Sub-Prime market and Consequences

What are sub-prime mortgages

Simply put, Sub-prime mortgages is practice of lending money to people with lower credit ratings. Prime lending is the normal lending practice and the rates of interest in sub prime would normally be a couple of percent more than a similar prime lending loan.

What is Securitisation

Securitisation is the process of converting future cash flows into tradeable bond like packages. These future cash flows can be anything from future home loans, student loans, credit card payments and even music royalties. Securities can be very useful as you can use the money that you were going to get in the future.

What happened in the current scenario

A type of security backed asset called collateralized debt obligation(CDO) based its future cash flow on sub-prime mortgages. With the default rates in the sub-prime mortgages rising the value of these CDO started falling exponentially. These securities which had a value of billions of dollars suddenly became useless. This created a massive credit crunch with banks not able to finance things with these securities. A slump in housing market caused a world wide credit crunch because in this global economy these CDOs were brought and sold by banks all over the world. The extent of damage caused by these CDOs is still not clear even after Banks around the world have taken big hits on their balance sheets in the financial quarter. There is a school of thought that suggests that Securitisation encouraged lax lending practices. 

(The Consequences of Mortgage Credit Expansion - Study link here)

What is the future of structured Financing

Even the most ardent opponent of Structured Financing and Securitisation will agree to the fact that it has brought a lot of benefits to economies across the world. To throw Financial engineering out of the window because of the sub-prime problems would be wrong. This quote from the Economist.com article stuck "So it may just be a matter of hanging on. As any punter in Las Vegas will tell you, every losing streak ends eventually, if you can only stay solvent for long enough."

Plan Ahead. Get Organized.

Well with many of us running around to meet deadlines to avail various tax benefits, can we plan and have a better year the next time around. Here are some suggestions to get in shape financially.

1) Early bird gets the interest.

With our income levels rising and many of us having some surplus cash to invest, invest early. Many of us must be owning a PPF Account (Guys, if you don't have one yet get one fast.) instead waiting for the fiscal year to end, invest by 1st week of April. This amount with your earlier invested amount is going to earn you a whole year's interest.

2) Get a contingency fund.

Many of us living a fast life and several dependants to take care of you never know what is going to strike you. Plan and park a decent amount of money in a risk free account (ideally a FD) to take care of those unwanted surprises.

3) Get a Life Insurance Policy.

A lot of us already must be having Life Insurances Policies already but is it really enough for your family? Well check out Term life insurance policies where you can get insured yourself for a larger sum for a smaller premium. Generally you won't get your premiums paid at the end of the term but there are some policies which will. Ask your insurance agent for this.

4) Invest regularly. Understand compounding.

Discipline yourself to save a portion of your money monthly. To achieve this check out various SIP schemes of successful Mutual Fund houses. Look out for a good history and a good track record. You will find loads of information. One good place to start is here.

If you are risk averse get a monthly Recurring Deposit account in a bank.

And yes most importantly understand Compounding. That's why getting a PPF account makes sense.

5) Get a home.

Though not easy but this is a great option for anyone who can avail of a home loan or with some surplus amount of money. While on the home loan front you can avail of attractive tax benefits. On the other it can become one of your assets. It can be a great little getaway when you want to retire. Happy Investing.

DISCLOSURE: All decisions have to be taken only after through research and sound advice. This blog is in no way responsible for anyone's actions.