The subprime crisis - what is it and why did it affect the stock market? 

What Is It?

Subprime lending is a general term that refers to the practice of making high interest loans to borrowers who do not qualify for the best interest rates because of their deficient credit history. Subprime lending is risky for both lenders and borrowers due to the potential for default

Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others. The term "subprime" refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself.

Subprime lending is highly controversial. Opponents have alleged that the subprime lending companies engage in predatory lending practices such as deliberately lending to borrowers who could never meet the terms of their loans, thus leading to default, seizure of collateral, and foreclosure. Proponents of the subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market.

In analyzing several reports concerning the credit crisis, some common themes came through:

• Many mortgages were granted with little or no down payment on the part of the borrowers.
• Initial rates on the mortgages were artificially low ("teaser rates") and borrowers didn't analyze what the impact of higher rates would be on their monthly payments.
• The "carrying costs" of a home - taxes, insurance, utilities, and repairs - were not well explained by lenders or understood by borrowers. This was particularly severe for first-time buyers.
• When rates initially declined, borrowers were not only encouraged to refinance their existing debt, but also to add in credit card debt and the purchase of new cars.

Despite being stretched to make their regular mortgage payments, many borrowers ran up tens of thousands of dollars of credit card debt; some hoping that appreciation of their homes would enable them to borrow even more.

I personally believe the bottom line for the cause of the crisis that occurred is greed and abuse of the long-standing credit guidelines, on the part of the lender and borrower, and failure to follow the intent of Psalm 37:21, "The wicked borrow and do not repay."

Why Did It Affect The Stock Market?

The stock market always moves according to perception of reality, rather than reality itself.  Investors have long been aware of the pull-back of the housing market and the increasing consumer debt levels.  When a few of the subprime lenders began experiencing higher than normal defaults, and when some went belly up, investors panicked. 

To put this all into perspective, the subprime mortgage market makes up less than 20% of all mortgage loans and the number of people who analysts estimate will default on their subprime loans is about 10%.  That is only 2% of the overall mortgage loan market.

A substantial amount of the selling activity on the market has been by hedge funds who also fell into the trap of what they thought was easy money.  They also borrowed heavily to leverage returns.  Many hedge funds financed subprime lenders.  Investors in these hedge funds were also promised easy money making them one of the fastest growing type of investments.

Many of us are familiar with the passage, "The love of money is the root of all evil", but many are not familiar with the words that precede it.  In I Timothy 6:9 just preceding the love of money passage we read, "But those who desire to be rich fall into temptation, into a snare, into many senseless and harmful desires that plunge people into ruin and destruction. "

That is exactly what happened.

Believe it or not, this purging of those who would abuse the intent of Psalm 37:11 and I Timothy 6:9 is healthy for our economy and the lending industry.

Once again we see that ignoring basic Biblical principles will cause ruin and destruction.  God wants the best for his children and has given us guidelines through His word to live by. 

We encourage you to consider using Biblically Responsible Investing principles when making investment decisions.  We at Christian Financial Principles are here to help you to do so.