April 2008 Report - Central Bank of Trinidad and Tobago

CENTRAL BANK OF TRINIDAD AND TOBAGO MONETARY POLICY REPORT APRIL 2008
Part V - Feature Article
The US Sub-Prime Mortgage Crisis:
Impact on Trinidad and Tobago
A. Origins of the Sub-prime Crisis
The phrase “subprime” refers to the practice of granting loans to borrowers who would
not normally qualify based on criteria such as income levels, credit history or employment
status. Encouraged by easier lending terms, many borrowers took out mortgages hoping to
be able to refinance at more favourable terms at a later date. However, as housing prices
started to fall in many parts of the US, refinancing became more difficult. Moreover, as
rates on adjustable mortgages were reset at higher levels, there was a dramatic increase
in defaults and foreclosure activity. During 2007, nearly 1.3 million US housing properties
were subject to foreclosure activity, up 79 per cent from in 2006.
As borrowers defaulted, the mortgage lenders who retained the credit risk on their
books were the first to feel the effects. Additionally, since many of the rights to mortgage
payments and the related credit risks on subprime loans were securitized and passed
on to third-party vendors via mortgage-backed securities (MBS) and collateralized debt
obligations (CDO), investors holding MBS or CDOs also began to face significant losses, as
the value of the underlying mortgage assets declined. The International Monetary Fund
has estimated mortgage market losses in the vicinity of US$565 billion and total losses
(including securities tied to commercial real estate and loans to consumers and companies)
at US$945 billion.
With the deepening of the crisis, interbank lending was seriously curtailed as banks became
concerned about the strength of each others’ balance sheets. The resulting credit crunch
prompted major central banks to introduce various measures to enhance liquidity and
re-invigorate financial markets.
The financial crisis along with the impact of reversal of the housing boom has precipitated
a sharp slowdown in US economic growth, raising concerns about the onset of a recession.
While the transmission of the US slowdown to the global economy has been contained thus
far, some analysts believe that emerging and developing economies, have not decoupled
sufficiently to avoid being affected. Indeed, global expansion has lost some momentum
with global growth now expected to slow to 3.7 per cent in 2008, about 1.25 percentage
points lower than in 2007.
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