SUBPRIME CRISIS AND IT’S EFFECT ON INDIA

Aman Gupta, Ruchi Saini, Shobhit Goel

ABSTRACT

The subprime lending crisis in the real estate sector within the United States where in borrowers

with a low or subprime credit rating were given loans to invest in the booming real estate sector in

2004-05 has led not solely to a big slowdown of the US economy but its impact was conjointly

felt over the foremost nations of the globe.

In this project it has been tried in the best means attainable to research the various ways in which

the subprime lending muddle truly started.

It has also been tried to analyze the way the United States banking and lending agencies

camouflaged their subprime loans into enticing ones and how backed by some credit rating

agencies were able to sell them off to different banks and investors by dividing them into

collateralized debt obligations (CDOs).

This project also tries to present a comprehensive image of the losses that the US banking sector

incurred and not simply that but how the complete subprime muddle settled and questioned the

banking practices in the world.

In the end it has been tried to take an Indian view of the whole subprime fiasco and the way India

was affected by it, though fortunately not in a massive way.

 INTRODUCTION

Economy of United States

The economy of the United States has been Earth's largest since the early 1870s by nominal GDP

and the second largest by purchasing power parity. It is a highly developed mixed economy and

private firms make the majority of microeconomic decisions, while being regulated by the

government. The U.S. economy is characterized by a high level of productivity (although not the

world’s highest), high overall GDP growth rate, a low unemployment rate, and high levels of

research and capital investment.

Subprime Lending

A subprime loan is a type of loan offered at a rate above market rate to individuals who don’t

qualify for prime rate loans. Very often subprime borrowers have been turned down by traditional

lenders attributable to their low credit ratings or alternative factors that recommend they need an

affordable probability of defaulting on the debt reimbursement. Since, these borrowers have been

turned owing to their low credit ratings, they are often charged higher interest rate due to enlarge

risk of default. These loans are generally characterized by higher interest rates and less favorable

terms to atone for the upper degree of risk.

Subprime lending encompasses a variety of credit instruments, including subprime mortgages,

subprime car loans, and subprime credit cards, etc. The term "subprime" refers to the credit status

of the recipient (being less than ideal), not the interest rate on the loan itself.
Subprime Lenders

A subprime lender focuses on disposition to borrowers with weak or restricted credit history. A

smaller range of enormous lenders concentrate on subprime lending compared to lenders that

concentrate on prime rate loans.

Subprime lenders provide loan to borrowers who are turned down by traditional lenders either due

to their lower credit score, or any other factor that counsel and affordable likelihood of their

defaulting on repayment. Since the amount of risk undertaken by these lenders is way higher than

traditional lenders, they sometimes charge a higher rate of interest. Subprime lenders generally

apply risk-based pricing systems to calculate the terms of the loans and interest rates they charge

to borrowers with variable credit histories. Risk-based pricing appearance at factors like a

consumer’s credit score, adverse credit history, employment status, and income.

Subprime Borrowers

A subprime borrower is a personal with a less-than-perfect credit rating. Subprime borrowers are

charged a slightly higher interest rate on loans; as a result, they’re viewed as having a greater risk

of defaulting. Borrowers may use this credit to purchase homes, or finance different kinds of

payments such as purchasing a car or refurbishing a building. A subprime borrower may not

perpetually stay in its subprime category as this disposal conjointly give a technique for ‘credit

repair’, if borrowers maintain an honest payment record, they ought to be ready to refinance back

onto mainstream rates after a period. Typical traits of subprime borrowers include:

● Two or additional 30-day default within the last twelve months or one 60-day default

within the past twenty-four months.

 ● A foreclosure in the last twenty-four months.

● A bankruptcy within the last sixty months.

● Debt-to-income ratio of fifty percent or a lot of.

Subprime Mortgages

A subprime mortgage is one that's normally issued to borrowers with low credit ratings. A prime

conventional mortgage isn't offered because the lender views the borrower as having a greater-

than-average risk of defaulting on the loan. Subprime mortgages are considered more risky loans

since borrowers with weakened credit histories that include payment defaults and severe problems

such as charge-off, judgments and bankruptcy are provided loan. Subprime borrowers are those

who have FICO (formerly the Fair Isaac Corporation) scores below 620 on a scale that ranges from

300 to 850.

Sometimes to avoid higher mortgage payments, most borrowers take adjustable-rate mortgages

that provide them lower initial interest rate. But with annual adjustments later, these ARMs end

up charging much more.

Subprime Credit Cards

A subprime credit card is a usual credit card but is issued specifically to borrowers with lower

credit scores or limited credit histories. These cards carry relatively higher rate of interest than

credit card issued to prime borrowers. Sometimes they may also come with extra fees and lower

credit limits.
Moreover, subprime credit cards can help a consumer improve poor credit scores. Consumers that

pay their bills on time may see an improvement in their credit rating by major credit reporting

agencies.
 OBJECTIVES OF THE STUDY

● To interpret “Subprime crisis of 2008”.

● To understand the risks and causes of Subprime crisis.

● To find out the causes and consequences of the Subprime crisis in USA.

● To find out the impact of Subprime crisis on India.

 LITERATURE REVIEW

About 44% of Americans owned homes in 1940, this percentage roused to around 68% in 2007.

This huge jump in ownership of houses by Americans was mainly due to a surge in subprime

mortgages. Figure below shows this rise in mortgages over the years 1994-06.

Subprime mortgages are generally provided to those borrowers who don’t qualify to get a loan

from conventional or prime sources. These are, by contrast, more risky when compared to the

prime loans because of low credit quality of the borrower.

Federal Housing Administration was created in 1936 to provide insurance to purchahsers of

mortgage loans, i.e purchaser would receive accrued payments even if the borrower defaulted.

Most mortgage bankers usually rely more on the capital markets than on direct borrowings as a

source of funds for their mortgage originations. These mortgage loans are bundled into portfolio

to sell to the investors through the issuance of new securities whose cash flows are collateralized

by the underlying loan pool. This process is also known as Securitization. The cash proceeds

received by originators through securitizations are used to finance the ongoing production of new

loans.
The credit crisis began as early as in 2005 with disruptions starting in U.S real estate market.

Although, initially this disturbance was considered independent of other markets, it started

spreading to other credit markets by 2007, which led to a system-wide banking panic. This

widespread panic and near-meltdown of financial system continued till the collapse of several

investment companies such as Lehman Brothers.

Essentially, this crisis happened due to excessive pressure on the U.S mortgage market. In a report

issued on November 30, 2005, for example, S&P stated: “The credit performance of mortgage

loans and HELOCs is expected to decline from year-to-date measures, due to several factors: rising

short-term interest rates, which are the basis for the repricing of many adjustable-rate mortgages

(ARMs) and HELOCs; more layering of risk; and weaker underwriting standards in some

mortgage products.” Despite such concerns, housing price appreciation continued for some time

to bolster the equity embedded in mortgage loans.

Rising prices of homes came to a standstill during 2006, mortgage default and foreclosures began

to rise and mortgage lenders started realizing losses. In a Special Report issued on December 11,

2006, Fitch Ratings indicated that more subprime-backed MBS were downgraded between July

and October 2006 than in any previous four-month period. Fitch further cautioned: The increase

in bond credit risk has been notable in the sub-prime sector, where serious delinquencies have

increased almost 50% and the number of downgrades has jumped in recent months. Additionally,

the sensitivity of subprime performance to the rate of and the large number of borrowers facing

scheduled payment increases in 2007 should continue to put negative pressure on the sector. Fitch

expects delinquencies to rise by at least an additional 50% from current levels throughout the next

year and for the general ratings environment to be negative, as the number of downgrades is

expected to outnumber the number of upgrades.

 SUBPRIME MORTGAGE CRISIS

The United States subprime mortgage crisis that appeared in the majority of newspapers

throughout 2007-08 has been said to have the potential to bring the US economy on the verge of a

recession. It has led to the removal of top executives of many renowned financial institutions such

as Citibank, Morgan Stanley, etc.

The United States subprime mortgage crisis was a nationwide financial crisis, set off by an

oversized decline in home prices after the collapse of the housing bubble during 2007-10 that led

to the US recession of December 2007 to June 2009. A fall in housing prices resulted in mortgage

negligence and foreclosures and therefore devaluation of housing-related securities.

The housing bubble prior to the crisis was financed with mortgage-backed securities (MBSs) and

Collateralized Debt Obligations (CDOs), which initially offered higher interest rates than

government securities, along with attractive risk ratings from rating agencies. While elements of

the crisis first became more visible during 2007, several major financial institutions collapsed in

September 2008, with significant disruption in the flow of credit to businesses and consumers, and

the onset of a severe global recession.

A subprime loan is available to potential borrowers who face severe financial problems and are

therefore labeled risky, because of factors like low-income or a poor credit history. Naturally,

owing to their poor credit history they are charged a higher than normal rate of interest. Such

individuals are referred to as subprime borrowers. Subprime lending is a general term that refers

to the practice of making loans to subprime borrowers.

Background of CRISIS

The subprime mortgage crisis was a sharp decline in the prices of homes leading to mortgage

defaults and foreclosures which started in the United States in late 2006 and became a global

financial crisis during 2007 and 2008.

The crisis was triggered after the bursting of the housing bubble in the US and high default rates

on "subprime" and other adjustable rate mortgages (ARM) made to higher-risk borrowers with

lower income or lesser credit history than "prime" borrowers. Higher loan incentives given by

lenders and a long-term trend of rising housing prices motivated borrowers to assume mortgages,

believing they would be able to refinance at more favorable terms later. However, once housing

prices started to drop moderately in 2006-2007 in many parts of the U.S., refinancing became more

difficult. The risk spread into mutual funds, pension funds, and corporations who owned these

mortgage-backed securities (MBS) .Defaults and foreclosure activity increased dramatically as

ARM interest rates reset higher.

A mortgage-backed security (MBS) is a type of asset-backed security that is secured by a mortgage

or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a

government agency or investment bank) that securitizes, or packages, the loans together into a

security that investors can buy. Similarly, a Collateralized Debt Obligation is an instrument backed

by a pool of loans, mortgages and other assets which is then sold to investors. Since the value of a

CDO depends on some other asset, it is also a type of derivative.

The housing bubble before the crisis was backed by mortgaged-backed securities (MBS) and

collateralized debt obligations (CDO), which offered a higher rate of interest to investors as

compared to the T-bills. While some elements of crisis became visible during 2007, the picture

became clearer by September 2008, when there was a significant disturbance in the flow of credit

to business and consumers.

As home prices fell, banker lost trust in each other. Due to this they couldn’t price the value of

these assets and hence were reluctant to lend to each other since they could receive mortgage

backed securities (MBS) as collateral. As banks didn’t lend to each other, the whole financial

system started to collapse.

The mortgage lenders that retained credit risk (the risk of payment default) were the first to be

affected, as borrowers became unable or unwilling to make payments. Major Banks and other

financial institutions around the world have reported losses of approximately U.S. $150 billion as

of February 2008. Due to securitization, many mortgage lenders had passed the rights to the

mortgage payments and related credit/default risk to third-party investors via mortgage-backed
securities (MBS) and collateralized debt obligations (CDO). Corporate, individual and institutional

investors holding MBS or CDO faced significant losses, because of the declining value of the

underlying mortgage assets. Stock markets in many countries declined significantly.

Lending capacity of financial institutions was severely affected due to the losses on their mortgage-

related securities, which led to overall economic slowdown. Concerns regarding the stability of

key financial institutions resulted in government bailing out some of them to encourage lending

and reinstate investor confidence in markets. Restoration of faith in markets was important at that

time since losses in stock markets and a fall in housing values had already put downward pressure

on consumer spending.

A downtrend in the housing market and following crisis in financial markets led to several

decisions around the world to cut interest rates and governments to implement economic stimulus

packages. Effects on global stock markets due to the crisis were substantial. On an average,

investors lost around 40% of their investments during this period.

 RISKS AND CAUSES INVOLVED IN THE CRISIS

Risks Involved

Due to innovations in securitization the risks related to the inability of homeowners to meet

mortgage payments have been distributed broadly, with a series of consequential impacts. The

crisis can be attributed to a number of factors, such as the inability of homeowners to make their

mortgage payments; poor judgment by either the borrower or the lender; inappropriate mortgage

incentives, and rising adjustable mortgage rates. Further, declining home prices have made

refinancing more difficult. There are three primary risk categories involved:

Credit risk: The risk of default (called credit risk) would be assumed by the bank from where the

loan is originating. However, due to more innovations and developments in securitization, credit

risk is now shared more broadly with the investors, because the rights to these mortgage payments

have been repackaged into a variety of complex investment vehicles, generally categorized as

mortgage-backed securities (MBS) or collateralized debt obligations (CDO). In exchange for

purchasing the MBS (mortgage-backed securities) and CDO (repacking of existing debt), third-

party investors receive a claim on the mortgage assets, which become collateral in case of

defaulting events.

Asset price risk: CDO (Collateralized Debt obligations) valuation is quite complex and related

"fair value" accounting for such "Level 3" assets are subject to wide interpretation. This valuation

basically derives from the collectibles of subprime mortgage payments, which is quite difficult to

predict because of lack of precedent and rising delinquency rates.

Liquidity risk: Liquidity risk involves the commercial paper market, a key source of funds for

many Corporations. Companies often obtain short-term loans by issuing commercial paper (which

is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of

accounts payable and inventories and meeting short-term liabilities) pledging mortgage assets or

CDO as collateral. However, because of concerns regarding the value of the mortgage asset

collateral linked to subprime and Alt-A loans, which basically affected the issuing ability of

Commercial paper for many corporations due to which the amount of commercial paper issued

falls by approximately 25% to $888 billion as on October 8. In addition, Investors charged higher

interest rates in providing loans against the commercial paper.

Causes

Disintegration of houses:

Subprime borrowing was a significant contributor to an increase in home ownership rates, and the

demand for housing. Between 1997 and 2006, American home prices inflated by 124%. Some

owners used the inflated property worth knowledgeable about within the housing bubble to

refinance their homes with lower interest rates, and remove second mortgages against the

supplementary worth to use the funds for consumer outlay. U.S. home debt as a proportion of

income rose to 130% during 2007, versus 100% earlier within the decade. A culture of

consumerism may be a factor. Overbuilding during the boom period, increasing proceedings rates

and unwillingness of many homeowners to sell their homes at reduced market prices have

considerably inflated the supply of housing inventory available. Sales volume (units) of new

homes dropped by 26.4% in 2007 versus the prior year. By January 2008, the inventory of unsold
new homes stood at 9.8 months based on December 2007 sales volume, the highest level since

1981. Further, a record of nearly four million unsold existing homes was offered.

This excess supply of home inventory places vital downward pressure on prices. As prices decline,

more homeowners were at the risk of default and legal proceedings. According to the S&P/Case-

Shiller housing price index, by November 2007, average U.S. housing prices had fallen

approximately 8% from their 2006 peak. However, there was significant variation in price changes

across U.S. markets, with several appreciating and others depreciating. The price decline in

December 2007 versus the year-ago period was 10.4%.

Borrowers

Easy credit, combined with the assumption that housing prices would still appreciate, conjointly

encouraged several subprime borrowers to obtain ARMs they could not afford after the initial

incentive period. Once housing prices started depreciating moderately in many parts of the U.S,
refinancing became tougher. Some homeowners were unable to refinance loans and started to

default on loans as their loans reset to higher interest rates and payment amounts. Other

homeowners, facing declines in the home market value or with limited accumulated equity, are

selecting to prevent paying their mortgage. They’re primarily "walking away" from the property

and permitting foreclosure, despite the impact to their credit rating.

Financial institutions:

A variety of factors have caused lenders to supply an increasing array of higher-risk loans to

higher-risk borrowers, the risk premium required by lenders to offer a subprime loan declined.

This occurred even if subprime borrower and loan characteristics declined overall during the 2001-

2006 period, which should have had the opposite effect. The combination is common to classic

boom and bust credit cycles. Some believe that mortgage standards became apathetic due to moral

hazard, wherever every link within the mortgage chain collected profits while believing it was

passing on risk.
Securitization:

Securitization is a structured finance process in which assets, receivables or financial instruments

are acquired, classified into pools, and offered as collateral for third-party investment. Because of

securitization, investor appetite for mortgage-backed securities (MBS), and therefore, the tendency

of rating agencies to assign investment-grade ratings to MBS, loans with a high risk of default

could be originated, packaged, and the risk promptly transferred to others. Asset securitization

began with the structured financing of mortgage pools in the 1970s. The securitized share of

subprime mortgages (i.e., those passed to third-party investors) increased from 54% in 2001, to

75% in 2006.

Mortgage Brokers:

Mortgage brokers do not lend their own money. There is not a direct correlation between loan

performance and compensation. They need massive money incentives for selling complex,
adjustable rate mortgages (ARM's), since they earn higher commissions. The chairman of the

Mortgage Bankers Association claimed brokers profited from a home loan boom however didn't

do enough to examine whether borrowers could repay.

Credit rating agencies:

A subprime loan is one that is offered at an interest rate higher than A-paper loans because of the

enhanced risk. Subprime, therefore, isn’t identical as "Alt-A” because Alt-A loans qualify for the

"A-rating" by Moody's or alternative rating corporations, albeit for an "alternative" means. Higher

ratings were theoretically due to the multiple, independent mortgages held in the MBS per the

agencies, but critics claim that conflicts of interest were in play.

Central banks:

Central banks are primarily concerned with managing the rate of inflation and avoiding recessions.

They are also the “lenders of last resort” to ensure liquidity. They are less concerned with avoiding

asset bubbles, such as the housing bubble and dotcom bubble. Central banks have usually chosen

to react after such bubbles burst to minimize collateral impact on the economy, instead of

attempting to avoid the bubble itself. This is often as a result of identifying an asset bubble and

determining the proper monetary policy to deflate it is not proven concepts. A potential

contributing factor to the increase in home prices was the lowering of interest rates earlier in the

decade by the Federal Reserve, to diminish the blow of the collapse of the dot-com bubble and

combat the risk of deflation.

 IMPACT OF SUBPRIME CRISIS ON U.S ECONOMY

The widespread dispersion of credit risk and the unclear impact on financial institutions caused

lenders to reduce lending activity or to make loans at higher interest rates. Similarly, the ability of

corporations to obtain funds through the issuance of commercial paper was impacted. This aspect

of the crisis is consistent with a credit crunch. The liquidity concerns drove central banks around

the world to take action to provide funds to member banks to encourage the lending of funds to

worthy borrowers and to re-invigorate the commercial paper markets.

The subprime crisis also places downward pressure on economic growth, because fewer or more

expensive loans decrease investment by businesses and consumer spending, which drive the

economy. A separate but related dynamic is the downturn in the housing market, where a surplus

inventory of homes has resulted in a significant decline in new home construction and housing

prices in many areas. This also places downward pressure on growth. With interest rates on a large

number of subprime and other ARM due to adjust upward during the 2008 period, U.S. legislators

and the U.S. Treasury Department are taking action. A systematic program to limit or defer interest

rate adjustments was implemented to reduce the impact. In addition, lenders and borrowers facing

defaults have been encouraged to cooperate to enable borrowers to stay in their homes. The risks

to the broader economy created by the financial market crisis and housing market downturn were

primary factors in the January 22, 2008 decision by the U.S. Federal reserve to cut interest rates

and the economic stimulus package signed by President Bush on February 13, 2008. Both actions

are designed to stimulate economic growth and inspire confidence in the financial markets.
Stock Markets

When the mortgage market liquefied down in 2007, it had a way broader impact than plummeting

home values. As mortgages went down, they additionally combined with alternative broader

economic problems to clean up credit markets and cause the securities market to lose worth.

Although, as of July 2013, the market as a full has recovered from its post-mortgage crisis lows,

some problems stay.

The bigger picture is that the mortgage crisis caused a lack of confidence in the financial system

and the economy. The mortgage market is a major part of global finance, and finding out that it

was on shaky grounds scared investors. In addition, the loss of housing values and the inability of

homeowners to pull money out of housing led to a recession that stalled corporate growth, further

causing prices to plummet. The mortgage crisis had specific effects on some stocks and industries.

several financial services corporations either disappeared or were swallowed up in mergers at

discounted costs, wiping out billions of dollars of stockholder worth. Companies in the housing

industry also experienced precipitous losses of value.

Financial institutions

Many banks, mortgage lenders, real estate investment trusts (REIT), and hedge funds suffered

significant losses as a result of mortgage payment defaults or mortgage asset devaluation. As of

February 19, 2008, financial institutions had recognized subprime-related losses or write-downs

exceeding U.S. $150 billion. Other companies from around the world, such as IKB Deutsche

Industriebank, have also suffered significant losses and scores of mortgage lenders have filed for

bankruptcy. Top management has not escaped unscathed, as the CEOs of Merrill Lynch and

Citigroup were forced to resign within a week of each other. Various institutions followed-up with

merger deals.

Home owners

According to the S&P/Case-Shiller housing price index, by November 2007, average U.S. housing

prices had fallen approximately 8% from their 2006 peak However, there was significant variation

in price changes across U.S. markets, with many appreciating and others depreciating. By January

2008, the inventory of unsold new homes stood at 9.8 months based on December 2007 sales

volume, the highest level since 1981.

Housing prices are expected to continue declining until this inventory of surplus homes (excess

supply) is reduced to more typical levels as home prices have declined following the rise of home

prices caused by speculation and as refinancing standards have tightened, a number of homes have

been foreclosed and sit vacant. Rents have not fallen as much as home prices with the result that

in some affluent neighborhoods homes that were formerly owner occupied are now occupied by

renters. In select areas falling home prices along with a decline in the U.S. dollar have encouraged

foreigners to buy homes for either occasional use and/or long-term investments.

International Trade

The United States is the most significant nation when it comes to international trade. For a long

period of time, the US has led the world in imports while at the same time it remains as one of the

top three exporters of the world. Due to its presence in foreign trade around the globe a large

amount of U.S. dollars in circulation all around the planet; about 60% of funds used in international
trade are U.S. dollars. The dollar is also used as the standard unit of currency in international

markets for various commodities such as gold and petroleum.

Since the US plays a central role in international trade, it enjoys several leverages, one being

because it is the world's leading consumer; it is the number one customer for all other countries.

Many businesses compete for a share of the United States market. In addition, the United States

occasionally uses its economic leverage to impose economic sanctions in different regions of the

world. USA is the top export market for almost 60 trading nations worldwide.
 HOW CRISIS WAS ADDRESSED

Bush administration plan

President George W. Bush announced a plan to voluntarily and temporarily freeze the mortgages

of a limited number of mortgage debtors holding ARMs. A refinancing facility called Federal

Housing Administration- FHA-Secure was created. This is part of an ongoing collaborative effort

between the US Government and private industry to help some subprime borrowers called the

Hope Now Alliance. The Hope Now Alliance released a report in February, 2008 indicating it

helped 545,000 subprime borrowers with shaky credit in the second half of 2007, or 7.7 percent of

7.1 million subprime loans outstanding in September 2007.During February 2008, a program

called "Project Lifeline" was announced. Six of the largest U.S. lenders, in partnership with the

Hope Now Alliance, agreed to defer foreclosure actions for 30 days for homeowners 90 or more

days delinquent on payments. The intent of the program was to encourage more loan adjustments,

to avoid foreclosures.

President Bush also signed into law on February 13, 2008 an economic stimulus package of $168

billion, mainly in the form of income tax rebates, to help stimulate economic growth.

Other actions

Some lenders have taken action to reach out to homeowners to provide more favorable mortgage

terms (i.e., loan modification or refinancing). Homeowners have also been encouraged to contact

their lenders to discuss alternatives. Corporations, trade groups, and consumer advocates have
begun to cite statistics on the numbers and types of homeowners assisted by loan modification

programs.

Credit rating agencies help evaluate and report on the risk involved with various investment

alternatives. The rating processes can be re-examined and improved to encourage greater

transparency to the risks involved with complex mortgage-backed securities and the entities that

provide them.

Regulators and legislators can take action regarding lending practices, bankruptcy protection, tax

policies, affordable housing, credit counseling, education, and the licensing and qualifications of

lenders. Regulations or guidelines can also influence the nature, transparency and regulatory

reporting required for the complex legal entities and securities involved in these transactions.
 IMPACT OF SUBPRIME CRISIS ON INDIA

Even though the Indian markets were experiencing the echo, the Indian banking system had

remained fairly insulated from any direct impact of the subprime crisis in the US. This was because

the Indian banks did not have significant exposure to subprime loans in the US. However, there

was a major impact on the equity Markets as many foreign institutional investors (FIIs) sold off

their investments into Indian Companies to cover their huge losses. International Trade also

suffered due to lack of demand for exports and Export growth suffered due to external demand

shocks which leads to fall of export from 40% to 22% in 2008-09. Also, a subprime like scenario

in India seems unlikely given the current state of affairs. First and foremost, thing, the mortgage

market in India stands nowhere in comparison with the developed economies like the United

States, China, UK, despite of rapid growth in the nation. Mortgages as a percentage of GDP in

India are still at a small percentage as compared with the US and the UK. Secondly, Balanced and

Forward-looking approach has been accepted by the Indian regulators. Its continuous doses of

monetary tightening aim to ensure that the money supply (and hence inflation) is kept within

manageable limits so they reduced the CRR by cumulative 400 basis points to 5%, Repo rate

reduced by 425 basis points to 4.75% and Reverse repo rate was reduced by 275 basis points to

3.25%. Also, no Doubt Housing prices in India got affected but it has more to do with Demand

and supply factors for Houses.

Source: RBI Data
 SUMMARY AND CONCLUSION

A subprime loan is given to individuals that don't qualify for a traditional loan, owing to factors

like low financial gain or a poor credit history. A subprime loan usually carries a higher rate of

interest than a traditional loan.

Subprime loans are most common in mortgage loans and also it has the ability to endanger the

entire financial system. These formed nearly one fifth of all U.S. mortgage loans in 2006, going

up from 9 per cent till 2004. Subprime loans were meant for such borrowers that couldn’t borrow

from conventional markets.

In order to attract borrowers, lenders adopted predatory practices. They did it intentionally

knowing there will be default, and if that occurred, seized the houses mortgage and sell them off

to make a profit. The main reason behind lenders taking this amount of risk was credit derivative

instruments based on these mortgages which were then sold to investors. Moreover, investors were

also willing to accept these derivatives (CDOs) since the rate of return was way higher than the

government backed securities.

Usually, a bank or mortgage finance company lent to a subprime borrower to finance the purchase

of a house. To lure its borrowers, lenders started adjusted-rate mortgage in which the interest rate

applied on the outstanding balance that vary throughout the life of the loan. For instance consider

a 2-28 loan. During the first two years of a 30-year mortgage loan, interest was pegged at a low

fixed rate of 4 per cent and then in the following 28 years, the rate was floating at around 5 per

cent over a benchmark rate.

All the expectations of lenders of higher profits and income took a jolt when housing prices started

its downward course during 2006-07. In order to sell the mortgage loans to investors, these lenders

had converted these mortgages into baskets and created Collateralized Debt Obligation. The basket

was divided on the basis of different risk and return characteristics. These CDOs were bought by

some big investment banks in which super rich invested for higher returns. They in turn financed

these investments by borrowing from banks against the security of CDOs. The whole arrangement

crumbled when things turned adverse with falling home prices and rising interest rates.

As a result of this downtrend in housing market, confidence in the banking system was rudely

shaken. Due to a lack of trust among banks, interbank money market fell to its lowest level.

Authorities in Europe and also the U.S. had to pump in cash to avert the system from collapsing.

These developments had their impact on Indian stock markets during which several hedge funds

and investment banks had invested with. Once they faced liquidity issues within the U.S., they

sold a part of their Indian holdings, causing the share indices down.

REFERENCES