The credit crunch and its effects: if the newspapers are to be believed, the mood at the recent 2008 World Economic Forum in Davos was nothing like the upbeat atmosphere of days past.

AuteurDonnellon, Brien
Fonction MONEY

Despite assurances from U.S. Secretary of State Condoleezza Rice as to the resilience of the American economy, many people left this year's WEF with the belief that a U.S. recession was not only a strong possibility, but likely to result in a global slowdown.

Last autumn it seemed the financial markets were beginning to recover from a turbulent year, but 2007 ended with lagging investor confidence as the troubled American housing market exposed huge banking deficits.

In December leading banks attempted to revive the markets. The European Central Bank loaned 350 billion Euros to banks at a below-market interest rate in a bid to ease tight credit markets and reduce the cost of lending between retail and commercial banks. The ECB confirmed that 390 European banks sought the funding.

Most analysts didn't believe this to be enough and, sure enough, the stock market experienced its biggest downward correction since 2002.

The sub-prime debacle

One of the contributing factors in the turmoil has been the sub-prime mortgage problem.

These mortgages were granted to borrowers with a poor credit report, who had missed or been late with payments on a debt. Lenders charged an inflated interest rate to compensate for potential losses from default. At first, this enhanced the lenders profits. But then the borrowers couldn't pay.

Hundreds of thousands of borrowers were forced to default and several major American sub-prime lenders filed for bankruptcy.

Worse, mortgage brokers had been paid for writing loans but weren't docked if those loans failed. The system of lending had become less transparent because sub-prime mortgages were 'bundled' by finance companies and sold to financial institutions around the world--including pension funds and hedge funds.

Many of these miscalculated the likelihood of defaults in a housing downturn; they've been left with a slew of bad loans that no one wants to buy.


In recent weeks, investors were shocked to see leading credit rating agencies downgrade tens of thousands of mortgage-based securities. They were especially upset that many of the plunging securities had carried the agencies' ultra-safe, 'triple A', tag.

Investors believe the rating agencies failed in their duty to foresee, and help them avoid, sub-prime housing losses.

This is fuelling political pressure for American and European regulators to clamp down on the agencies, which are subject to less-than-stringent regulation.

Moody's, Fitch, and Standard &amp...

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