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Subprime Crisis Triggers Spillover Effect

Posted November. 29, 2007 03:10,   


The growing ramifications of the U.S. subprime mortgage meltdown are threatening to derail the world economy. Spillover effects can impact the broader economy as a credit crunch triggered by the U.S. subprime meltdown is forcing financial institutions to reduce the amount of loans offered to individuals and companies; which, in turn, will lead to shrinking investment and consumption, and slowing of economic growth, according to a number of experts.

“When the subprime mortgage crisis hit the U.S. in September, 2007, the fallout was limited to the U.S. However, now it is likely to spread to other countries around the world, depressing the world economy as well as American economy,” warned former U.S. Treasury Secretary Lawrence Summers in Monday`s Financial Times. The International Monetary Fund (IMF) also forecast that next year’s growth rates in the U.S., the EU, and Japan will be lower that this year’s.

“The U.S. hasn’t faced a downturn like this since the Great Depression of the 1930s. The slump in the housing market and increases in household debt will have negative effects on consumption and future lending attitudes, which could bring us close to the zero line in terms of economic growth,” the Financial Times quoted Bill Gross, chief investment officer of Pimco, the world`s largest bond fund, as saying.

In a recent report, Goldman Sachs chimed in with Gross’ opinion and forecast: “Financial losses incurred by the subprime mortgage turmoil could reach $400 billion. That may force financial institutions to cut lending and if the reduction in lending continues for more than one year, the U.S. economy could fall into recession.”

MarketWatch, one of the world’s leading market research firms, pointed out that a series of woes that are plaguing the world economy, such as the weakening dollar, soaring oil prices, increasing tensions in the Middle East, increases in U.S. housing prices, and the credit crunch, are reminiscent of events which occurred in the run-up to the Great Depression.”

With risks spreading to financial circles, inter-bank-offered rates are also skyrocketing, accelerating the credit crunch. All this causes financial institutions, including banks, to become bent on preventing losses while refraining from investment.

The changing global financial environment is one of the factors that trigger capital outflow from Korea and leaves local companies and banks having difficulty borrowing money from overseas.

As short-term liquidity dries up further, both the European Central Bank and the U.S. Federal Reserve has recently announced huge injections of liquidity into the financial markets. However, there is a warning against liquidity injections. Inflation in Germany reached a 13-year high in the third quarter of this year after the country ramped up liquidity provisions.