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and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system. Approximately 80% of U.S. mortgages issued in recent years to subprime borrowers were adjustable-rate mortgages. After U.S. house prices peaked in mid-2006 and began their steep decline thereafter, refinancing became more difficult. As adjustable-rate mortgages began to reset at higher rates, mortgage delinquencies soared. Securities backed with subprime mortgages, widely held by financial firms, lost most of their value. The result has been a large decline in the capital of many banks and U.S. government sponsored enterprises, tightening credit around the world.
Many factors directly and indirectly caused the ongoing Financial crisis of 2007-2009 (which started with the US subprime mortgage crisis), with experts placing different weights upon particular causes. The complexity and interdependence of many of the causes, as well as competing political, economic and organizational interests, have resulted in a variety of narratives describing the crisis. One category of causes created a vulnerable or fragile financial system, including complex financial securities, a dependence on short-term funding markets, and international trade imbalances. Other causes increased the stress on this fragile system, such as high corporate and consumer debt levels. Still others represent shocks to that system, such as the ongoing foreclosure crisis and the failures of key financial institutions. Regulatory and market-based controls did not effectively protect this system or measure the buildup of risk. Some causes relate to particular markets, such as the stock market or housing market, while others relate to the global economy more broadly. In July 2009, the U.S. announced the members of the Financial Crisis Inquiry Commission to investigate the causes of the crisis. Its report is expected at the end of 2010.
Subprime is the cause of USA Economy melt down. It is the very popular news among everyone and it is become very serious then expected. It caused more damage to all the industries. Subprime crisis caused big loss to the banks and now it is affecting the other industries like AutoMobile companies (GM, Ford, etc.). In this blog I will write about what exactly is the Subprime crisis and why USA banks created such a big mistake in their era. Some experts comparing this disaster with the 1930 Economy slow down in USA.
For example. When the bank gives him loan of some lakhs. Even they don’t have clear idea on how will they make profit. These individuals may have had job loss. This is the one simple example how Subprime problem starts. especially for large purchases such as automobiles or real estate. Due to these previous credit problems. What caused 2001 recession? Subprime problem is more severe then what we saw in the 2001 recession. he will just surrender the house to bank and go away. Since the invention of internet. The real fact is that. To meet this demand. A small company without any profit valued as a billion dollar company.What is Subprime lending? Subprime Mortgage Loans (or housing loans or junk loans) are very risky. there is dozens of new companies coming up with the Dot Com dreams. people started investing more on the Dot Com companies and the prices of the share value is increased dramatically. a lot of lenders get into this business to try and make a quick money. .20000-Rs. usually these events were unforeseen and cause a major setback in finances. one which allows these individuals to pay a higher interest rate. a person who is working on IT company earns Rs. As a result.These loans are given to people who have inability to repay the loan and they don’t have stable income. The price of the stock market is over valued. repossessions and even foreclosures may result. previous debt or marital problems. or unexpected medical issues. lenders have seen that a tiered pricing arrangement. There is lot of hype around Dot Com is that any company can make the billions of dollars. If he lose the job.30000. the EMI for the month would be Rs. 2001 what happened is Dot Com Bubble followed by the recession. these individuals may also be precluded from obtaining any type of loan for an automobile. late payments.40000 per month and he doesn’t have any other income or assets. charge-offs. But since profits are high where the risk is high. there is no possibility for him to pay the EMI. So. Who opt subprime lending? Individuals who have experienced severe financial problems are usually labeled as higher risk and therefore have greater difficulty obtaining credit. may allow loans which otherwise may not occur.
etc. When selling shares is more than buying shares. ebay. SubprimeCrisis and Banking Industry Subprime crisis has ended history of many banks in the USA. So. You can read that in the next section. The discussion is going on and the decision will be taken by the next week. It is not yet over and now the Automobile companies are struggling. It caused sudden fall on the stock market and the companies tumble to survive. Amazon. they are spending investors money and promising that they will make profit in future. This is what happened in the USA’s 2001 recession. it is called as recession. i will write the another post on details of how automobile companies went into trouble. If there is two quarters continuous fall in the GDP. The major three companies in the USA. It is followed by Washington Mutual Funds. The fall of automobile companies will be more. General Motors(GM). Dozens of small companies vanished and only few big companies like Yahoo. whoever working on Dot Com companies lost their jobs immediately. American International Group (AIG) survived by giving the $80 billion bail out money by the USA government. a 138 year old company filed bankrupt. investors realized that company is not making any profit and stared selling the shares. CitiBank also rescued by the USA government using bail out plan. What we are seeing as Subprime is different from the 2001 burst. I have referred many sites to get the knowledge of Subprime lending and once I have read a book named “Dot . Survival of Automobile Biggies Now the turn is Automobile industry and it is affected more than any other industry in the USA. Ford and Chrysler needs help from the government to survive. Another major collapse with Citi Bank which has written off $60 billion as the bad debts. when there is increase in the unemployment will decrease the country’s GDP growth. It is started with the Lehman Brothers.To keep running the company. Like this 20 other small and medium size banks fallen easily. Summary I hope you have enjoyed reading this article. has managed to survive on the burst. After some period of time. the value of the share will be coming down. so it is expected that government will come to the rescue. As of now 22 banks closed because of Subprime crisis. It is estimated that USA needs atleast $800 billion required to handle the Subprime crisis.
Thanks for reading this article. Let us simplify this issue to understand better how sub-prime loans work and how they brought the world down to its knees. Sub-prime loans are dicey as they are given to people with unstable incomes or low creditworthiness. This is going to be good lesson for USA Banks and they need to learn from Indian banks. However. why should it affect Indian and other markets? A sub-prime loan Sub-prime mortgage loans (or housing loans or junk loans) are very risky. It is expected that this down turn will continue for the next 1-2 years minimum. But since profits are high where the risk is high. These individuals are not financially sound enough to be given a loan when judged under the strict standards that should normally be followed by a bank or lending institution. It is because of the USA governments mistake. But there is a slight problem. .Com” which helped me to understand the 2001 recession in better way. Every company is now looking for the cost cutting measures and plan to spend efficiently. Of course we are doing pretty much better than other countries. He doesn't have good credit rating. . It all begins with an American wanting to live the famed American dream. Although there are many reasons responsible for bringing the world to the doorstep of financial doom. there's more to it. This means that he is unable to clear all the stringent conditions that a bank imposes on an individual before it sanctions a loan. . a lot of lenders get into this business to try and make a quick buck. Read on. the main cause of this financial disaster is said to be the ?sub-prime loan.' So what is this sub-prime loan? And why has it caused global panic? If it is related to the American housing sector. So he seeks a housing loan to give shape to his dream home. the entire world is jolting on economy crisis. What is subprime crisis? How it caused financial mayhem? The current upheaval in the global financial markets has caused more mayhem in a fortnight than the world has seen in its entire economic history.
Also by giving out a home loan to lots of individuals. So what does the institution do? It goes ahead and ?securitises' these loans. before the American dream can fade away.like the first American -. And how are these investors repaid? The interest and the principal that is repaid by the subprime borrowers through equated monthly installments (EMIs) is passed onto these institutional investors. and he will end up making a neat profit. Given his good credit rating. which has given it the loan. These financial securities are then sold to big institutional investors. the second American is trying to hedge his bets. The institution giving out loans in the sub-prime market does not stop here. Now if this home loan market is sub-prime. Many investment banks (or institutions like the ?second American' in our story) sold complicated securities that were backed by debt which was very risky. He feels that even if a few of his borrowers default.Since his credit is not good enough. But lo!. Now let's get back to the sub-prime market. This higher rate is referred to as the sub-prime rate and this home loan market is referred to as the sub-prime home loan market.who do not have a great credit rating and to whom the bank would not have given a home loan in the first place. The bank gives the loan at a certain rate of interest. what is prime? The prime home loan market refers to individuals who have good credit ratings and to whom the banks lend directly. It does not wait for the principal and the interest on the sub-prime home loans to be repaid. Securitisation means converting these home loans into financial securities. The second American gives out these loans at a rate of interest that is much higher rate than the rate at which he borrowed money from the bank. which promise to pay a certain rate of interest. there enters a second American -usually a robust financial institution -. the bank is willing to give the second American a loan. his overall position would not be affected much.who has good credit rating and is willing to take on some amount of risk. no bank will give him a home loan as there is a fear that the chances of a default by him are high. Banks don't like customers who default on their payments. . The second American then divides this loan into a lot of small portions and gives them out as home loans to lots of other Americans -. so that it can repay its loan to the bank (the prime lender).
and thus bigger and better homes. lack of consumer spending. leading to huge losses. In their zeal to make a quick buck. thereby repaying the loan. Few controls were put in place to handle the situation in case the housing ?bubble' burst. Their mortgage-backed securities were almost worthless as real estate prices crashed. defaulted. With the American economy doing well at that time and housing prices soaring on the back of huge demand for real estate and bigger and better homes. The moment it was found out that these institutions had failed to manage the risk. a virtual halt to new jobs. But life was fine. Sub-prime homeowners began to default as they could no longer afford to pay their EMIs. A lot of them in the first place had unstable incomes and poor credit rating. The sub-prime home loans were given out as floating rate home loans. Or so it would have seemed. financial institutions saw a mouthwatering opportunity in the mortgage market. As interest rates to be paid on floating rate home loans go up. high inflation and rising oil tags together led to a fall in stock markets. panic spread. job losses. thus encouraging Americans to go in for housing loans. high interest rates. The crisis began with the bursting of the United States housing bubble. . A floating rate home loan as the name suggests is not fixed. Higher EMIs hit the sub-prime borrowers hard. the interest rate on floating rate home loans also go up. Investors realised that they could hardly put any value on the securities that these institutions were selling. wiping out their net worth. Once more and more sub-prime borrowers started defaulting. And when the US economy began to slow down. thus. the EMIs that need to be paid to service these loans go up as well. This caused many a Wall Street pillar to crumble. growth stagnation. With US interest rising. Lower interest rates led to buyers wanting to take on bigger loans. A deluge of such defaults inundated these institutions and banks. A slowing US economy. unrealistic real estate prices. As interest rates go up. and foreclosures and defaults. payments to the institutional investors who had bought the financial securities stopped. the EMIs too increased. And everybody lives happily ever after. the house of cards began to fall. They. these institutions relaxed the strict regulatory procedures before extending housing loans to people with unstable jobs and weak credit standing.The institution giving out the sub-prime loans takes the money that it gets by selling the financial securities and passes it on to the bank he had taken the loan from. or mortgages. The problem primarily began with the United States keeping its interest rates very low for a very long time.
Whether the individual taking the home loan had the capacity to repay the loan or not. Now burdened with tons of debt and no money to pay it back. it can borrow again to give out loans. Given the fact that institutions giving out the loan did not take the risk. why stock markets in India. So they turned to other financial firms to help them out. eh? And so the story continued. Investors who bought the financial securities could be serviced. that still does not explain. they were able to securitise more. Well.As defaults kept rising. Another advantage of securitisation. these institutions could not service their loans that they had taken from banks. hence. which has now become a disadvantage. it does not remain on the books of the institution. By giving out greater amounts of home loan. fell? Here's why. greater the amount of loan that the institution gave out. greater was the amount it could securitise and. Once an institution securitises the first lot of home loans and repays the bank it has borrowed from. . their incentive was in just giving out the loan. Quite a vicious cycle. Thus proper due diligence to give out the home loan was not done and loans were extended to individuals who are more likely to default. Hence that institution does not take the risk of the loan going bad. so that they could give out greater amount of home loans. The risk is passed onto the investors who buy the financial securities issued for securitising the home loan. the back of these financial entities broke. wasn't their problem. After borrowers started defaulting. it came to light that institutions giving out loans in the subprime market had been inflating the incomes of borrowers. . but after a while these firms too stopped extending credit realizing that the collateral backing this credit would soon lose value in the falling real estate market. Other than this. issue more financial securities and earn more money. leading to the current meltdown The problem worsened because institutions giving out sub-prime home loans could easily securitise it. . till the day borrowers stop repaying. Once an institution securitises a loan. is that money keeps coming in. The bank having been repaid and made its money does not have any inhibitions in lending out money again. greater the amount of money it could earn.
to leveraged loans that financed reckless debt-laden leveraged buy outs. home equity loans. Most big investors have a certain fixed proportion of their total investments invested in various parts of the world. So. to the derivative markets whose risk are indeterminate. to maintain that fixed proportion. money had to come in from somewhere. to commercial real estate.. To make up their losses in the sub-prime market in the United States. It has been a total systemic failure that has its roots in the US real estate and the sub-prime loan market. although it is to blame for the beginning of the end. etc.Institutional investors who had invested in securitised paper from the sub-prime home loan market in the US. the Sensex began to tumble. In order to invest more money in the US. Since the amount of selling in the market is much higher than the amount of buying. auto loans). more money had to be invested in the US. This crisis is spreading from sub-prime to prime mortgages. Once investments in the US turned bad. Of course! Sub-prime crisis alone could not have caused such mayhem. student loans. to corporate bonds. to unsecured consumer credit (credit cards.. to industrial and commercial loans. . they went out to sell their investments in emerging markets like India where their investments have been doing well. to municipal bonds. So these big institutional investors. to make good of their losses in the sub-prime market. The flight of capital from the Indian markets also led to a fall in the value of the rupee against the US dollar. saw their investments turning into losses. began to sell their investments in India and other markets around the world.
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