Over view of Sub-prime Crisis in US

2007-10 SUB PRIME CRISIS IN US…. The US sub-prime mortgage lending crisis or simply sub-prime crisis has been the catchphrase in various media over the last few weeks in the year 2007-2010 Sub-prime borrower In US almost everything, right from getting a credit card to receiving various banking services, is dependent on the credit history of a person. A good credit history can be directly attributed to making payments on time, less revolving credit on credit cards, fewer payment defaults and check bounces etc. and is denoted by the FICO score or credit score of a person set by few credit rating agencies. It is easy for a person with a good credit history to get loans and other services while it’s exceedingly difficult for a person with a not so good credit history or low FICO score to avail banks’ services, let alone loans. Such poor credit history borrowers are called sub-prime borrowers. Since there is a risk of default on loans to sub-prime borrowers, US banks usually charge a higher rate of interest to them for the risk they are taking. From the bank’s side, a higher interest means a higher return, well with a risk. As a result, some banks had seen lending money to sub-prime borrowers as an opportunity. Sub-prime boom :For a crisis to happen, first there has to be a boom. There were a few things that led to the sub-prime boom. Global Central Bank let monetary policy move to a nearly unprecedented accommodative stance, pumping money into the system. At the same time, corporate, the traditional mainstays in terms of borrowing funds to invest moved to a defensive stance, having grown much more conservative in the wake of the Enron and WorldCom fiascos. Finally, the major developed countries began to gain a measure of fiscal discipline, with budget deficits shrinking, which further reduced the demand for credit on a global basis. That imbalance between investors flush with cash and the traditional borrowers not really needing or wanting that cash meant that investors had to look for new markets to invest in. As the Asset Backed Securities (ABS) market had been taking off and coming into the mainstream, a natural target was the sub-prime borrower borrowers who in the past had wanted to borrow but who had been locked out of credit markets. Eager lenders met eager borrowers, with the mortgage

Hedge Funds hold majority of these sub-prime related securities due to the inherent nature of their business making them extremely vulnerable to sub-prime related issues. which made it more difficult for other sub-prime borrowers to refinance their mortgages into loans with lower rates. Some started force selling their houses due to which property prices came down. found themselves in distress due to the rising defaults by sub-prime borrowers. more and more defaults! Now at the securities side. The total volume of CDOs in the US market is around $900 billion and only 17% of the CDOs were created out of subprime mortgages. Who could do this better than the banks? Banks gave money to sub-prime borrowers and then they bundle the loans to a package and sold securities whose value was linked to the performance of the package of mortgage loans. some defaulted.” Now. let's see what the banks or mortgage originators did to target the sub-prime borrowers’ market. These added to their inability to payback the money. banks did away with the role of playing a financial intermediary. Investors bought these securities and thus indirectly provided the money required for sub-prime lending. As a result. and the sub-prime boom was born. So everything was set and now let’s find out what triggered the crisis. Since . These derivative instruments are called Collateralized Debt Obligations (CDOs). The result. And thus started a vicious spiral of forced selling of sub-prime securities! This reduced the price of these securities in the market and thus the crisis grew new bounds.originators. Another catalyst was the rising segment of credits like Home Equity Loans through which the borrowers could take a second credit on the same mortgage. the highly leveraged hedge funds. Role of Banks and Hedge Funds :So there was an opportunity among sub-prime borrowers and there has to be someone who could take the money from investors and give it to the borrowers. which is one form of Asset Backed Securities. which affected the returns of CDOs. Sub-prime crisis Quite obviously the sub-prime crisis occurred when the sub-prime borrowers defaulted in their mortgage loans. Investors who had put their money in these funds wanted their money back which forced these funds to liquidate their assets. Thus. ABS underwriters. The main reason was the inability of sub-prime borrowers to pay back the money. and credit ratings agencies playing the role of matchmaker.

which had total obligations of a very scary $US24 billion and could lose more than $A1.hedge funds are highly leveraged.11% Sub Prime Crisis in Germany:The ECB’s decision came a week after the German government arranged the bailout of IKB Deutsche Industries bank.2 billion invested but what was frightening about the move was. France’s biggest bank. stopping withdrawals from three funds linked to subprime mortgages. The London interbank’s offered rate rose to 5. only a week ago the CEO of the bank had said its exposure to subprime mortgages was “absolutely negligible”. The intervention by the ECB raised concerns that there might be more problems among European financial institutions. The ECB offered unlimited cash to borrowers at its main lending rate of 4% after overnight rates rose sharply past that level. causing concern and growing fear of a credit crunch in Europe. advancing by a few minutes its daily injection of funds into US money markets to make sure there was no liquidity lock up and ease a credit squeeze that had appeared overnight in the huge (and usually very liquid) commercial paper market. Sub Prime Crisis in UK:Anyone who thought the subprime mortgage crisis was a problem for the markets and moneymen who created the mess had that bit of sophistry destroyed last night when European money markets nearly froze. Thus the sub-prime crisis showed its red face! Effects The US Federal Reserve did its bit.86% from 5.35% and in euros jumped to 4.2 billion of an emergency credit line of $A5 billion. a small decrease in their asset values is enough to make them bankrupt. . As a result several funds filed for bankruptcy. BNP Paribas. The funds had around $US2.. firstly the commentary by the bank that liquidity had evaporated and secondly. forcing the European Central Bank to pump in more than $A150 billion of emergency funds to free up liquidity.31% from 4.

is offered up to $A1.MORGAN STANLEY BOSTON — Morgan Stanley agreed to a nearly $103 million settlement with Massachusetts investigators who alleged the investment bank backed subprime mortgage lending that it knew to be risky. was dissolved in August 2008 after filing for bankruptcy protection. CASE STUDY: . 2 U. The majority of the risky loans were made by New Century Financial Corp. several other German banks and investors have exposures of up to $US500 million or more. based on values established a week or so ago. Dutch investment bank NIBC Holding NV said yesterday that it lost at least $US188 million on subprime investments this year. provider of subprime mortgage loans. Irvine. once the No. and Union Investment Management of Germany in stopping fund redemptions.BOP joined Bear Stearns Cos. Morgan Stanley would provide $60 million to borrowers and the rest to the state treasury and to state agencies that had invested in securities backed by the risky loans.S. Axa." . she said. California-based New Century. Morgan Stanley continued to back the loans despite signals as early as 2005 that New Century's practices were unsound. They started with low teaser rates but then they kicked to higher interest rates that borrowers predictably could not afford. the big French insurer.2 billion to bail out investors in two funds that have subprime exposure. Besides BNP and IKB. Morgan Stanley funded and securitized New Century loans. and had "intimate knowledge" of the company's loan portfolio. including loans approved without documentation or supporting paperwork. and backed by Morgan Stanley.

5 million to the Massachusetts general fund and $23. which according to the settlement purchased securities through an intermediary from Morgan Stanley that were backed by New Century loans. Morgan Stanley would provide $58 million in direct relief to about 1." The company declined to make further comment.000 Massachusetts borrowers struggling to repay subprime loans or facing foreclosure. resulting in "significant losses" for those agencies. Borrowers could receive up to a 35 percent reduction in their principal depending on their property values.4 million to state entities. Morgan Stanley also agreed to make "structural changes" in the way it does business. Under the settlement. including the Massachusetts Municipal Depository Trust and the Pensions Reserve Investment Trust. Morgan Stanley would also be required to pay $2 million to nonprofit agencies that assist foreclosure victims.In a brief statement. The company would pay $19. Morgan Stanley said it was "pleased to resolve this matter in a way that will help many Massachusetts homeowners stay in their homes. .

What is Sub Prime Crisis in USA ??? .Bullet form for the Powerpoint Presentation:- • • US sub-prime mortgage lending crisis or simply sub-prime crisis has been the catchphrase since 2007.

reduced the demand for credit on a global basis.• Sub Prime Borrower In US. less revolving credit on credit cards. Banks – Opportunity Sub Prime Boom • • • • • • Asset Backed Securities Global Central Bank let monetary policy Major developed countries . Asset Backed Securities (ABS) market Eager lenders met eager borrowers ABS underwriters and credit ratings agencies playing the role of matchmakers . with budget deficits shrinking. Higher Interest Rates. A good credit history . High Risk 3.payments on time. fewer payment defaults and check bounces.measure of fiscal discipline. Difficult for a Low FICO Score to get Loans (Subprime Borrower) 2. 1.

Investors wanted their money back which forced these funds to liquidate their assets Reduced the price of these securities in the market.Role of Banks and Hedge Funds • • CDO’s (Collateralized Debt Obligations) . which is one form of Asset Backed Securities The total volume of CDOs in the US market is around $900 billion Hedging • • • Sub Prime Crisis • • • • • • Sub-prime borrowers defaulted in their mortgage loans. Affected the returns of CDOs. France’s biggest bank. These derivative instruments are called Collateralized Debt Obligations (CDOs). Several funds filed for bankruptcy. BNP Paribas. stopping withdrawals from three funds linked to subprime mortgages The ECB’s decision came a week after the German government arranged the bailout of IKB Deutsche Industries bank. Inability of sub-prime borrowers to pay back the money.Banks gave money to sub-prime borrowers and then they bundle the loans to a package and sold securities whose value was linked to the performance of the package of mortgage loans. which had total obligations of $US24 billion . Effects of Subprime Crisis on the World Economy • • • European Central Bank to pump in more than $A150 billion of emergency funds to free up liquidity.

and backed by Morgan Stanley . 2 U. financial institutions.000. Morgan Stanley started giving loans at low teaser rates moving on to higher interest rates borrowers predictably could not afford." Majority of the risky loans -new Century Financial Corp.S. and individuals. • . 36 countries around the world. Morgan Stanley agreed to a nearly $103 million settlement with investors of Massachusetts investigators who alleged the investment bank backed subprime mortgage lending that it knew to be risky. with over 600 offices and a workforce of over 60.CASE STUDY – MORGAN STANLEY • • • • Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations. governments.No. provider of subprime mortgage loans dissolved in August 2008 after filing for bankruptcy protection.

2008 that they would become traditional bank holding companies regulated by the Federal Reserve. the last two major investment banks in the US. Morgan Stanley and Goldman Sachs.• • • • Morgan Stanley would provide $58 million in direct relief to about 1.000 Massachusetts borrowers struggling to repay subprime loans or facing foreclosure. Morgan Stanley would provide $60 million to borrowers and the rest to the state treasury and to state agencies Morgan Stanley would also be required to pay $2 million to nonprofit agencies that assist foreclosure victims. both announced on September 22. .

Master your semester with Scribd & The New York Times

Special offer for students: Only $4.99/month.

Master your semester with Scribd & The New York Times

Cancel anytime.