Jan

31

American sub-prime crisis: should the rest of us care?

Filed Under banking and economics | 28 Comments

lego townThis article will be featured in Home Finance: All you need to know about home ownership at rocket finance on Friday.

It should be no news to anyone that there is currently a sub-prime mortgage crisis in the good old United States of America. It’s been on the news, and in the papers for months already.

But, does it really matter to non-Americans? And if so, how?

what is a sub-prime mortgage?

In order to persuade a bank to lend an extremely large sum of money to buy a house, you generally used to need a few things:

  1. A sizeable deposit
  2. A verified income
  3. A house in mind, in fit condition
  4. A good credit score

In the olden days, it used to be almost impossible to get a mortgage without these things. But then, someone realised that there were likely to be people with deposits, incomes and satisfactory houses in mind, who just didn’t quite have a good credit score.

The idea was that you could offer them a mortgage at a higher interest rate than normal, to offset the greater risk of default. Then people who could afford to buy houses (they had enough income) wouldn’t be cut off from the mortgages they required. The sub-prime mortgage industry was born.

what went wrong?

Quite simply, more sub-prime mortgages holders defaulted than expected. There are various structural reasons for this, to do with mortgage backed securities and other financial products (for more information check out this explanation).

As mortgage holders defaulted, the people they owed money to had to write off lots of debt. This included British banks such as HSBC, who had a sub-prime mortgage unit Decision One Mortgage. They lost in the region of $945m and last February made their first ever profits warning (that they wouldn’t make as much money as expected).

Although the defaults had an impact, they haven’t directly had much effect over here as US sub-prime arms of British banks were generally small.

what happened next?

The number of defaulting mortgages was unexpected, and by this time, the money was owed to many different investors - particularly banks - forming part of their assets (a bit like buying a bond). They realised that they didn’t quite know how much liability they were likely to have, and what the return would be on their investments.

It is thought that this the caused banks to be more wary of making loans to each other, or make them at higher rates, as they were unsure of both there own and everyone else’s true financial position. In any case, credit is in short supply - a credit crunch.

has the credit crunch had an impact?

Yes. Most British banks raise their money for loans from the deposits of their customers, but not all do so. Some, instead borrow the money on the credit markets (effectively from other banks) and then re-lend it to members of the public.

As you can imagine, if it is harder or more expensive to buy money, but you are still lending it out, you’ve got something of a problem on your hands. Which is exactly what Northern Rock realised in September. They were forced to borrow from the Bank of England, which led to a short run on Northern Rock branches as lots of people queued up to withdraw their savings.

In order to prevent a panic (or something) the government announced that they would guarantee the deposits - Northern Rock pretty much had enough money to cover it all, but it would have been the end of the bank. This mess is still in the process of being fixed.

The other important but less obvious impact of the credit crunch is the general impact on the economy. Developed economies are somewhat linked together, and with increasing globalisation, if something effects one of the biggest world economies, it tends to affect everyone to a certain extent, especially if they are a major trade partner.

In addition, the financial sector is one of the powerhouses of the British economy, and this crisis directly affects them. This is probably one of the causes of the recent stock market slides.

any more bad news?

In a bid not to get caught out in the same way that the Americans have been, British banks and building societies are tightening their criteria for mortgage lending. People on the margins are finding it harder to get new financing. Having a good financial footing with low or no consumer debt is more important than ever, if you are trying to qualify for a mortgage. But then, it’s good practice to get rid of as much debt as possible before taking on a mortgage.

Image by yananine.

Dec

6

7 tips to manage your cash when traveling - a guest post

Filed Under banking and economics, guest posts | 28 Comments

I didn’t quite get time to put this guest post up before I left for DC, but it is ace. If you’d like to write a guest post for plonkee money, drop me a line.

A personal finance and life blogger from metropolitan New York, bripblap is extremely well travelled. Enjoy his tips below and subscribe to his excellent feed.
American Express - don’t leave home without it! That may be one of the most famous phrases in advertising history, but it tapped into a deep fear for most travelers: the fear of being stranded in the distant unknown parts of the world without ready access to their money. What are some simple tricks to use to safeguard access to your money when traveling?

1. If you are traveling to very remote areas, make sure you have plenty of cash. The parts of the world that don’t accept credit cards or debit cards are dwindling, but there are still places. Keep plenty of cash, but keep it spread amongst your wallet, your luggage and even a bit hidden somewhere else. I used to prefer to keep some spare money hidden in my toiletry bag on the theory that nobody is going to check there.

2. Carry dollars. Despite the fact that the dollar is terribly weak right now, it is still the most accepted currency in the world. Carry $100 bills; these are far easier to exchange, ironically enough, overseas than in the US. If you are coming from another country (you’re a European traveler, etc.) I would still recommend carrying US dollars. Don’t count on your drachmas or forints being accepted everywhere.

3. Keep a list of your credit card numbers and customer service - and give a copy to someone at home. There is nothing like having your wallet stolen overseas. However, you want to be able to quickly cancel them if you do lose them or have them stolen, and the easiest way is to have a separate “panic card” ready. Give one to a friend at home in case your panic card is stolen, too.

4. Debit cards are convenient, but pricey. When I started traveling in the early 90s, debit cards were almost worthless when traveling. As time has passed, though, they have become far more useful. Be careful when changing money, though - you may pay a fee to your bank and the local bank. In addition, you may get hit with an exceptionally unfriendly exchange rate.

5. Go gray. I can’t emphasize enough that you should stay in compliance with the laws of the countries you visit, which often prohibit individual currency exchanges. Depending on the country you visit, though, you may find significantly better exchange rates dealing with individuals than with banks or exchanges. In developing countries with high inflation rates local people will often be willing to give you better rates simply to protect their earnings by converting them to dollars. I would not recommend exchanging with locals, however, unless laws (and safety) permit.

6. Get rid of change. Spend your change as fast as you get it, and small bills, too. These are often difficult - if not impossible - to exchange on your return. Try to spend all of your local currency before you leave the country. Exchanging your money to local money and then back to your money is a terrible waste. Try to spend down to 0 before you leave; put your last few expenses on a credit card.

7. The most important money tip when traveling, of course, is to keep it and yourself safe. Never flash large sums, never discuss how much you have, keep it well hidden and ensure you know how you could get ‘emergency money’ if you needed it (for example, where ATMs are that accept your bank’s ATM network).

Fun (and safe) travels!

Nov

27

how do interest rates affect inflation?

Filed Under banking and economics | 12 Comments

John commented on a previous post about the importance of the Bank of England’s interest rates:

I suggest you write an article about how interest rates effect inflation and vice versa. Something practical for the masses.

It sounded like a good idea to me, so here goes:

supply and demand in pancakes,… or anything else

Imagine people selling pancakes. If there is a big demand for pancakes, but there aren’t many people supplying pancakes then the prices will go up as the customers outbid each other for pancakes. If there is a big supply of pancakes, and not a lot of people demanding pancakes, then the price of pancakes will go down as the pancake sellers undercut each other.

Now what is true for pancakes is also true for the relationship between money and prices. If there is more money than there are goods and services to buy, then the prices for the goods and services will go up. If there is less money than there are goods and services to buy, then the prices for the goods and services will go down. The measurement of the change in prices over time (the rate at which prices change) is inflation.

the price of money

This is where interest rates come in. One of the ways that you can think about interest rates, is as the price of money. If you look at something like zopa* or prosper*, you get borrowers saying how much interest they’re willing to pay (what price are they willing to pay for money) and you get lenders saying how much interest they want to charge (what price are they willing to sell money for).

As I’ve explained before the interest rate, or the price of money overall, in a currency is effectively determined by the central bank - such as the Bank of England, the European Central Bank or the Federal Reserve for example. This means that if the central bank’s interest rates are high, money is more expensive, and if the central bank’s interest rates are low, then money is cheaper.

bringing it all together

As with all things, if money is expensive then it will tend to be in short supply, and if money is cheap it will tend to be in plentiful supply. But as we saw before, if money is in short supply [interest rates are high] then prices overall will go down [inflation is low or negative], and if money is in plentiful supply [interest rates are low] then prices overall will go up [inflation is high].

This is why higher interest rates tend to lead to lower inflation; and lower interest rates tend to lead to higher inflation.

*these are affiliate links, regular links are zopa and prosper

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