Mortgage Crisis of the Markets 

Hardly a day passes without coming upon news related with problems that were caused by the crisis which broke out in the subprime mortgage markets first and spread into financial markets as well. Bankruptcy cries from funds, sharp falls in many national stock markets which are in parallel with the U.S. stock markets,  large scale losses by many banks among which also are some of the world’s largest banks, resignations of executives, lay offs… Reactions of markets to the crisis-related negative news which came one after another were also of wide scale since they could not remain indifferent. The exact size of the resulting losses cannot be known for sure at the moment, but guesses are not so encouraging! 

Mortgage system is a housing credit system which has been adopted for many years in the U.S. and which enables people to own a house on terms extending up to 20-30 years. In this system credits borrowed from credit institutions by those wanting to buy a house are repaid either on fixed-interest rates or variable rates. Those planning to borrow credit are rated on the basis of their credit record. According to this, those having a bad credit record (whose rating is not A) have to pay higher interest rates as compared to those having a good credit record (whose rating is A). In other words, in the subprime mortgage market even those who cannot meet the requirements for getting a credit are granted credit. Credit record of these persons may not be suitable for getting housing loans. Moreover, it is not required that these persons should have sufficient income in order to repay the credit and the interest on it. A substantial risk is taken by including these persons into the system in exchange for high interest. The U.S. mortgage market is considered to be the largest in the world with its volume of 10 trillion dollars.

 The size of the subprime mortgage market in the U.S. is around 1.4 trillion dollars. That is to say, the entire subprime mortgage sector makes up around 15% of the overall mortgage market. The rate of problematic subprime mortgages is around 20%. When measured against the size of the overall mortgage market, this rate corresponds to 2.8%. However, spread of the crisis, which is not limited to housing market, also into financial markets enlarges the size of the damage and makes the situation all the more dangerous. 

Its Effects on Financial Markets

 Mortgage market is not a type of market that is dependent only on the relation between the institution lending the credit and those borrowing it. Banks may turn the credits they lent into investment instruments through securitization. For example; mortgage backed securities (MBS) and collateralized debt obligations (CDOs) are among these investment instruments. Credit institutions have found an opportunity to derive new earnings through these investment instruments which are of a complicated structure. These securities, which are formed through combining and repacking such risky or less risky debts as credit card loans and auto loans, have become a new alternative for investors who want to obtain higher profits. Funds that carry out high leveraged transactions like hedge funds have shown a great interest in this kind of credit products with the expectation of getting high profits. However, effects of the crisis which started in subprime mortgage market have been felt also in this field.

With the resulting problems, confidence of investors in the derivative products based on this kind of credits subsided. Besides, criticisms have begun to increase claiming that ratings given to CDOs by credit rating agencies were high. Credit rating agencies S&P and Moody’s have lowered the rating of more than 17 billion dollars’ worth of bonds. With the increase in the number of investors who want to draw their money from funds, it has become difficult to turn these products into cash. Prices of these investment instruments have fallen down considerably and funds amounting up to billions of dollars have become almost worthless. Companies could not find money in order to make payments to investors wanting their money back and even for rolling funds. In the end, funds were frozen and companies that had invested in those funds have either incurred great losses or came close to bankruptcy. Banks which lent credits to the companies that pledged these products as collateral have found themselves in a difficult position. Since it was not known exactly which company has incurred how much loss, banks have begun to avoid even lending to each other in the wake of the crisis. Liquidity in the markets has dried up and as a result the crisis which had started in the subprime mortgage market has become a liquidity crisis. 

What Kind of Measures Were Taken?

Central banks could not remain indifferent to this turbulence which affected almost all the leading markets in the world. European, Japanese and American central banks, which wanted to reduce the effects of shocks after the crisis, injected nearly 350 billion dollars of liquidity into the markets in August 9. After reducing the discount interest rates from 6.25% to 5.75% FED announced it would lend unlimited credit to banks that are in need. These measures have helped markets to feel relieved even if for a short time. With the expectation of an interest rate cut in the markets, FED reduced the benchmark interest rate firstly from 5.25% to 4.75% and then to 4.50% with an additional 0.25% cut. The Federal Reserve Bank further reduced the benchmark interest rate in December 11 by a quarter from 4.50% to 4.25%. Lastly, U.S. President George W. Bush announced the interest rates to be applied on debtors who can not repay their mortgage credit installments were frozen for five years. On the other hand, The Bank of England reduced the interest rate by a quarter to 5.5% on the grounds of a slowdown in growth and the credit squeeze.  But worries in the markets over the crisis still go on despite the interventions. Negative news which came one after another upset financial markets.

Real-estate industry is one of the keystones of the U.S. economy. So, the thought that a negative course in that sector may bring recession to the U.S. economy causes markets to get worried. In such a situation, it is inevitable to face huge problems for developing countries like China a great part of whose exports is to the U.S. In short, it is not baseless to have worries that the crisis in the U.S. mortgage market may carry the U.S. economy into recession and cause recession in the global economy. Because of this; various indicators for the U.S. economy like growth figures and unemployment data are closely watched. Negative signals from these indicators or bad news about the mortgage market are enough to upset markets. Growing risks divert investors from risky investment instruments and direct them to such havens as U.S. treasury bonds. Sudden selling waves may be faced. As the Japanese yen appreciates against the dollar, investors who close their carry trade positions leave the developing markets quickly. Sharp falls in stock markets are accompanied by depreciations of national currencies, but dollar appreciates as a result of increasing demand since it is still seen as a safe harbor.   

Banks’ Losses Are Huge

As financial markets lick their wounds, a new wave of turbulence was brought about when banks began to gradually report losses on their balance sheets which had been caused by the mortgage crisis. Since banks lent to hedge funds and to institutions which are in danger of bankruptcy, they also got worried over the problems of these institutions. Again, losses became inevitable since funds formed by many banks have also invested in mortgage backed financial products. Many leading banks of the world such as; UBS, HSBC, Deutsche Bank and Credit Suisse have started to report in succession the losses they incurred due to the mortgage crisis. Lastly, UBS which is considered as the largest bank of Europe has announced it incurred a further loss of 10 billion dollars. Thus, mortgage losses of UBS which it said was 3.5 billion dollars in early October reached 13.5 billion dollars. While the cost reduction program envisaged by UBS due to “mortgage losses” necessitated the dismissal of 1.500 employees, CEO Marcel Rohmer also lost his job. The bill of the resulting huge losses had to be paid by top executives and employees at UBS just like in many other banks. 

The Effects of the Crisis on Turkey

Unlike the countries mentioned above, there is not a developed mortgage market in Turkey. Although the housing finance system called mortgage has been applied for years in many countries, the related law in Turkey was passed in February 2007. Since subprime mortgage markets where the mortgage crisis in the U.S. started do not exist in Turkey, we can not talk about the spread of an effect into the real estate market in our country. However, it would be wrong to claim that this crisis which originated in the U.S. did not have impact on Turkey in a general sense. Turkey was among the countries where the anxiety that emerged in financial markets was felt most strongly. Losses at the stock markets abroad brought sharp falls also at Istanbul Stock Exchange (ISE). With the increasing demand of foreign investors for dollar, there occurred great losses in Turkish Lira just like in the currencies of other developing countries. Since investors who closed carry trade positions began to leave developing countries, danger for Turkey which faces a high current account deficit has grown bigger.

But despite that, expectations for Turkey are positive with respect to the real estate market. Henry Alster, Chairman of the Global Real Estate Institute (GRI) which brings together real estate investors worldwide, stated that due to the mortgage crisis in markets investments shifted to Turkey and Russia and if prices do not raise quickly Turkey will attract two times more foreign direct investment in 2008 as compared to 2007. When the anatomy of the latest mortgage crisis is analyzed together with those of previous crises, the dictum that “capitalism does not accept intervention” emerges. This is not the first upheaval that global economy has experienced… Capitalism has faced such crises of different size along its history. Natural selection which came to be formed during these crises has caused bankruptcy in firms that did high-risk business and could not operate productively, while it further enlarged successful firms. Indeed, one of the main reasons and perhaps the most important one for the survival of the system to date is that mechanism. Interventions for putting back such upheavals have brought nothing other than the exacerbation of crises. Trying to make markets happier by injecting more than needed money into the system with the purpose of preventing the latest disturbances in the U.S. economy, can be compared to those medicines which provide a temporary relief to patients. Dragging the global economy into a liquidity trap may create bigger dangers than envisaged. While it puts market players, who have a temporary happiness today, into great trouble it can also turn into a risk with the capacity to have a deep impact on real economies