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U S SUBPRIME CRISIS

PRESENTED BY:- Ranjit Kr Pandey

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KIET School Of Management

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N
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IN 
 What is Sub-prime?
 

The  Term  sub  prime  is  usually  used  in  the  context  of  loans. 

 

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        A prime customer is one who has a very good history and can repay 
the  loan  comfortably  during  the  agreed  tenure. 

 
       A subprime customer is one who does not have a good credit history 
and also does not have enough income to substantiate the loan payments 
monthly. 
 
The loans granted to a subprime customer is termed as a subprime loan... 

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 What is Subprime Mortgage?
A poor credit rating people are disqualified

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to apply for conventional mortgage or
loan application.
 They’re disqualified because they have
higher risks that they are not able to
make the loan payment due to their poor
credit history.
 Bank is very clever. They come out a
special type of loan to these poor
credit rating people. This loan or
mortgage is called “Subprime Mortgage”4
or “Subprime Loan”.
 Subprime Mortgage Crisis
The subprime mortgage crisis is an


ongoing real estate crisis and

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financial crisis triggered by a dramatic
rise in mortgage delinquencies and
foreclosures in the United States, with
major adverse consequences for banks
and financial markets around the globe.


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 Why Banks Want Subprime
Mortgage?

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 It is all related to money. The banks are also
greedy and they want to earn more.
 The main reason why the banks want to do this is
they predict the value of the property will be
going up. So they increase the mortgage
interest rate (higher than the conventional
loan) and they call it a subprime mortgage.
 They earn more with the higher mortgage interest
rate and just in case the borrowers can’t
continue the payment, they still can sell the
houses with higher value due to the property
appreciation. 6
 Contd….
To further reduce the risks and to get more loans
(earn more money by loan interest), the banks

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repackage all mortgages into an investment
product and sell it to financial institutions in all
over the world (not just in U.S).
 This is now not only between banks and borrowers
get involved in this subprime mortgage but also all
the financial institutions around the world.


 You may ask why they want to invest in this

high risk product?
 One reason, they believe that the
property value will go up.
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 What happen to subprime
borrowers?
 They buy the house only for one reason which is
expecting value of the houses to go up and

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they earn from the property appreciation.
 They can rent out their house with higher value
or they can sell the house with higher value.
 All the debts they had previously can be easily
paid off. Because house prices had increased
so rapidly in the past few years, paying back
the loan payment is not a problem at all.


 Can you see that? Everybody wins! Borrowers,

banks and financial institutions are eating the
same things happily and the things is8
“property appreciation”.

 When and Why Crisis Happens?
 I think you should be able to guess it by now

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when the crisis happened. Everybody enjoys
the same things, if the things is gone, what
happen? Crisis happens. It is that simple.
When the house or property values drops,
the things is gone. Everybody wins now
becomes everybody loses!


When demand is more than supply (everyone

wants to buy house), the property values went up.
Until one day, when it becomes much more
expensive to borrow, less people could afford to
buy a house. As there were not as many buyers,9
the real estate market begin to cool down and
house prices begin to fall.
 CONTD…

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 When the house prices begin to fall, the subprime
borrowers are going to suffer. Not only they’re not
able to pay their existing debt, they are stuck
having to pay a much larger mortgage payment.
This causes many of these borrowers to not be able to
make their house payment.


So for the financial institutions, they are going

to lose their money that they invested because the
borrower are not able to pay the loan payment. On
the other hand, banks have a very big problem also
because they rely on this, these financial institutions to
invest in the pool of mortgages investment product.
Financial institutions no longer wants to invest and do not
trust the bank anymore. If no wants want to buy them,10
where the banks get the money to offer the loans?

CONTD….

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They bank also suffer from the lost for
those borrowers who failed to make payment.
As a result, the banks increase the
mortgage interest rate to cover loses and
hopes that borrowers (who afford to pay)
can pay more. Sadly, the effect is opposite and
this even makes the conditions worst. More and
more borrowers failed to pay their monthly loan
payment due to the interest rate increases.
Crisis happens! Everyone suffers!

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
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REASONS OF US


SUBPRIMECRISIS

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 What are the reasons ?

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 The main reason is too much debt.
 The crisis can be attributed to a number of
factors pervasive in both housing and
credit markets, factors which emerged
over a number of years.
 Causes proposed include the inability of
homeowners to make their mortgage
payments,

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 Boom and bust in the housing market
Causes…….

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 Homeowner Speculation
 High-risk mortgage loans and lending/borrowing practices
 Securitization practices
 Inaccurate credit ratings
 Government policies
 Policies of central banks
 Financial institution debt levels and incentives
 Credit default swaps
 US Balance of Payments



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 Boom and bust in the housing market
 Low interest rates and large inflows of foreign funds
created easy credit conditions for a number of years prior

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to the crisis, fueling a housing market boom and
encouraging debt-financed consumption.

 The USA home ownership rate increased from 64% in 1994
(about where it had been since 1980) to an all-time high
of 69.2% in 2004.

 Subprime lending was a major contributor to this increase
in home ownership rates and in the overall demand for
housing, which drove prices higher.
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 Cont…

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

 This housing bubble resulted in quite a few homeowners

refinancing their homes at lower interest rates, or
financing consumer spending by taking out second
mortgages secured by the price appreciation.

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 Homeowner Speculation

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 Speculative borrowing in residential real estate has been
cited as a contributing factor to the subprime mortgage
crisis.


 During 2006, 22% of homes purchased (1.65 million

units) were for investment purposes, with an additional
14% (1.07 million units) purchased as vacation homes.


 During 2005, these figures were 28% and 12%,

respectively.


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 High-risk mortgage loans and
lending/borrowing practices

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 In the years before the crisis, the
behavior of lenders changed
dramatically. Lenders offered more and
more loans to higher-risk borrowers,
including undocumented immigrants.
 A study by the Federal Reserve found
that the average difference between
subprime and prime mortgage interest
rates (the "subprime markup") declined
significantly between 2001 and 2007. 18

Ø
 Securitization practices

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 The traditional mortgage model involved a bank
originating a loan to the borrower/homeowner and
retaining the credit (default) risk


 With the advent of securitization, the traditional model has

given way to the "originate to distribute" model, in
which banks essentially sell the mortgages and
distribute credit risk to investors through mortgage-
backed securities.


 Securitization meant that those issuing mortgages were no

longer required to hold them to maturity.
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 Inaccurate credit ratings

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 Credit rating agencies are now under scrutiny for having
given investment-grade ratings to MBSs based on risky
subprime mortgage loans.

 These high ratings enabled these MBS to be sold to
investors, thereby financing the housing boom. These
ratings were believed justified because of risk reducing
practices, such as credit default insurance and equity
investors willing to bear the first losses.

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 Government policies

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 Both government failed regulation and deregulation
contributed to the crisis.
 Securities and Exchange Commission (SEC) and Alan
Greenspan conceded failure in allowing the self-
regulation of investment banks.
 Increasing home ownership has been the goal of several
presidents including Roosevelt, Reagan, Clinton and
G.W.Bush.
 In 1982, Congress passed the Alternative Mortgage
Transactions Parity Act (AMTPA), which allowed non-
federally chartered housing creditors to write
adjustable-rate mortgages.
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 Policies of central banks

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 Central banks manage monetary policy and may target the
rate of inflation. They have some authority over
commercial banks and possibly other financial
institutions.


 They are less concerned with avoiding asset price bubbles,

such as the housing bubble and dot-com bubble.


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 Financial institution debt levels and
incentives

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 Many financial institutions, investment banks in
particular, issued large amounts of debt during 2004–
2007, and invested the proceeds in mortgage-backed
securities (MBS), essentially betting that house prices
would continue to rise, and that households would
continue to make their mortgage payments.


 Borrowing at a lower interest rate and investing the

proceeds at a higher interest rate is a form of financial
leverage.

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 US Balance of Payments

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 In 2005, Ben Bernanke addressed the implications of the
USA's high and rising current account deficit, resulting
from USA investment exceeding its savings, or imports
exceeding exports.


 Between 1996 and 2004, the USA current account deficit

increased by $650 billion, from 1.5% to 5.8% of GDP.


 The US attracted a great deal of foreign investment,

mainly from the emerging economies in Asia and oil-
exporting nations.
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 IMPACT OF US SUBPRIME
CRISIS IN INDIAN ECONOMY
 The US has been a major investor in Indian

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markets. The slowdown could mean The foreign
banks & hedge funds started unloading their
holding in Indian equities resulting in fall in the
stock price & weakling the domestic currency.
 


 Many leading companies, particularly IT, BPO and

exports, have flourished on the back of a robust
US economy. They have contributed a lion’s share
to India’s foreign exchange reserves. Any
slowdown could mean a reduction in profitability
in these sectors, which in turn can lead to
companies closing down and unemployment. This 25

could lead to a slowdown in the Indian economy

as well.
 Cont….
 Hitting the IT enabled services since a

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majority of the Indian IT firms derive
75% of their revenues from US.
 Manufacturing sectors has to ramp up
scale economies & improve
productivity & operational efficiency.
 Tourism sector could be affected .
 The recession in US has seen the loss of
some jobs in India.
 The recession situation in the US has
lead to loss of demand for Indian 26

exports hence loss of export earning

 Cont….

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 Investment banks & others financial
institution are on a job slashing spree to
cut costs.


 There will be several implication for the

banking sectors Indian banks have to
follow Stricter norms while disbursing
loans.


 The number of investor accounts at stock

exchange has surged a crash in the
equity price is effecting more people 27
then ever before.
 Indian

Banking Sector: Negative Impact

 · ICICI bank’s loss: India's largest private bank is
faced with a loss of Rs10.56 billion till January

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2008. ICICI did not have exposure to the US sub-
prime market.
 Its profits were hurt by depreciation in the value of
securities it bought in the international markets.
 The sub-prime crisis led to a rise in global interest
rates, which in turn caused a decline in the value of
securities, leaving ICICI with the task of making up
the difference from its profits.
 The investment losses resulting from the sub-prime
crisis could eliminate approximately 9% of its
profits this year.
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 Cont….

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

 Other Indian banks with exposure to credit

derivatives include the country’s largest
bank, the State Bank of India (SBI) – Rs 40
billion, Bank of India - Rs12 billion and Bank
of Baroda – Rs 6 billion.
 Applying the same rate as ICICI’s 7.6% to the
exposure of these government-run banks,
we have a loss of Rs 7.04 billion for SBI, Rs
2.11 billion for Bank of India and Rs1.08
billion for Bank of Baroda
 29
US Subprime Crisis: Impact on
Indian Industries

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 IT sector & outsourcing: Limited impact
 Nasscom: The global financial meltdown following
the collapse of US investment banks will have
limited impact on the Indian IT sector in the short
and medium terms, but poses a challenge in the
long term.
 Growth will happen but at 22-23 percent it will be
lower than in the last two-three years when the
booming IT industry posted a CGPA (cumulative
growth per annum) of 31 percent.


 IT-enabled services (ITES) such as business process

outsourcing (BPO) comprising voice and data, 30

captives may get affected


 Cont…

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 In the next two-three quarters, clients in the
financial sector will be conservative,
withhold spending on new projects and
delay expansion. On the contrary, they will
try to leverage the vendors' expertise to
rationalise operational costs.
 India’s outsourcing industry could be cut to
size coupled with lower revenue, job loss
and poorer salary hikes. The industry is
slated to grow only by 22-24% from the
earlier 29%. Although the association says
the long term prospects of the sector to
touch US$60-billion mark this year is on
track 31


 Solutions …
Loan modification, pumping money into market


may slow down the crisis.

 Establish rescue funds for borrowers facing
short-term problems caused by illness,
layoffs or other one-time events.
 Establish a bond fund to pay for switching
borrowers out of unaffordable ARMs.
 Refinance loans for victims of predatory
lending. This would involve working with
Fannie Mae, the quasi-governmental
corporation.

 Guidelines ……
Never respond favorably to a solicitation


without first checking other options. If you

deal with only one loan provider, your
prospects are better if you make your
selection by throwing a dart at the yellow
pages than by accepting a solicitation.


 Check your eligibility for mainstream financing

with mainstream lenders. The easiest way to
do that is on-line. Some sites that I like for
this purpose are Eloan.com, Amerisave.com,
and NationalMortgageAlliance.com. These
are all Upfront Mortgage Lenders.

 Cont….
If you can’t qualify with any of them, your best


bet is an Upfront Mortgage Broker. They may

charge sub-prime applicants a little more
because they require more time. You will know
what they charge, however, and you will know
that you are getting the wholesale price
posted by the lender, which means you won’t
be exploited.

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K S
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