the subprime mortgage crisis 1

The Subprime The Subprime Mortgage Mortgage

CrisisCrisis

Devendra NikaleDevendra Nikale

Role No. 1Role No. 1

Batch 20Batch 20

ITM EEC, KhargharITM EEC, Kharghar

What are subprime What are subprime mortgages?mortgages? Typically, those who qualify for the most ideal Typically, those who qualify for the most ideal

mortgages with the best interest rates are mortgages with the best interest rates are those with good credit scores and minimal debt. those with good credit scores and minimal debt.

A subprime mortgage is a type of loan granted A subprime mortgage is a type of loan granted to individuals with poor credit histories to individuals with poor credit histories (typically below 600), who would not be able to (typically below 600), who would not be able to qualify for conventional mortgages. qualify for conventional mortgages.

Subprime mortgages charge interest rates that Subprime mortgages charge interest rates that are above the typical interest rate because of are above the typical interest rate because of the risk that is involved on the part of the the risk that is involved on the part of the lender. lender.

What are subprime What are subprime mortgages?mortgages? There are several different types of There are several different types of

subprime mortgages, but the most subprime mortgages, but the most common is the adjustable rate mortgage common is the adjustable rate mortgage (ARM). (ARM).

ARMs can be misleading to subprime ARMs can be misleading to subprime borrowers because they initially pay a borrowers because they initially pay a lower interest rate. After the given lower interest rate. After the given period of time, their mortgages are set to period of time, their mortgages are set to a much higher rate. Therefore, their a much higher rate. Therefore, their mortgage payments increase mortgage payments increase dramatically. dramatically.

How did the housing bubble How did the housing bubble develop?develop?

The housing bubble grew alongside the stock bubble in the mid The housing bubble grew alongside the stock bubble in the mid 1990s. The stock bubble increased the wealth of people, which led 1990s. The stock bubble increased the wealth of people, which led them to spend money on consumption including bigger and better them to spend money on consumption including bigger and better houses. houses.

The increased demand led house prices to rise. People lost faith in The increased demand led house prices to rise. People lost faith in the stock market and thought investing in a home would be a the stock market and thought investing in a home would be a much safer alternative. much safer alternative.

Also going on at this time was the slow recovery from the 2001 Also going on at this time was the slow recovery from the 2001 recession. This led the Federal Reserve Board to cut interest rates recession. This led the Federal Reserve Board to cut interest rates in an effort to stimulate the economy. Fixed-rate mortgages, as in an effort to stimulate the economy. Fixed-rate mortgages, as well as other interest rates hit 50 year lows. This was a huge well as other interest rates hit 50 year lows. This was a huge incentive to buy a home.incentive to buy a home.

Between 1997 and 2006, the price of the typical American house Between 1997 and 2006, the price of the typical American house increased by 124%increased by 124%

Amount of Subprime Mortgages allotted on time scaleAmount of Subprime Mortgages allotted on time scale

The Subprime Mortgage Crisis The Subprime Mortgage Crisis Explained:Explained:

Up until 2006, the housing market in the United Up until 2006, the housing market in the United States was flourishing due to the fact that it States was flourishing due to the fact that it was so easy to get a home loan. was so easy to get a home loan.

Individuals were taking on subprime mortgages, Individuals were taking on subprime mortgages, with the expectations that the price of their with the expectations that the price of their home would continue to rise and that they home would continue to rise and that they would be able to refinance their home before would be able to refinance their home before the higher interest rates were to go into effect. the higher interest rates were to go into effect. 2005 was the peak of the subprime boom. At 2005 was the peak of the subprime boom. At this time, 1 in 5 mortgages was subprime. this time, 1 in 5 mortgages was subprime.

However, the housing bubble burst and housing However, the housing bubble burst and housing prices had reached their peak. They were now prices had reached their peak. They were now on a decline. on a decline.

At this point, many who had taken on these At this point, many who had taken on these subprime mortgages and their interest rates subprime mortgages and their interest rates were beginning to “reset” to the higher were beginning to “reset” to the higher rates, making their monthly mortgage rates, making their monthly mortgage payments much higher than before. payments much higher than before.

People then began to sell their homes – but People then began to sell their homes – but there was a problem to doing this. Since the there was a problem to doing this. Since the price of homes had severely decreased, they price of homes had severely decreased, they did not have enough money after selling to did not have enough money after selling to cover the amount of the mortgage.cover the amount of the mortgage.


If a person could not sell their home, this If a person could not sell their home, this ultimately left the homeowner with one ultimately left the homeowner with one option, and that was to DEFAULT. option, and that was to DEFAULT.

When a home is defaulted, this is the first When a home is defaulted, this is the first step towards foreclosure. step towards foreclosure.

After the notice of default, there is a After the notice of default, there is a reinstatement period before the home is reinstatement period before the home is put up for auction by the bank. put up for auction by the bank.

If the defaulted loan isn’t taken care of in If the defaulted loan isn’t taken care of in a given amount of time, the bank a given amount of time, the bank resumes responsibility of the home and is resumes responsibility of the home and is put up for auction. put up for auction.

The Subprime Mortgage Crisis The Subprime Mortgage Crisis Explained: Explained:

However, when put in an auction, the bank usually sells However, when put in an auction, the bank usually sells the home at a price that is much lower than what it is the home at a price that is much lower than what it is worth. The amount that they receive in this process worth. The amount that they receive in this process gets put towards the borrower’s loan, but the borrower gets put towards the borrower’s loan, but the borrower still has to account for the difference that they owe still has to account for the difference that they owe towards the loan. towards the loan.

The process of auctioning off these houses creates a The process of auctioning off these houses creates a

increase in supply of homes in the market, which will increase in supply of homes in the market, which will decrease the home prices.decrease the home prices.

U.S. Housing market: 3 million foreclosures (2008)U.S. Housing market: 3 million foreclosures (2008)

U.S. Banking sector: $1-$2 trillion net cost of bailoutU.S. Banking sector: $1-$2 trillion net cost of bailout

World stock markets: Almost 50% loss in the total World stock markets: Almost 50% loss in the total capitalization in 2008--$30 trillion of wealth capitalization in 2008--$30 trillion of wealth disappeareddisappeared

The Subprime Mortgage Crisis The Subprime Mortgage Crisis Explained: Explained:

Financial Institutions – Write-DownsFinancial Institutions – Write-Downs– Citigroup (USA) - $24.1 bln Citigroup (USA) - $24.1 bln – Merrill Lynch (USA) - $22.5 bln Merrill Lynch (USA) - $22.5 bln – UBS AG (Switzerland) - $16.7 bln UBS AG (Switzerland) - $16.7 bln – Morgan Stanley (USA) - $10.3Morgan Stanley (USA) - $10.3– Credit Agricole (France) - $4.8 bln Credit Agricole (France) - $4.8 bln – HSBC (United Kingdom) - $3.4 bln HSBC (United Kingdom) - $3.4 bln – Bank of America (USA) - $5.28 bln Bank of America (USA) - $5.28 bln – CIBC (Canada) – 3.2 bln CIBC (Canada) – 3.2 bln – Deutsche Bank (Germany) - $3.1 bln Deutsche Bank (Germany) - $3.1 bln


Responses to the CrisisResponses to the Crisis US: Bailout Package – around $800 bnUS: Bailout Package – around $800 bn

Emergency Economic Stabilization Act of 2008 and the Emergency Economic Stabilization Act of 2008 and the Homeowners Affordability and Stability Plan.Homeowners Affordability and Stability Plan.

Former President Bill Clinton and former Federal Former President Bill Clinton and former Federal Reserve Chairman Alan Greenspan indicated they did Reserve Chairman Alan Greenspan indicated they did not properly regulate derivatives, including credit not properly regulate derivatives, including credit default swaps. A bill called the Derivatives Markets default swaps. A bill called the Derivatives Markets Transparency and Accountability Act of 2009 has been Transparency and Accountability Act of 2009 has been proposed to further regulate the CDS market. This bill proposed to further regulate the CDS market. This bill provided the authority to suspend CDS trading under provided the authority to suspend CDS trading under certain conditions.certain conditions.

Issues To RethinkIssues To Rethink Five main topics are important to consider when discussing solutions to Five main topics are important to consider when discussing solutions to

the crises: liquidity, solvency, economic stimulus, homeowner assistance, the crises: liquidity, solvency, economic stimulus, homeowner assistance, and regulation. and regulation.

Liquidity: Central banks have expanded their lending and money supplies, Liquidity: Central banks have expanded their lending and money supplies, to offset the decline in lending by private institutions and investors. to offset the decline in lending by private institutions and investors.

Solvency: Some financial institutions are facing risks regarding their Solvency: Some financial institutions are facing risks regarding their solvency, or ability to pay their obligations. Alternatives involve solvency, or ability to pay their obligations. Alternatives involve restructuring through bankruptcy, bondholder haircuts, or government restructuring through bankruptcy, bondholder haircuts, or government bailouts bailouts

Economic stimulus: Governments have increased spending or cut taxes to Economic stimulus: Governments have increased spending or cut taxes to offset declines in consumer spending and business investment. offset declines in consumer spending and business investment.

Homeowner assistance: Banks are adjusting the terms of mortgage loans Homeowner assistance: Banks are adjusting the terms of mortgage loans to avoid foreclosure, with the goal of maximizing cash payments. to avoid foreclosure, with the goal of maximizing cash payments. Governments are offering financial incentives for lenders to assist Governments are offering financial incentives for lenders to assist borrowers. borrowers.

Regulation: rules designed help stabilize the financial system (such as Regulation: rules designed help stabilize the financial system (such as regulating derivatives)regulating derivatives)

Sources:Sources:

www.google.comwww.google.com wikipediawikipedia

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the subprime mortgage crisis 1

Economy & Finance