The global financial turmoil, precipitated by problems with subprime mortgages in the US, has abated - at least for now. Last Friday, markets were steadied by the reassurance from Federal Reserve chairman Ben Bernanke that he will "act as needed" to protect the US economy.
His remarks suggest that the Fed may consider an interest rate cut later this month. The European Central Bank, which before this credit crunch began had indicated that it was likely to raise rates at its next meeting on Thursday, may not do so. That too would go some way towards calming investor nerves.
This global credit problem has stemmed from difficulties in the US subprime mortgage market, which caters for borrowers with poor credit records. There, the combination of reckless borrowing by house purchasers and imprudent lending practices by banks and financial institutions, when set against the background of rising interest rates and falling property prices, has proved to be a lethal mixture. As subprime borrowers were squeezed by higher mortgage repayments and were facing negative equity, where their home was worth less than their loan, many simply defaulted on their debt. The banks, however, had bundled and repackaged these home loans as mortgage securities and sold them on to investors. By doing so, they had transferred the default risk to others, including some European banks.
The bundling of so many subprime mortgages on such a huge scale, not surprisingly, meant the underlying loans of these asset-backed securities were not adequately scrutinised by investors, partly because of their financial complexity. But neither were they properly assessed by the credit rating agencies, which is inexcusable. They failed utterly to detect the lax underwriting standards involved.
The size of the mortgage-backed securities market, and the continuing market uncertainty generated by problems in the subprime sector, has meant serious disruption in lending and borrowing worldwide. Nervous investors have become more risk averse as credit dries up. If the origins of this problem are in the US, the consequences have been felt worldwide, and not least here.
Ireland may have a much smaller subprime mortgage market, of which securitisation of mortgage loans is a minor feature. But yesterday's ESRI/Permanent TSB house price index, which showed a 3 per cent drop in house prices from January to July last, confirmed that property prices have peaked. In that regard, the US subprime debacle has some cautionary lessons for Irish property investors, not least about the dangers of reckless borrowing and the hazards of imprudent lending.