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Sub-prime woes to hurt more than just the City Boys, by Carl Malways

To those who haven’t been around for the past couple of weeks the stock markets have been going through absolute turmoil. The fall out from the sub-prime lending market in the United States has had ramifications not only in the United States but across the global financial system. How long this crisis will last is yet to be seen and the wider outcome is yet to be known. However don’t be fooled into thinking this is not going to have an impact upon those outside the financial markets, it will.

To those who don’t know the current market turmoil has been created by a problem in the United States sub-prime mortgage market. The sub-prime mortgage market is where banks lend to people with a poor credit rating at a higher interest rate – in the hope of higher returns. However, the market became too loose and too overstretched. As base interest rates rose in the United States and the economy slowed, borrowers saw mortgage payments rise at a point when jobs were being cut and wage growth slowing. As a result defaults on mortgages increased rapidly.

So why didn’t the problem stop with the mortgage lenders? The problem has had wider consequences because those banks that lent in the sub-prime market packaged up some of this debt as a financial product and sold it to willing buyers in the international financial market. This was done as an insurance measure against widespread defaults. However, the selling of sub-prime mortgages went too far and rather than acting as an insurance against the risk, international financial markets have been pulled into the crisis.


The result is that financial markets have seen billions of dollars wiped off them in August. Several hedge funds have been closed and many of the major banks have suffered huge losses. This crisis has also led to a steep drop in confidence. Banks are no-longer willing to take the risk and lend to one another. As a result this has created a credit crunch where investors have not been able to borrow credit and as a result of a falling credit supply the cost of borrowing has risen rapidly. The Fed, the European Central Bank and other major banks have reacted strongly by cutting interest rates and by pumping credit into the markets. This has helped to temporarily stabilise markets but volatility remains high and no-one is yet saying things are in the clear.

Looking forward to the rest of the year and into 2008 it seems likely that the impact of the sub-prime market will run on and on in a number of different forms. Businesses are likely to find it increasingly difficult to find credit, especially the cheap credit they’ve been used to in recent years. This will reduce the ability of businesses to expand and capitalise on opportunities as and when they arise. Consequently business activity will be reduced, which will hit GDP growth.

 

The reduction in business activity will also hit employees. The first people hit are likely to be the City Boys who are not going to see the same bonus payments they have become used to. It has already been estimated that city bonuses may be reduced by up to 20 per cent in 2007. Jobs in financial services are also likely to suffer, with slowing headcount additions and even with a net loss of jobs.

The reduction in business activity will also hit employees. The first people hit are likely to be the City Boys who are not going to see the same bonus payments they have become used to. It has already been estimated that city bonuses may be reduced by up to 20 per cent in 2007. Jobs in financial services are also likely to suffer, with slowing headcount additions and even with a net loss of jobs.

However, with slowing business activity and reduced consumer demand from those working in financial services, the impact will be felt by every sector of the economy. There are few that will not be affected by the current financial crisis; jobs will be lost in all sectors. Those businesses which are not able to grow will not be able to increase the amount they spend on suppliers.

Those thinking that the sub-prime mortgage crisis is something that only those working in finance need worry about should think twice. Get ready for higher unemployment, slower wage growth and ultimately a difficult couple of years.

 

 

 
 

 

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