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By: Akashdeep Singh
The Subprime Mortgage Crisis
• Typically. • A subprime mortgage is a type of loan granted to individuals with poor credit histories. who would not be able to qualify for conventional mortgages. those who qualify for the most ideal mortgages with the best interest rates are those with good credit scores and minimal debt. • Subprime mortgages charge interest rates that are above the typical interest rate because of the risk that is involved on the part of the lender. .
About the crisis… • Post 2001. to encourage spending & investing mainly for the purpose of buying houses • These banks granted loans to large number of borrowers despite having lower income levels. The economy was flush with liquidity & stock markets were booming . • Huge number of borrowers availed of bank credit without evaluating their repayment capacities. the US government had encouraged US banks to lend money to people. etc. unscrupulous credit history. unsure employment status.
The crisis began with the bursting of the housing bubble in the US & high default rates on “subprime” & “adjustable rate mortgages (ARM)” made to higher-risk borrowers with lower income or lesser credit history than “prime”. .
CDO and CDS Housing prices in USA began to drop in 2006. which witnessed an unprecedented boom since 2001 The boom was led by rising housing prices.The bubble burst… A silent storm brewed in international financial markets with origins in the US housing market. low interest rates & aggravated by financial innovation viz. Rising interest rates & falling housing prices led to rise in sub prime mortgage delinquencies & resultant foreclosure Result: The housing bubble burst in Aug 2006 Source: Sub Prime Crisis . MBS.Presentation by Astha .May 2008 .
000 97.The Housing Bubble and the Crash of 2008 Loan Amount: $100.314 322 472 528 Interest Paid 83 324 397 Interest Rate 1% 4% 5% Total 405 796 925 .000 Interest Rate: 1% Rate Adjustments: 3 Month 1 13 25 Beginning Balance Principal Paid 100.126 95.
Sub Prime Crisis 8 .
LIQUIDITY OVER 9 .
that caused the real problem .Impact of Sub Prime Crisis in USA The chart above brings out the irony and shows that underlying sub prime houses are only a small percentage of the total housing market and it was the bubble formed due to financial instruments viz. CDO and CDS. MBS.
Its banking assets are sold to J.P. The drama began with Lehman Brothers declaring bankruptcy on 15 September 2008.P. Morgan Chase for US$1. for US$1. a commercial bank. Morgan Chase.9 billion The problem with investment bank balance sheets is that on the left side nothing is right and on the right side nothing is left . witnessed major shakeouts in the US financial sector.Impact of Sub Prime Crisis in USA Initial impact was felt in March 2008. facing a refusal by the federal government to bail it out Washington Mutual is closed by the US government in the largest failure of a US bank. when investment bank. Bear Stearns was acquired by J.2 billion September 2008.
which will be repaid by selling off assets of AIG Investment bank. American International Group (AIG). Goldman Sachs and Morgan Stanley to convert themselves into commercial banks US Treasury Department confirmed that both Fannie Mae and Freddie Mac.Impact of Sub Prime Crisis in USA US Federal Reserve provided an emergency loan of US$85 billion to insurance major. would be placed into conservatorship with the government taking over their management . Merill Lynch was acquired by Bank of America in September 2008 for $50 billion US Federal Reserve granted approval to investment banks.
2 billion which was backed by the US Government US Government releases a US$700 billion bailout package for its financial industry What's the difference between a guy who just lost everything in Las Vegas and an Investment Banker? A tie .1 blln The deal forced Wachovia to backtrack from the Citigroup deal worth US$2. Wells Fargo. a commercial bank. drafted an agreement to acquire assets of Wachovia for US$15.Impact of Sub Prime Crisis in USA Wachovia Corp agrees to sell most of its assets to Citigroup Inc in a deal brokered by regulators. However.
while its savings operations and branches are to be sold to Spain's Santander . (UK’s largest mortgage lender) scooping up Britain's biggest home loan lender in an all-share deal which values HBOS at over £12 billion (US$22.3 billion) • In September 2008.Domino Effect across the World • Northern Rock Bank had difficulty finding finance to keep the business going and was nationalised in February 2008 • British bank Lloyds TSB Group Plc agrees to buy rival HBOS Plc. which will take control of the bank's £50bn mortgages and loans. British bank Bradford & Bingley was nationalised by the UK government.
the Australian government announced that AU$4 billion was to be raised to fund non-bank lenders that are unable to obtain funding to finance new loans.Domino Effect across the World • The Dutch operations of Fortis. Nomura Holdings Inc. Europe's largest victim of the credit crisis. who vowed to restore stability in a banking system hit by the worst crisis since the 1930s • In October 2008. After industry feedback this was increased to AU$8 billion • Japanese financial powerhouse. bought over Lehman's franchise in Europe and Asia Pacific. have been nationalised in a €16. including Japan and Australia . underlining the challenge facing European leaders.8 billion (£13 billion) deal aimed to calm investors in the troubled banking and insurance group • Germany struggled to rescue lender Hypo Real Estate (Mortgage Giant).
resulting in sharp drop in stock prices • Many banks.Crisis caused panic in the financial markets and investors sold out and withdrew their money.banks became extremely careful parting with their capital and decreased lending activities either to business houses.Domino Effect across the World • Stock markets tanked . mortgage lenders. especially in the financial sector What's the difference between a bond and a bond trader? A bond matures . retail customers and even to each other • Effect on jobs – Many employees lost their jobs. real estate investment trusts & hedge funds suffered significant losses • Credit got tighter .
the dollar exchange rate decreased In 2008. including oil prices. as the Sensex was on its way to a historic peak of over 20.Domino Effect in India FII investments increased in most of 2007 in a booming Indian economy. FIIs liquidated their equity investments in a big way – leading to a crash in the stock markets Simultaneously international commodity prices.000 points Since the inflow of dollars in the Indian economy increased. due to the effect of the sub prime crisis. were on a rise due increasing demand for these commodities The combined effect resulted in an increase in the dollar exchange rate . however.
Sequence of events .
) • This started to affect the stock market when investors lost confidence in the economy . etc. construction.The Housing Bubble and the Crash of 2008 • Other sectors also lost money (real estate.
the crisis is truly GLOBAL! .Poland: Part of Eurozone. huge current account deficit Russia: Fast growing economy with large foreign reserves China: ??? Strained with economic surplus and counterfeit goods Singapore: Prosperous. government guarantee for deposits till 2010 India: Economic slowdown with high inflation and poverty BUT.but has a stable banking sector Ireland: First Eurozone country to slide into recession France: Sluggish economy heading for recession Hungary: -ve credit raing. heavy debts.
venture capital lending. mergers and acquisitions.Banks pull back: • Banks re-evaluate high-risk loans in the face of potential losses on loans to hedge funds. credit is tightened for borrowers across the board. leveraged buyouts. etc. affecting commercial real estate. • As a result. .
Ongoing Effects: • Subprime mortgage industry collapses. thousands of jobs are lost • Surge of foreclosure activity • Housing prices and sales are both down • Interest rates rise across the board as the effects of the collapse of the subprime mortgage industry seep into the near-prime and prime mortgage markets • Investors lost billions of dollars in securities tied to the subprime mortgage industry. resulting in upheavals throughout the global financial market .
• The injected government funds are designed to encourage banks to continue making loans rather than conserving cash and making the credit crunch worse.Government Action: • To avoid complete market failure and to allow banks to borrow money cheaply. • Analysts are concerned that rather than calming the markets and biding time for the crisis to pass. and yen in August 2007. Euros. the Federal Reserve. and their counterparts flood the market with billions of dollars. government action will lead to inflation and an international credit crunch that would slow economic growth worldwide. European Central Bank. .
e.Steps taken by Indian Govt. . There is flow of 120+ thousand crore into Indian market • Plan to lift the Ban from PN (i.5% • Through cut into CRR.e. aircraft turbine fuel) • Planning for putting Ban on short selling. participatory notes) • Reduced the Prime Landing Rate by all Public sector Banks • Reduced into ATF’s price (i. • Reduced into CRR to 5.
Who is to Blame? • Lenders: for their predatory lending practices focused on subprime mortgage candidates • Mortgage brokers: for steering borrowers to unaffordable loans • Appraisers: for inflating housing values • Wall Street investors: for backing subprime mortgage loans without first verifying the security of the portfolio • Borrowers: for overstating income levels on loan applications and entering into loan agreements they could not afford • Government: for lack of oversight .
would you be unable to afford the payments? • Are you convinced that real estate prices will continue to rise? • Do you have a poor credit history? • Congratulations if you answered "Yes" to most or all of those questions! You're an ideal target for a subprime mortgage lender. .An Example of Subprime Mortgage • Would you like a mortgage that lends you more than the value of your house? • Would you like it structured so that your first payments are extra low? • If the mortgage weren't structured that way.
Thank You .