The Causes of the

Sub-Prime
Department
Mortgage Crisis of
Economics
and Effects on US
Economy

Context of Global
Recession

November 18, 2019

 PRIME?
2. What is SUB-PRIME
CRISIS?
3. Causes of SUB-PRIME
CRISIS
4. How Sub-Prime Crisis
Spread? 5. Housing BUBBLE Burst
6. SUB-PRIME Crisis: Impact
on US
8. Conclusion
New Model of Mortgage
Lending
 PR IM E L OA NS &
S UB-P RI ME LO ANS

PRIME
These are the loans that are offered to borrowers with
good credit histories and carry lower interest and low
rates as compared to subprime crises.

S UB-P RIME
These are the loans that are offered to borrowers with
bankruptcies, defaults, or late payment histories.
 What is SUB-PRIME
Crisis?
 A situation starting in 2008 affecting the mortgage industry due to
borrowers being approved for loans they could not afford.

As a result, a significant rise in foreclosures led to the collapse of many

lending institutions and hedge funds. The financial crisis in the
mortgage industry also affected the global credit market resulting in
higher interest rates and reduced availability of credit.

*** A hedge fund is basically an investment pool contributed by a limited number of

partners (investors) and operated by a professional manager with specific goals in mind
- mainly to maximize returns and minimize risk. 
 How did SUB-PRIME
Mortgage Crisis Spread?
T he SUB-PRIME MO RTG AGE
Crisis Exp l ai ned

 Up until 2006, the housing market in the United States was

flourishing due to the fact that it was so easy to get a home loan.
 Individuals were taking on subprime mortgages, with the expectations
that the price of their home would continue to rise and that they
would be able to refinance their home before the higher interest rates
were to go into effect. 2005 was the peak of the subprime boom. At this
time, 1 in 5 mortgages was subprime.
 However, the housing bubble burst and housing prices had reached
their peak. They were now on a decline.
SUB-PRIME Mortgage
Crisis Explained
 Housing
BUBBLE
 Housing price go up because demand goes up.

 Housing bubbles usually start with an increase in demand , in the face of

limited supply which takes a relatively long period of time to replenish.

 Speculators enter the market, believing that profits can be made through
short-term buying and selling. This further drives demand.

 It is impossible to predict and difficult to detect !

Ameri ca Faci ng
B UBB LE Trouble! America’s housing
B U B B L E was far greater
than any on record
BUBBLE
BURST!
 Why did the Housing
BUBBLE Burst?

 Home prices reached their peak in the second quarter of 2006. They did
not fall drastically at first.

 Home prices fell by less than 2 percent from the 2nd quarter of 2006 to
the 4th quarter of 2006.

 The foreclosure start rates increased by 43 percent over these two

quarters, and increased by 75 percent in 2007 compared to 2006.

 This implies that mortgage default rates began to rise as soon as home
prices began to fall.
 Why did the Housing
CONTIN UE D …
BUBBLE Burst?

 Just as rising home prices reinforced the continuing rise in home

prices, falling home prices reinforced the continuing fall in home
prices.

 The increase in foreclosures added to the inventory of homes

available of sale.

 This further decreased home prices, putting more homeowners

into a negative equity position and leading to more foreclosures.
 The bursting of the Housing BUBBLE led
to enormous losses…
 Most of the losses were not incurred by homeowners but by the financial
institutions also. Large losses were incurred by the following groups-

i. Mortgage Lenders: One thirds of top 30 mortgage lenders have either been
acquired or have filed for bankruptcy or have been liquidated.

ii. Investment Banks: Since the housing bubble burst, the five largest U.S. investment
banks have either filed for bankruptcy (Lehman Brothers), been acquired by other
firms or become commercial banks subject to greater Regulation.

iii. Foreign Investors: (mainly banks and governments) who had invested in mortgage
backed securities.

iv. Insurance Companies: (e.g., AIG) who had sold credit default swaps. Credit default
swaps are a type of contract that insures against the mortgage-backed securities.
***Mortgage-backed securities (MBS), are bonds that represent an investment in a group of home
loans. MBSs are simply shares of a home loan sold to investors.
 Impact on United States of
America (USA)

i. Between June 2007 and November 2008, Americans lost more than a quarter of
their net worth.
ii. Housing prices had dropped 20% from their 2006 peak, with futures markets
signaling a 30–35% potential drop.
iii. Total home equity in the United States, which was valued at $13 trillion at its peak in
2006, had dropped to $8.8 trillion by mid-2008.
iv. During the same period, savings and investment assets lost $1.2 trillion and pension
assets lost $1.3 trillion. Taken together, these losses total $8.3 trillion.
v. Real gross domestic product (GDP) began contracting in the Q3 2008 and did not
return to growth until Q1 2010.
Source: The Impact of the US Subprime Mortgage Crisis on the World Economy,
Author: Sayuri SHIRA (2019)
 Impact on United States of
CONTINUED… America (USA)

i. The unemployment rate rose from 5% in 2008 to 10% by late 2009

ii. The number of unemployed rose from 7 million in 2008 to 15 million by 2009.
iii. Housing prices fell 30% on average from mid-2006 peak to mid-2009.
iv. Stock market prices, fell 57% from October 2007 peak of 1,565 to 676 in March
2009.
v. The net worth of U.S. households fell from a peak of $67 trillion in 2007 to $52
trillion in 2009.
vi. U.S. total national debt rose from 66% GDP in 2008 to over 103% by the end
of 2012.
Source: The Impact of the US Subprime Mortgage Crisis on the World Economy, Author:
Sayuri SHIRA (2019)
 CO NC LUSION

The Sub-Prime Mortgage crisis created several

consequences in the global economy such as:
global recession, low consumer spending, lose
jobs, weak financial market, business close out
or lose money (banks, builders etc.), lack
confidence in stock market so on and so for. As
a result, this crisis creates global economy slow
down. In return, slow economy increases the
unemployment rate
Thank you
 Any
Questions
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