SUB PRIME
EFFORTS BY AKANSHA NAGPAL (B-10) DAVNEET KAUR (C-10) SHONIMA RATHEESH (B-38)
SUB-PRIME LOAN
The term
is defined as:
From the lender's perspective, a sub-prime mortgage loan is a residential loan directed to borrowers who are less likely to repay a loan because of lack or insufficient credit history (below 600). Therefore, the lenders can charge higher upfront and continuing costs than conventional or prime mortgage.
There are several different types of sub-prime mortgages, but the most common is the adjustable rate mortgage (ARM).
1) Banks predicted that the value of the property will be appreciated. 2) In case the borrowers cant continue the payment, then BANKS can sell the houses with higher value due to the property appreciation. 3) To further reduce the risks and to get more loans, the banks repackage all mortgages into an investment product and sell it to financial institutions.
Everybody wins!
Everybody wins now becomes everybody loses!
When the house prices began to fall, the sub-prime borrowers suffered. Not only theyre not able to pay their existing debt, they are stuck having to pay a much larger mortgage payment The financial institutions lost their money that they invested because the borrower are not able to pay the loan payment. The banks also suffered because borrowers failed to make payment.
As a result, the banks increase the mortgage interest rate to cover loses.
BIGGEST CULPRIT: THE LENDERS
Most of the blame should be pointed at the mortgage originators (lenders).
They lent funds to people with poor credit and a high risk of default.
Central banks flooded the markets with capital liquidity LOWERED INTEREST RATES + DEPRESSED RISK PREMIUMS.
PARTNER IN CRIME: HOMEBUYERS
Many were playing an extremely risky game by buying houses they could barely afford. They were able to make these purchases with non-traditional mortgages (such as interest-only mortgages) that offered low introductory rates and minimal initial costs such as "no down payment". Also allowed to refinance at lower rates and take the equity out of the home for use in other spending.
INVESTMENT BANKS WORSEN THE SITUATION
The increased use of the secondary mortgage market by lenders added to the number of subprime loans lenders could originate. Instead of holding the originated mortgages on their books, they were able to simply sell off the mortgages in the secondary market. The snowball began to build momentum. A lot of the demand for these mortgages came from the creation of assets that pooled mortgages together into a security, such as a collateralized debt obligation (CDO).
RATING AGENCIES: POSSIBLE CONFLICT OF INTEREST
The rating agencies should have foreseen the high default rates for subprime borrowers. They should have given these CDOs much lower ratings than the 'AAA' rating given to the higher quality tranches.
FUEL TO FIRE: INVESTOR BEHAVIOUR
One should put blame on those who invested in CDOs. Investors were the ones willing to purchase these CDOs at ridiculously low premiums over Treasury bonds. These enticingly low rates are what ultimately led to such huge demand for subprime loans
FINAL CULPRITS: HEDGE FUNDS
Another party that added to the mess was the hedge fund industry.
It aggravated the problem not only by pushing rates lower, but also by fueling the market volatility that caused investor losses. The failures of a few investment managers also contributed to the problem.
SUB-PRIME FALLOUTS
The burst of housing bubble which had increased/peaked in 2005-06. The credit quality of borrowers declined. Therefore it had become very easy to gain loans The mortgage application process was lax and there were very few checks on income. People could not handle the higher monthly payments that were due when the starter interest rate period ended. That is ARMs. People thought good times would last forever and house prices will continue to grow Expectations that refinancing will be available Interest rates began to rise and housing property began to drop drastically in 2006-07 in many parts of US
EFFECTS of crisis
Stock market had dropped very low. Many financial institutions went bankrupt Housing prices went down, sales of new houses also dropped and many families were evicted from their homes Economic condition went very poor and later became a cause of recession in world economy Has lead to near loss of confidence in US market It also lead to loss of demand of Indian exports Investment banks and other financial banks went on a job splashing spree to cut costs
When you're in a pit, the first thing to do is to stop digging.
Thank You