Banks lend aggressively and create a Sub Prime industry.
Sub-prime lending refers to lending (at slightly higher interest rates) to people who may not be eligible for a loan under normal circumstances. Maybe they don’t have a regular job or income, or have defaulted in the past.
A Trap in which Banks were trapped - Banks traditionally did not lend to such people due to high risk of default. But since these loans were mortgaged against property and property prices were rising continuously, banks started doing so. If customers defaulted, they could sell the mortgaged property.
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2005 : The booming housing market halted abruptly in many parts of the US.
2006 : Prices are flat, home sales fall.
February 2007 : Sub-prime industry collapses in the US; more than 25 sub-prime lenders declare bankruptcy, announce significant losses, or put themselves up for sale.
While they were lending, banks did not factor in the possibility of a fall in property prices. When the Federal Bank (the US equivalent of RBI) started increasing interest rates, the sub-prime borrowers started defaulting and banks started selling off the mortgaged properties. As more and more properties came into the market for selling, the property prices fell.
A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rate loans. Quite often, subprime borrowers are often turned away from traditional lenders because of their low credit ratings or other factors that suggest that they have a reasonable chance of defaulting on the debt repayment.
Subprime loans tend to have a higher interest rate than the prime rate offered on traditional loans. The additional percentage points of interest often translate to tens of thousands of dollars worth of additional interest payments over the life of a longer term loan.
The Bear Stearns Companies, Inc. , based in New York City, was one of the largest global investment banks and securities trading and brokerage firms prior to its collapse in 2008.
Beginning in 2007, the company was badly damaged by the subprime mortgage crisis.
In March 2008, the Federal Reserve Bank of New York provided an emergency loan to try to avert a sudden collapse of the company.
The company could not be saved, however, and was sold to JPMorgan Chase for ten dollars per share, a price far below the 52 Week High of $133.20 per share, traded before the crisis, although not as low as the two dollars per share originally agreed upon by Bear Stearns and JP Morgan Chase.
Lehman Brothers Holdings Inc. (NYSE: LEH) was a global financial-services firm until its bankruptcy in September 2008.
The firm did business in investment banking, equity and fixed-income sales, research and trading, investment management, private equity, and private banking.
It was a primary dealer in the U.S. Treasury securities market. Its primary subsidiaries included Lehman Brothers Inc., Neuberger Berman Inc., Aurora Loan Services, Inc., SIB Mortgage Corporation, Lehman Brothers Bank, FSB, and the Crossroads Group.
The firm's worldwide headquarters were in New York City, with regional headquarters in London and Tokyo, as well as offices located throughout the world.
On September 15, 2008, it filed for bankruptcy protection; the filing marks the largest bankruptcy in U.S. history.
The following day, its investment banking and trading divisions were acquired by Barclays along with its New York head office.