Big swings, big losses

We know it’s August—the month for vacations and a much-needed brain break. But the market meltdown is too tough to ignore. Briefly, here’s what’s happening…

Since hitting an all-time record high in July, the Dow Jones Industrial Average Index lost over 1,100 points and gave up most of its gains for the year. Wild point swings up and down just minutes before the close added to the drama of the declines.

Blame it on “subprime”
Much of the turmoil has stemmed from fears of losses in the home-loan market, or more specifically, the subprime mortgage market. Subprime refers to a group or “class” of borrowers with bad credit histories, which makes them risky loan candidates because they may not be able to repay the loan on time.

Over the last several years, when the housing market was booming, loaning to this group became very popular. Many bought homes without having to put any money down or with adjustable rate mortgages, meaning the cost of borrowing money would eventually “adjust” or "reset"—in most cases, upward.

Why are bad loans impacting the market?
Interest rates are rising and mortgage payments are “resetting” upward. Many of the folks who took out loans are having trouble making the higher payments. Thus, the banks or lending firms likely aren’t being repaid.

To make matters worse, companies that make loans don’t wait to be paid back. They combine thousands of loans they’ve made together into one security and sell that (think of it loosely like a bond) to another company, which assumes the risk of the loan. The companies that bought those securities now are the ones who won’t be repaid, meaning they are holding a losing asset. And that’s what has Wall Street unnerved.

Big picture
On Friday the Federal Reserve cut interest rates, hoping to alleviate some pressure on the markets, and the Dow jumped 300 points in the first few minutes of trade. But the subprime issue is likely to linger for some time as more loans default. Some in Congress are calling for better regulation of mortgage lending practices, though President Bush has said he doesn’t see a need for it. Stay tuned, this wild ride may not be over.