity.

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Published on September 9-rd, 2007 in Home Loans
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.
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