Some Economic Terms Explained – Particularly Useful In Light Of Current Events (Sub-Prime Mortgage Crisis/Credit Crisis/Housing Values Crisis/Foreclosures)

I’m throwing out some definitions relating to terminology you may have heard used in news stories, etc. during these tumultuous economic times.

I’m starting out with just one term – Commercial Paper – but I will add more as I hear a trend in any given obscure term’s usage.

Commercial Paper: Short-term funding that many companies rely upon to pay their workers and buy supplies.  Periods typically range from overnight to less than a week.  In more normal times, about $100 billion of these short-term IOUs were outstanding at any given time, sold by companies to buyers(investors) that included money market mutual funds, pension funds and other investors. But this market (part of the broader "credit" market) has virtually dried up as investors have become too jittery to buy Commercial Paper for longer than overnight or a couple of days.

10/10/2008: I have found another term worthy of explanation.  Recently, the federal government has asked for a three-week ban on "short selling" of some stocks.  These stocks included those of U.S. automakers like GM and Ford.

Short Selling: Short selling involves
borrowing a company’s shares, selling them, and then buying them back
when the stock falls and returning them to the lender. The practice
allows investors to profit from the decline in a stock’s value (assuming such a decline occurs).

11/11/2008: More terms relating to our current Financial Tumult

Sub-Prime Lending: Contrary to some beliefs, the "Prime" in Sub-Prime Lending is NOT a direct reference to the Prime Lending Rate (at least not since the 1990s) . Rather, it is more geared towards the reliability of the borrower in question – either a prime lending candidate or a sub-prime lending candidate (a.k.a near-prime, non-prime, or second chance lending candidate).  Sub-Prime borrowers have a heightened perceived risk of default, such as those who have a history of loan delinquency or default, those with a recorded bankruptcy, or those with limited debt experience. Generally speaking, these borrowers will have a FICO score at or below the mid-600s.  While Sub-Prime mortgages consume current discussions, Sub-Prime lending may also be in the form of  auto loans, credit cards and other varieties of debt.

Mortgage-Backed Securities (MBS):  A Mortgage-Backed Security is an asset-backed security whose cash flows are backed by the principal and interest payments of a set of mortgage loans. Payments are typically made monthly over the lifetime of the underlying loans.  They can be further grouped into Residential Mortgage-Backed Securities (RMBS) from such items as single family home mortgages and Commercial Mortgage Backed Securities (CMBS) from such items as apartment buildings, retail or office properties, hotels, schools, industrial properties and other commercial sites.

Housing Bubble: Housing bubbles may occur in local or global real estate markets. They are typically characterized, in their late stages, by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that can result in many owners holding negative equity—a mortgage debt higher than the value of the property. The underlying causes of the housing bubble are complex; factors include historically-low interest rates, lax lending standards, and a speculative fever.

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