This whole downward spiral seemed to start with U.S. subprime mortgages. What exactly are they?Subprime mortgages are home loans made to people who would not, under normal circumstances, be ideal candidates to get a mortgage – thus they are “subprime.” These are individuals who have a higher risk of defaulting on their loan, such as those who have been delinquent in making payments in the past, or people with a bankruptcy on their credit record, or those who simply don’t have a credit history.
Starting around 2005, U.S. lenders loosened their rules and began granting mortgages to borrowers who provided very little evidence of their income and ability to repay. Many of these mortgages had very low initial interest rates, for the first six months to three years, but when that period ended the payments jumped sharply. Borrowers were led to believe that they would be able to refinance their homes at this point because the value of the property would have increased. But the slump in the housing market meant that didn’t happen. As a result many people – especially those who had not been completely frank about their income levels – defaulted on their mortgages and lost their homes.What is the “money market,” and why does it matter if it freezes?The money market is made up short-term loans (generally of less than one year), such as certificates of deposit, commercial paper, banker’s acceptances, and 30-day treasury bills.
If the money market freezes up – in other words, no one wants to make short-term loans because they are worried about borrowers defaulting – companies cannot get the cash they need to pay staff, buy supplies, or pay rent. Often companies need to borrow this money because they are waiting for revenue that may not arrive for a few days or weeks.