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  • 1. 1.0 AbstractsThis paper will discuss about the subprime mortgage crisis toward Caribbean Island and it hasrelated on US mortgage crisis in the same year. Actually, subprime mortgage crisis begun 2007until 2008 and stated at US, these financial turmoil start with the cause and look through theconsequences on effect toward on Caribbean Island. In terms on the causes these turmoil arelikely boom and bust in housing market, housing bubble, high-risk mortgage loans and lendingor borrowing practices, collateralization and securitization and last capital adequacyrequirement. The causes will leads to the consequences on affect to Caribbean Island. Thereare several effect namely trades activities, tourism sectors, Caribbean financial institution andalso foreign direct investment (FDI), last in others remittances. This paper will end with severalrecommendations that useful to recover the crisis and ensure that to improve the imbalance interms trades activities, tourism sectors, financial institution and as well as FDI, and last onremittances expenses.2.0 IntroductionThe financial press is full of stories about the collapse of the subprime mortgage market, whatcaused this collapse and who should bear the blame. Sub-prime mortgages are generally forborrowers with a low credit score. They often have higher interest rates, prepayment penalties,balloon payments, and run a greater risk of foreclosure. Many times, subprime mortgages areadjustable rate mortgages. These start out with a low rate for the first year or two and thenadjust every 6 months or more to a much higher rate. Lending to homeowners and buyerswithout good credit has become a very bad business and a very big problem for the U.S.economy as a whole. Sub-prime mortgages include mortgages with very low or no down payments and secondmortgages that serve as the down payments for first mortgages to eliminate the need for acash down payment and a monthly premium for private mortgage insurance. Although sub-prime and other risky mortgages were relatively rare before the mid-1990s, their use increaseddramatically during the subsequent decade. An undeniable fact in the current subprime loan crisis is that, as more individualhomeowners default on their home mortgages, an increasing number of investments, whichrely on payments from those mortgages, will fail. The magnitude of investment losses from this Serena Williams | Cause of the subprime mortgage crisis and its effect towards 1 Caribbean
  • 2. crisis is currently incalculable as this multifaceted travesty unfolds. Certainly, investors will losebillions. Losses from subprime mortgages will surface in a number of investments portfoliosincluding: pension plans, governmental agencies, insurance companies, non-profit charitableorganizations and mutual funds. Many fixed income investments which rely heavily onmortgages to pay their investment obligations are at significant risk of investment losses. In our discussion and findings part, we will elaborate more about the causes ofsubprime mortgage crisis and its effects on Caribbean.2.1 Scope of studyThe financial turmoil start at US when the failure of Bear, Streams & Co (NYSE;BSC) causedby global process of de-leveraging. This leads to subprime mortgage crisis at 2008, the crisismake the private market face 1 trillion amounts contained subprime mortgage. Other than that,the subprime mortgage also occurs by agency debt, as well as paper issued by governmentsponsored entities. In addition, some of financial institution was collapsed for instance; Citibankreported US$9.83 billion net loss during this period, caused by a US$18.1 billion write down insubprime losses. Here is having several issues that likely the roof of problem to enhance thesubprime mortgage crisis. When demand is more than supply (everyone wants to buy house),the property values went up like crazy. Until one day, when it becomes much more expensiveto borrow, less people could afford to buy a house. As there were not as many buyers, the realestate market begins to cool down and house prices begin to fall. This paper also indentifies the consequences of the 2008 financial crisis on thecountries whereas; to identify and investigate the cause of the crisis and also identify thechannel through it will exert its impact on developing countries. In this research we focus thatthe subprime mortgage effect towards Caribbean. First, under the literature review we put theproof about cause the crisis and effect towards Caribbean. Second it’s discussed about thecause such as homeownership, This organism such as companies, banks, associate andgovernment agencies enhance the availability of “affordable to finance housing” or refinancinghousing by using the creative financial techniques. Also discuss about roof problem is rapidgrowth of over-the-counter (OTC) derivatives and securities by all the financial institutions,under this situation also supported by encouragement of SEC and federal bank regulator. This Serena Williams | Cause of the subprime mortgage crisis and its effect towards 2 Caribbean
  • 3. is leading to a breakdown in safety and soundness at banks and securities. Other than that,problem is an ill-advised change in reporting standard for public companies means it’s relatedon embrace by the SEC and Financial Accounting Standard Board (FASB) of the fair valueaccounting. Further study on this paper which the study underlines several cause and effect.On the cause it more generally because the turmoil financial crisis is stated on US, so weidentify namely boom and bust in housing market, housing bubble, high-risk mortgage loansand lending or borrowing practices, collateralization and securitization and last capitaladequacy requirement. Other than that, this study underlines several effects toward CaribbeanIsland likely trades activities, tourism sectors, Caribbean financial institution and also foreigndirect investment (FDI), last in others remittances. Furthermore, the scope of this study is referring US mortgage crisis and also itsconsequences effect toward on Caribbean Island. This is necessary background forunderstanding the effect and requires responses. Also discuss the option the impact of thecrisis, arguing that crisis makes it imperatives to accelerate financial development internationalfinancial system. Based on the surface this study it discuss the subprime mortgage crisis onhow Caribbean economies may be effect. And the main consequences are, first, Caribbeaneconomies will nonetheless feel the impact from the meltdown in the US financial market.Second, the effect of the subprime housing crisis and the third is remittances from relatives inthe United States play an important role in the economies of Latin America and the Caribbean.Lastly is undoubtedly after the housing bubble burst. In concludes is refer to limitation duringresearch and some of recommendation of this mortgage subprime crisis and the effect towardsCaribbean.2.2 Objective of studyThe main objective of study is; a) To identify the causes of subprime mortgage crisis b) To determine the effects of subprime mortgage crisis towards Caribbean Serena Williams | Cause of the subprime mortgage crisis and its effect towards 3 Caribbean
  • 4. 3.0 Literature reviewAccording to Raina Antonopoulos, what began as a subprime mortgage debacle in the UnitedStates has by now become the worst global financial crisis since the Great Depression. As ofFebruary 2009, all advanced countries were in recession, with a job crisis intensifying acrossthe board. IMF and DESA world economic growth projections now stand in negative territory.ILO estimates warn that the ranks of the unemployed will expand by as much as 52 millionwithin the year, up from a previous figure of 20 million. In the meantime, international financialand trade flows are contracted at rates not seen in the past fifty years. Statistics thus far alsoshow that, for developing countries, not only export demand and tourism, but also worker’sremittances, have been declining at alarming rates, all of which imply reversals of financialflows. (Antonopoulos, 2009) Trough the journal of The Financial Crisis of 2008 and the Developing Countries, saidthat follow the burst of the ‘dotcom’ bubble in 2000 and the 2001 terror attacks on the UnitedStates, the US and most other advanced economies embarked on a period of sustainedexpansionary economic policies to ward off recession. The Federal Reserve, for instance,lowered its discount rate no less than 27 times between 2001 and 2003 (Lin 2008). Lowinterest rates, facilitated by the huge trade surpluses which China and other countries used topurchase US Treasury Bonds, stimulated rapid growth in credit. Accompanying rises in houseprices further fuelled credit growth, especially through mortgage lending. In the US, subprimemarket mortgage lending, to households without the essential means to repay loans, took onhuge proportions; according to Lin (2008) about US$1.3 trillion was lent in subprime mortgages.(Naude, 2009) Other than that the deepening crisis in the subprime mortgage market has affectedinvestor confidence in multiple segments of the credit market, with problems for commercialmortgages unrelated to subprime, corporate credit markets,9 leverage buy-out loans (LBOs),10auction-rate securities, and parts of consumer credit, such as credit cards, student and carloans. In January 2008, the cost of insuring against default by European speculative bonds hadrisen by almost one-and-a-half percentage point over the previous month, from 340 bps to 490bps11, while the U.S. high-yield bond spread has reached 700 bps over Treasuries, from 600bps at the start of the year. (Michel G. Crouhy, 2007) Serena Williams | Cause of the subprime mortgage crisis and its effect towards 4 Caribbean
  • 5. From 2000 to 2006, the USA observed a rapid rise in housing prices. In some areashousing prices doubled, which increased far beyond the rate of fundamental economic growth.The housing bubble was mainly the result of oversupply of US dollars, leading to “over flows ofdollars” in the housing market through the provision of low interest rates by the US FederalReserve. The Federal Reserve cut interest rates by a total of 550 basis points between 2001and 2004. The low return on the stock markets and treasury bonds further pushed money toflow into the housing market to boost the housing bubble. Much of this money was lent to thehouseholds who otherwise would not be qualified for mortgage loans.(UNHABITAT, 2011) According to Economic Commission for Latin America and the Caribbean (2008), theepicenter of this economic weakening are subprime mortgages which are highly riskymortgages issued to borrowers who could not qualify for ordinary or prime mortgages due tolow incomes or bad credit history. This is due to the United States economy is currentlyconfronted with many challenges catalyzed by the property bubble bust. The collapse of realestate prices has resulted in unprecedented losses and bankruptcies of hedge funds, mortgagelenders and banks and has led to unnerving uncertainty on Wall Street and global financialmarkets. The drastic increase in housing inventory, followed by sizeable reduction in houseprices, gave rise to negative equity for both subprime and prime homeowners. Being the mainasset of most households, the collapse of the price of houses has had a significant negativewealth effect, which will undoubtedly reduce consumption significantly. Caribbean economieswould be affected through different channels which are trade, tourism, remittances, finance andFDI. Naude (2009) argued that there are many and various channels for the impact to affectcountries differently, depending on the extent to which they are vulnerable to particularchannels. A slowdown in economic performance in most developing countries during 2009 willbe affected in the form of lower growth, higher unemployment and poverty, and changes ininequality. Two factors in particular have encouraged asset managers to throw caution to thewind which is the growing global economy and their pay incentives. Risk-management toolshave been inadequate in properly assessing risk during the upswing in the global economy.Rating agencies in particular seem to have been awarding high ratings much easier underfavorable growth conditions. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 5 Caribbean
  • 6. The examination stated that the difficulties are attributable to familiar mistakes ratherthan to new features of the financial system. There has been concern that the failure of somehedge funds could lead to more systemic problems. The problems are not simply theconsequences of using a new technology. Rather, the problems arise from a failure torecognize: (i) the incentives affecting different participants, (ii) how those incentives changedwith the dynamics of market growth, and (iii) the need for tougher forms of risk control as thequality of the borrower pool changes. Johnson & Neave (2007). Besides that, Study shown thatthe cross-country causes of the financial crisis are hard to pin down with standard econometrictechniques (Multiple Indicator Multiple Cause (MIMIC) model). However, the author provides anearly warning that model-based early warning systems are unlikely to predict future crisesaccurately. Rose & Spiegel (2009). Some study support that the global nature of the crisis imposes to the governments theadoption of a systemic approach and it is also necessary a change of perspective, that is achange of culture by decision makers who, inspired by the categories of ethics and morality,should find the balance among entrepreneurial and personal interest and collective interest.Iannuzzi & Berardi (2012). Interventions and fiscal stimulus packages must be commensurablewith the seriousness of the problem and it is the responsibility of the state and of the globalcommunity to put in place policies and strategies that will lift all boats, and lift them more evenly.The worst scenario ahead does not rest with the instability deficit spending brings; rather, it laysin the deadly combination of the despair poverty engenders Antonopoulos (2009). According to Rhoda Reddock and Juliana S. Foster (2009) on Caribbean, they havestated that women are at the center of the fallout from the current crisis, which itself combinesinterlocking crises: a global economic recession, the devastating effects of climate change, anda deepening food and energy crisis. All of this is compounding the increasing poverty andinequality in different parts of the world, as well as the impacts of the HIV and AIDS pandemic.At the same time, traditional power relations among international players are shifting, the so-called ‘middle income countries’ with the BRICs (Brazil, Russia, India and China) assuminggreater power. The current situation, a result of aggressive free-market capitalism pursued in the pastdecades, calls into sharp question dominant and even many of the so-called alternative suchas models for development of the developing countries that have struggled with crises in the Serena Williams | Cause of the subprime mortgage crisis and its effect towards 6 Caribbean
  • 7. 70’s, 80’s, 90’s and beginning of 2000’s. This crisis, however, reached global proportions whenit impacted hegemonic economies and their role in global arenas and put in evidence theinterconnectedness of the diverse realities of countries in this globalized world. Yet in Godfrey Smith (2008) statement said that the financial trauma affecting the USeconomy would have already plunged the Caribbean into an economic coma. It is unlikely thatthis will happen. But the outward ripples of the financial crisis in the US will cause an economicdownturn in the Caribbean. In the Theoretically way, the third parties picking up thesesecuritized instruments would do so only after reputable credit rating agencies had given aninvestment grade rating to the transaction. But often, the credit rating agencies are paid by thecompany that is selling the debt to investors, giving rise to questions of conflict of interest. ButInternational investors were on the receiving end of downgraded Belize investments just likethe international investors who picked up the US subprime mortgages have suffered losses inthe hundreds of billions of dollars, because Belize and much of the Caribbean do not have astock market, there probably were not many investment banks or investors to speak off thatwould have picked up US mortgage backed securities. Stock exchanges exist only in Jamaica, Barbados and Trinidad and Tobago. Directfinancial losses from the US housing crisis may therefore not be that substantial in theCaribbean. As these bring the Caribbean consequences in economies will nonetheless feel theimpact from the meltdown in the US financial market. The effect of the financial crisis will mostimmediately be felt in the tourism sector which is the primary foreign exchange earner for mostof the Caribbean. The general financial climate in the US may also cause people to be moreconservative and postpone vacations in order to save. Some studies said that investors are adequately protected if all relevant aspects of thesecurities being marketed are fully and fairly disclosed. The reasoning is that full disclosureprovides investors with sufficient opportunity to evaluate the merits of an investment and fendfor them. It is a basic tenet of federal securities regulation that investors’ ability to make theirown evaluations of available investments obviates any need that some observers may perceivefor the more costly and time-consuming governmental merit analysis of the securities beingoffered. There are two levels of reasoning that explain the insufficiency of disclosure in thesubprime crisis. First is whether institutional investors will hire securitization experts as neededto decipher complex deals. But is rejected by the evidence and theory explain. The second Serena Williams | Cause of the subprime mortgage crisis and its effect towards 7 Caribbean
  • 8. reason is goes to agency costs stemming from a conflict between the interests of individualemployees and the institutions for which they work. Steve Schwarcz (2008). From the 19th Annual Conference of the Caribbean Actuarial Association (2009), theCaribbean economies’ fastest growth period since the 1960s has been abruptly interrupted bythe worldwide economic crisis that began with the meltdown in the US financial system. Theimpact on these countries is being felt through a slump in exports that started in late 2008, andfalling tourist arrivals in the first nine months of 2009 that led to contracting GDP in nearly allcountries, rising unemployment, and declining government revenues. Investment activity hasalso plummeted, and is reflected in sharp reductions in foreign direct investment flows and adownturn in the construction sector. While there have been no financial panics as in earlierexternal shocks, some countries such as Antigua and Barbuda, Dominica, Guyana andJamaica, are grappling with large current account and fiscal deficits, as well as difficulty inaccessing private external financing. These countries have limited room to implement policiesthat could moderate the production and employment effects of the crisis. Hence, several ofthem have either settled or, as in the case of Jamaica, are negotiating borrowing arrangementswith the IMF. The overall it must be concluded that the variables we investigate as potentialdeterminants of the financial crisis of 2008 deliver only disappointing results. While many seemlike they should be empirically relevant determinants, in practice they are simply not closelylinked to crisis severity. These results indicate that creating an empirically viable early warningsystem will be challenging; such a system must conquer all the problems we faced, while alsobeing able to predict the timing of future crises out of sample. (Spiegel, 2009) According to journal of ECLAC a financial crisis in the United States would also affectFDI as banks would be more reluctant to grant loans to multinational corporations and theresulting increased uncertainty would make them less willing to invest. In this context, thiswould also negatively affect the Caribbean countries. Notwithstanding, it is worth noting thatthis effect could be offset in countries with abundant oil and mining reserves. This is truebecause of the unprecedented high prices these commodities have recorded recently, whichmake investment in these sectors highly profitable. Table 8 presents FDI as a percentage ofGDP in 2002-2006.(ECLAC, 2008) Serena Williams | Cause of the subprime mortgage crisis and its effect towards 8 Caribbean
  • 9. 4.0 Discussion and FindingIn this paper, we support the use of the emerging literature in new institutional theory on theinterplay of organizations and institutions to understand the current financial crisis. On this part,we elaborate several causes of subprime mortgage crisis and its effects towards Caribbean.4.1 The causes of subprime mortgage crisisHousing bubble (Boom and bust in the housing market) The sub-prime problem could not have happened without the housing bubble, it ishappened in the early 1998-2000 and it is could not have happened without the FederalReserves accommodative interest rate policy. The proximate cause cannot provide a fullexplanation about what exactly happened of the sub-prime mortgage crisis. The US housingmarket leads to the problem such as the housing bubble. According to Vukovis (2010) thehousing bubble was due by the lowered of interest rates and increased incentives for mortgageand lending and home ownership. This kind problem is affect and started to inflate as financialinnovation through the securitization of mortgage and their repackaging into new type ofsecurities made this possible. The bubble grew large when as more and more securities werebeing underwrite. Actually, the housing bubbles are happen cause of the US house prices rosedramatically from 1998 until late 2005; John Marshall (2009),and the rise of pricing house isreflected large increases in demand for housing and happened despite a rise of supply forhousing. The situation on housing bubble also leads the lower of interest rates, which theseencouraged people to refinancing they house; mean simply related on borrowing money in thelower inters rates, as we can prove it has strong evidence where in many parts of the US, it hadbecome a lot easier, and cheaper to receive a subprime mortgage. Major cause subprime mortgage crisis that affect Caribbean Island which in terms oftrade whether weakening of household consumption and business investment would directlyinitiate a curtailment of demand in the United States for foreign goods and services.Occasionally, the direct impact of a reduced demand will be felt most severely by countries thathave a large share of their export to the United States. These make sense to Caribbean whichdecline the number of trade on it island. In other hand, according the research by United Nation, Serena Williams | Cause of the subprime mortgage crisis and its effect towards 9 Caribbean
  • 10. the cause of mortgage crisis also has related on fuel price crisis since 1971-2007, in 2007 alsohas happen the price shock, these matters effected Caribbean tread.Declines in home valuesResearchers, policymakers, and the general public have noticed that a large number ofmortgage defaults and foreclosures followed the decline in house prices. This observationresulted in a general belief that the crisis occurred because of declining home values. Thedecline in home values only revealed the problems with subprime mortgages; it did not causethe defaults. Research shows that the quality of newly originated mortgages was worseningevery year between 2001 and 2007; the crisis was brewing for many years before house priceseven started slowing down. But because the housing boom allowed homeowners to refinanceeven the worst mortgages, we did not see this negative trend in loan quality for years precedingthe crisis.Homeowner speculationThe availability of subprime mortgages in the United States did not facilitate increasedhomeownership. Between 2000 and 2006, approximately one million borrowers took subprimemortgages to finance the purchase of their first home. These subprime loans did contribute toan increased level of homeownership in the country at the time of mortgage origination.Unfortunately, many homebuyers with subprime loans defaulted within a couple of years oforigination. The number of such defaults outweighs the number of first-time homebuyers withsubprime mortgages. Given that there were more defaults among all (not just first-time) homebuyers withsubprime loans than there were first-time homebuyers with subprime loans, it is impossible toconclude that subprime mortgages promoted homeownership.High-risk mortgage loans and lending/borrowing practicesBanks offered easy access to money before the mortgage crisis emerged. Borrowers got intohigh risk mortgages such as option-ARMs, and they qualified for mortgages with little or no Serena Williams | Cause of the subprime mortgage crisis and its effect towards 10 Caribbean
  • 11. documentation. Even people with bad credit could qualify as subprime borrowers. Fraud on thepart of homebuyers and mortgage brokers helped make the mortgage crisis more serious.Mortgage applications were not checked for accuracy as well as they should have been. Aslong as the party never ended, everything was fine.Securitization practicesCause of subprime mortgage also because of securitization accelerated in the mid-1990s. Thetotal amount of mortgage-backed securities issued almost tripled between 1996 and 2007, andthe amount is $7.3 trillion. The securitized share of subprime mortgages such as for those whopassed to third-party investors via MBS whereas increased from 54% in 2001, to 75% in 2006.American homeowners, consumers, and corporations owed around $25 trillion during 2008. Then after that American banks reserved about $8 trillion of that total directly astraditional mortgage loans. Bondholders and other traditional lenders provided another $7trillion. The remaining $10 trillion came from the securitization markets. The securitizationmarkets started to close down in the spring of 2007 and nearly shut-down in the fall of 2008.During this time more than a third of the private credit markets thus became unavailable as asource of funds. Early of February 2009, Ben Bernanke stated that securitization markets remainedeffectively shut, with the exception of conforming mortgages, which could be sold to FannieMae and Freddie Mac. The relationship between securitization and the subprime crisis relatesto a fundamental fault like underwriters, rating agencies and investors modelled the correlationof risks among loans in securitization pools. Correlation modeling is the technique which is to develop by David X Li. this techniquedetermining how the default risk of one loan in a pool is statistically related to the default risk forother loans and it is based on a Gaussian copula technique developed by statistician DavidX. Li. This technique also, widely adopted as a means of evaluating the risk associated withsecuritization transactions, used what turned out to be an overly simplistic approach tocorrelation. Unfortunately, the flaws in this technique did not become clear to marketparticipants until after many hundreds of billions of dollars of ABS and CDOs backed by Serena Williams | Cause of the subprime mortgage crisis and its effect towards 11 Caribbean
  • 12. subprime loans had been rated and sold. Because of that situation the investors has stoppedfrom buying subprime backed securities, which halted the ability of mortgage originators toextend subprime loans. So this effected to the crisis were already beginning to emerge.Policy i) Government policiesAlthough the reasons are many and distant in the years, the root cause of the global financialcrisis of 2007-2008 is the growth of the bubble of real estate loans, as an effect of too muchliquidity placed on the market by strongly expansive monetary policy of the Fed of Greenspan.Between 2001 and 2004, in order to strengthen the labor market and the economic system, itlowered the interest rate to 1 percent. This, together with the propensity for speculation andover-indebtedness expressed by American peoples and fostered by generous ratings andwidely optimistic evaluations of risk, led to a dilation of mortgage loans. A high percentage of these loans were subprime and Alt-A mortgages, namely loans of lowquality. The new Basle II capital requirements made it attractive for banks to invest in supersenior tranches. Money markets funds are required only to invest in AAA rated assets. Otherfinancial institutions are regulated only to invest in investment grade assets. These investorsprovided a receptive market for the AAA rated asset backed bonds. ii) Policies of Central banksCentral banks manage monetary policy and may target the rate of inflation. They have someauthority over commercial banks and possibly other financial institutions. They are also lessconcerned with avoiding asset price bubbles, such as the housing bubble and dot-com bubble. Because of this acting of Central banks, Central Banks have generally chosen to reactafter such bubbles break open so as to minimize collateral damage to the economy, rather thantrying to prevent or stop the bubble itself. This is because central banks need to identify anasset bubble and determining the proper monetary policy to deflate it are matters of debate Serena Williams | Cause of the subprime mortgage crisis and its effect towards 12 Caribbean
  • 13. among economists. Some market observers have been concerned that Federal Reserveactions could give rise to moral hazard. A Government Accountability Office critic have been said that the Federal ReserveBank of New York s rescue of Long-Term Capital Management in 1998 would encouragelarge financial institutions to believe that the Federal Reserve would intervene on their behalf ifrisky loans went sour or unpleasant because they were “too big to fail.” A contributing factor to the rise in house prices was the Federal Reserve s making tolowering of interest rates early in the decade. From 2000 to 2003, the Federal Reserve loweredthe federal funds rate target from 6.5% to 1.0%. This was done to soften the effects of thecollapse of the dot-com bubble and of the September 2001 terrorist attacks, and to combat theperceived risk of deflation. The Fed then raised the Fed funds rate significantly between July2004 and July 2006. On this situation it is encourage and contributed to an increase in oneyear and five year ARM rates and making ARM interest rate resets more expensive forhomeowners. So because of this, it is may have also contributed to the deflating of thehousing bubble, as asset prices generally move inversely to interest rates and it became moreriskier to speculate in housing.Inaccurate credit ratingsSubprime mortgages went to all kinds of borrowers, not only to those with impaired credit. Aloan can be labeled subprime not only because of the characteristics of the borrower it wasoriginated for, but also because of the type of lender that originated it, features of the mortgageproduct itself, or how it was securitized. Specifically, if a loan was given to a borrower with a low credit score or a history ofdelinquency or bankruptcy, lenders would most likely label it subprime. But mortgages couldalso be labeled subprime if they were originated by a lender specializing in high-cost loansalthough not all high-cost loans are subprime. Also, unusual types of mortgages generally notavailable in the prime market, such as “2/28 hybrids,” which switch to an adjustable interestrate after only two years of a fixed rate, would be labeled subprime even if they were given toborrowers with credit scores that were sufficiently high to qualify for prime mortgage loans. The process of securitizing a loan could also affect its subprime designation. Manysubprime mortgages were securitized and sold on the secondary market. Securitizes rank Serena Williams | Cause of the subprime mortgage crisis and its effect towards 13 Caribbean
  • 14. ordered pools of mortgages from the most to the least risky at the time of securitization, basingthe ranking on a combination of several risk factors, such as credit score, loan-to-value anddebt-to-income ratios, etc. The most risky pools would become a part of a subprime security.All the loans in that security would be labeled subprime, regardless of the borrowers’ creditscores. The myth that subprime loans went only to those with bad credit arises from overlookingthe complexity of the subprime mortgage market and the fact that subprime mortgages aredefined in a number of ways not just by the credit quality of borrowers. One of the myth’s byproducts is that examples of borrowers with good credit and subprime loans have been seen asevidence of foul play, generating accusations that such borrowers must have been steeredunfairly and sometimes fraudulently into the subprime market.Oversupply of US Dollars i) distort real economyTo maintain the expansionary fiscal and monetary policies, United States has supplied moremoney to financial market and made US dollars “overflow” in financial institutions. This resultcauses the oversupply of dollar that led to the increased commodity prices, inflation andreduced the purchasing power parity of US dollar. Usually the magnitude of currency problemcan be reflected in the rise of gold price, for instance the gold price increased from USD 288per ounce in 1999 to more than USD 905 in 2008 and early June 2011 the gold currency hadrise to USD 1,530. The oversupply of US dollars led to the depreciation of US dollar, householdneeded to spend more money for same amount of services and consumption in non-housingitems. So as the consequences in less money available for them to pay housing mortgage andincreased their chance of defaults in their residential mortgages. ii) making financial institutions lowering lending criteriaThe oversupply of US dollars largely increased the liquidity of US dollars and the US financialinstitutions are full of US dollars, these causes the financial institutions have increasedpressure to lend out the oversupplied money so financial institutions should expand their clientbase to absorb the money. The subprime mortgage a loan is the innovated new products of Serena Williams | Cause of the subprime mortgage crisis and its effect towards 14 Caribbean
  • 15. lowered their lending criteria where they lent money to clients who are not qualified for loans onconventional criteria. Unfortunately, these instruments had contributed to the subprimemortgage crisis because people could not repay their loans.Deregulation opens door for subprime lendingThese factors also contributed to the boost of subprime lending, in 1980 the United Statespassed the Depository Institutions Deregulation and Monetary Control Act ( DIDMCA) whichhelped the Savings and Loan (S&L) industry to offer checkable deposits and allowed thefinancial institutions to charge interest rated they choose. While in 1982, the deregulationcontinued with the way of alternative mortgage transaction parity which preempted state lawsthat restricted banks from making any mortgage except conventional fixed rate amortizingmortgage. It is also allowed the use of variable interest and balloon payments and allowedlenders to make loans with term unclear the total cost of loans which led to new mortgageinstruments and cause many borrowers failed to understand and could not afford. These lawshad opened the door for development of subprime market but it not became a viable largescale lending alternative until the passage of Tax Reform Act of 1986 (TRA). The TRA removedthe tax deduction of interest on consumer loans but encourage the homeownership initiativesthroughout the increasing the home mortgage interest deduction as well as the addition of lowincome housing tax credit to boost homeownership for low income households. By 1995, theUS federal government executes a major reform of Community Reinvestment Act (CRA) andissued the National Homeownership strategy which led the financial institutions to lower themortgage lending standards. By the way, these increased the riskier and unsustainable lendingpractices through lowering mortgage underwriting standards and shifting from ensuring theequitable lending procedures without careful considering of the borrower’s ability to repay themortgage loans.Reckless lending of financial institutionsThe reckless lending by financial institutions is factor contributing the subprime mortgage crisis,the financial institutions give subprime loans to individuals who do not qualify for prime credit Serena Williams | Cause of the subprime mortgage crisis and its effect towards 15 Caribbean
  • 16. and basically not suitable for credit from traditional sources. Mortgage lending allows theunsuitable borrowers to get credit which is they often unable to offer a down payment, unableto pay debts and do not have source of income. In the case of those who have income, theircredit liability is disproportional to that income. The financial institutions went down markets toreach income and the lenders would promise loans with less paperwork but quick approval andno down payments. Financial institutions would attract the subprime borrowers with easy togets loan and short term interest rates for the beginning years but they subsequently had toreset to higher rates for the majority of the loan period. The lack of diligence had resulteddifferent types of subprime loans, some loans required little documentation of borrower’s abilityto meet repayments while other loans needed no proof of income or credit history. In additionthe mortgages were also sold by brokers and intermediaries without assessing the buyers’affordable capacity.Globalization, technology and the trade deficitDuring a year of 2005, Ben Bernanke addressed the implications of the United States’ high andrising current account deficit, resulting from U.S. investment exceeding its savings, or importsexceeding exports. Between 1996 and 2004, the U.S. current account deficit increased by $650billion, from 1.5% to 5.8% of GDP. The U.S. attracted a great deal of foreign investment, mainlyfrom the emerging economies in Asia and oil-exporting nations. The balance of paymentsidentity requires that a country (such as the U.S.) running a current account deficit also have acapital account (investment) surplus of the same amount. Foreign investors had these funds tolend, either because they had very high personal savings rates (as high as 40% in China), orbecause of high oil prices. Neo-liberalism” and “globalization” are new terms for policies and tactics the capitalistsand their governments have always used to attack working people in order to increase profits.For example, capitalists have always spread their system around the globe in order to exploitraw materials and cheap labor and to control trade routes and new or established markets.Chasing cheap labor around the globe and using cheap immigrant labor in order to get aroundlabor organizing. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 16 Caribbean
  • 17. Under “globalization” with the use of new technology the exploitation of cheap labor ona world scale intensified, sped-up in real time, and reached further distances. But the essenceof globalization has always existed under capitalism. For example, the collapse of Stalinism inthe Soviet Union and Eastern Bloc countries also breathed some new life into neo-liberalismand its offshoots, like globalization. Stalinism left in its rubble new areas of cheap labor toexploit and new parts of the globe to tear up and pollute. From the mid-1970s up through today, working class wages and social conditionsinevitably worsened under this worldwide neoliberal attack. In order to maintain demand, theability of masses of working people to consume while their wages were stagnating or falling,the capitalists began a massive expansion of credit. This included every aspect of individualdebt, from credit cards to car loans to house mortgages. Also, macroeconomic policies steepedin borrowing, like international currency speculation and financial market deregulation, werebrought to new international heights. Government deficit spending reached record levels. As a result, the development of the U.S. housing bubble and housing bubbles in othercountries spurred on by the fact that the vast majority of working people could no longer affordto buy a house due to wages stagnating or falling.Credit default swaps (CDS)Under a CDS, a bank originates loan to a company. A second bank (or other financialinstitution) can agree to cover the credit risk for the loan, by agree to make payment tooriginating bank if the company defaults on the original loan. The originating bank pays a smallinsurance premium to the second bank for assuming the risk of the loan. Typically, paymentsunder a CDS would only be triggered by the companys failure to pay interest or principal on itsdebts due to bankruptcy or some other severe liquidity issue. Actually, bank traders sold the credit risk of a loan not just once, but as many as 10times. And they sold it not to solid banks and insurance companies, but to three solid banks,one solid insurance company, three dodgy brokers and three hedge funds. But since itprobably hedged those positions against others, if the company does go bust, and dodgybrokers and hedge funds stop paying up, the total losses in the system from that companys Serena Williams | Cause of the subprime mortgage crisis and its effect towards 17 Caribbean
  • 18. credit risk are likely to be a substantial multiple of the original $10 million loan. The total creditrisk in the system has been increased from the original $10 million loan to somewhere between$160 million to 200 million, depending on whether the banks and insurance company arefinancially solid.4.2 The effect towards CaribbeanFinancial SectorThe financial sector in the Caribbean is quite insulated from the current global crisis, partlybecause it is small and underdeveloped and so mortgage backed securities were not dumpedonto their market by the USA investment banks. But in the case of AIG there can be said to bea direct connection, since that firm has insurance and re-insurance coverage for a number ofproducts and services in Jamaica and Trinidad and Tobago, inter alia. However, the massiveloan by the USA Government may serve to keep AIG afloat, although customers may be askedto pay a higher premium. Merrill Lynch the manager of certain Caribbean pension funds (e.g.that of the CARICOM Secretariat) which prompts the question as to whether the ‘minimum localassets ratio’ regulation, a requirement for both prudential and regional capital marketdevelopment purposes, is still being respected by the institutional investors (includinginsurance companies) in the non-commercial banking sector. The commercial banking sector in the Caribbean is quite tightly regulated, particularlysince the occurrence of the decline in Jamaica in the 1990s. So the managers tend to be ratherrisk averse during this time. At this moment, Caribbean have not sounded any serious problempartly because the USA correspondent banks that handle their day-to-day dollar transactions,being commercial banks rather than investment banks are on the greater of the crisis. Butaccording to the effect of financial sector in Caribbean, it would be fine if the regulators in theCaribbean region follow the pattern of Jamaica and Trinidad and Tobago and decree thatcommercial banks hold deposit insurance, moral hazard notwithstanding which is on the othermean is without being affected or prevented by something. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 18 Caribbean
  • 19. Economic growthEconomic growth in the Caribbean also is likely to be considerably lower than what it was in2007. In 2007, the Caribbean Development Bank (CDB) had reported that economic growthslowed in nine territories and accelerated in only four. so the whole of Caribbean, therefore,economic growth fell from 6.9% in 2006 to 3.9% in 2007 refer to the result of rising oil andcommodity prices, slower growth by major trading partners, depreciation of the USA dollar andthe high cost of intra-regional travel. Before the economic crisis happened, the Caribbean economies is the fastest growthsince the 1960s but the impact from meltdown in US financial system causes the economies ofCaribbean has change which can see from the slump in exports that happened in late 2008. Infirst nine months of 2009, the falling of tourist arrivals has led to the contracting GDP in nearlyall countries, rising unemployment and declining government revenues. Other than that, theinvestment activity has became plummeted that reflected in sharp reductions in foreigninvestment flows and a downturn in the construction sector. If the U.S economic fall it is give big impact to Caribbean economic and the financialtrauma affecting the US economy would have already plunged the Caribbean into an economiccoma. Even if the situation it is unlikely that this will happen. But the outward ripples of thefinancial crisis in the US will cause an economic downturn in the Caribbean. The US financial meltdown has its origins in what has been called the US subprimemortgage crisis. Mortgage lenders made loans available to borrowers who would not normallyqualify for mortgages at market rates. These mortgages would typically have attractive, easyinitial payments but included adjustable rates of interest if the market changed. At a time whenhousing prices were climbing, many borrowers took on difficult mortgages, thinking that as thevalue of their homes increased, they could quickly refinance. But once housing prices started to fall due to oversupply of housing stock, refinancingbecame more difficult and the adjustable rates on mortgages kicked in, unleashing a wave ofdefaults and foreclosures. The effects of this were felt beyond the borders of the United Statesbecause the credit risk did not remain solely with US lenders but had been transferred toinvestors all over the world. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 19 Caribbean
  • 20. Flow of RemittancesWith rising unemployment, falling house values and depreciation of other asset holdings,remittance flows to the Caribbean are expected to fall considerably as a effect of the financialcrisis. Because of the crisis some of the countries in Caribbean recoded that in 2007remittances from the USA alone were cited as Jamaica US$1.9 billion, Haiti US$1.8 billion,Guyana US$424 million, Trinidad and Tobago US$125 million, Suriname US$115 million andBelize US$105 million. Remittances have become a crucial source of income for some of theCaribbean countries. For example, in Guyana they represented 43% of the GNP, and in Haiti35% and Jamaica 18%. These figures are likely to fall considerably for 2008 and the poor andmost vulnerable or easily effected segments of the Caribbean population are likely to beseverely impacted. Retail establishments and related consumption sectors will accordinglyexperience a decline of activity.Foreign Exchange ReservesCaribbean Banks have about US$20 billion invested abroad as foreign exchange reserves. Thesubprime mortgage crisis gives effect to the Caribbean Central Banks whereas, these“sovereign wealth funds” earn income when invested in government bonds, corporate bonds orequity and earnings have fallen as a result of the crisis. In the case of Trinidad and Tobago, thereserves are said to be managed by a subsidiary of Lehman Brothers, which is a USAinvestment bank that has filed for bankruptcy protection. The crisis encourages reviewing of the Caribbean foreign exchange reserves holdingsstrategy. The effect to foreign exchange whereas the Caribbean facing some questioning, firstshould all of a country’s foreign exchange reserves be managed by one overseas investmentbank or be denominated in one international currency? And the second are the foreignexchange reserves adequate in a world that continues to be rattled by recurring financial crises?After the 1997-98 S.E. Asian financial crises, the Central Banks in the Caribbean region made Serena Williams | Cause of the subprime mortgage crisis and its effect towards 20 Caribbean
  • 21. a conscious or more alert attempt to increase their foreign exchange holdings above thetraditional three months import cover figure and some now have over five months import cover.For example, Trinidad and Tobago, for its part, has also placed US$9 billion of its petroleumand gas earnings into a Heritage and Stabilization Fund. Undoubtedly after the housing bubble burst, the US construction industry that employsa large number of Central Americans, notably Salvadorans, would experience a decline. Thepercentage of Caribbean immigrants employed in the construction industry in the United States,compared to Central Americans, is perhaps not that great.TourismTourism is the major income that contribute the GDP in their countries, in 2006 there are manytravelers come into Caribbean such as Bahamas, Jamaica, Guyana, Trinidad and Tobago butdue the effect from subprime crisis in US the Caribbean has faced uncertainty recession thatlead to reduced travel demand from that countries. The weakening of US dollar are tied withcurrencies in Caribbean that lead to increase in travel demand from Europe because the euroand sterling pound much stronger than dollar, however this may not be able compensate forthe loss from US market so as the result the Caribbean needs brace for the impact. Therefore,a United States recession would undoubtedly be felt in Caribbean economies because itreduced demand market from the market and negatively impact tourism and overall economic. Other than that, the energy crisis and related high oil prices continue to cause seriousair-lift problems for the Caribbean tourism sector such as a collapse of certain airlines,elimination of certain destinations, and reduction in the frequency of flights and increases inairfares. In addition, there is the adverse effect of a reduction in the baggage allowance. Thesituation is now further forced by the financial crisis with smaller number of persons being ableto afford holidays abroad. This coming winter season is therefore expected to be a ratherunwelcoming one for the hotel and entertainment industries. A double unpleasing thing such as hurricane season is increasing trouble for thetourism industry will come on top of the adverse impact of natural disasters whereas someCaribbean countries have been experiencing this. So this encourage those who contribute the Serena Williams | Cause of the subprime mortgage crisis and its effect towards 21 Caribbean
  • 22. least to global warming are most adversely affected and the World Bank Grant DisbursingFacility need to setting up of a disaster relief purposes. The Caribbean economies fastest growth period since the 1960s has been rapidlyinterrupted by the international economic crisis that began with the meltdown in the USfinancial system. The impact on these countries is being felt through a slump in exports thatstarted in late 2008, and that situation makes falling tourist arrivals in the first nine months of2009 that lead to contracting GDP in almost all countries, rising unemployment, and declininggovernment revenues. Investment activity has also plummeted, and is reflected in sharpreductions in foreign direct investment flows and a depression in the construction sector.Cost of BorrowingThe rate of interest is different among country so, there is a credit crunch in the markets of thedeveloped countries as loans are either not available or available at a rather high rate ofinterest. In situation of Caribbean entities, whether government or corporate, that Caribbeanattempt to tap the international market, will face this kind of situation experience and it will bemore difficulty even for those have a very good credit rating. However, because of this cost of borrowing Caribbean in recent years, CaribbeanGovernments and corporate entities have been secure financing for an increasing proportion oftheir debt from the surplus economy of Trinidad and Tobago, where the rate of interest,moreover, tends to be lower than the international rate.Foreign Direct Investment (FDI)The crisis happened in US has effected in Caribbean financial institutions, their financial assetsare less risky than previous years. Besides, the continuous reduction in interest rates in USmakes the region attractive to capital inflows which raise the growth in asset prices. Thefinancial crisis worsen in United States would severely affect the global financial systemharming particularly the more financial services dependent Caribbean country. It also affect FDIwhere the banks would be more reluctant to grant loans to multinational corporations and Serena Williams | Cause of the subprime mortgage crisis and its effect towards 22 Caribbean
  • 23. would result the increased uncertainty which make them less willing to invest, this conditionwould give negatively affect the Caribbean countries. The year 2008 is expected to show a decline in foreign direct investment (FDI),particularly since the USA accounts for a large share of FDI in the Caribbean. Because of thecredit crunch (and fall in the level of economic activity) investors would not have the level ofcapital or business confidence that would be required to engage in large projects of a naturalresource or hotel construction and infrastructure nature. One exception would be explorationand drilling activity in the area of petroleum and natural gas. Accordingly, FDI in the Caribbeanin 2008 is likely to be less than the 2007 estimate of US$4.5 billion or the actual 2006 figure ofUS$3.8 billion. Although FDI per capita has been relatively high in the Caribbean, there is now needfor a redoubling of investment promotion efforts and greater geographical diversification of thesources of investment inflows. In addition, intra-Caribbean investment should be morevigorously encouraged. The year 2008 is expected to show a decline in foreign direct investment (FDI) asoccurred after the 9/11 event in 2001, particularly since the USA accounts for a large share ofFDI in the Caribbean. Because of the credit crunch (and fall in the level of economic activity)investors would not have the level of capital or business confidence that would be required toengage in large projects of a natural resource or hotel construction and infrastructure nature.One exception would be exploration and drilling activity in the area of petroleum and naturalgas. Accordingly, FDI in the Caribbean in 2008 is likely to be less than the 2007 estimate ofUS$4.5 billion or the actual 2006 figure of US$3.8 billion. Although FDI per capita has been relatively high in the Caribbean, there is now needfor a redoubling of investment promotion efforts and greater geographical diversification of thesources of investment inflows. In addition, intra-Caribbean investment should be morevigorously encouraged. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 23 Caribbean
  • 24. Other Export EarningsThe intensification of the crisis adversely affects USA demand for Caribbean manufacturedgoods whether these enjoy preferential market access (CBI/CBTPA) or not. The Caribbeandollar tends to be tied to the USA dollar and so when the latter fell in the early stages of thecrisis Euro and Pound earnings from commodity (and tourism) sales to Europe partiallycompensated; however, now that there is tending to be a currency realignment, this is nolonger the case. In any event, if the deepening of the crisis is prolonged, European demand forour traditional exports (bananas, sugar, rice, etc) will fall, as well as demand by China, Russia,etc for bauxite resources. Two other commodities worth mentioning are petroleum and gas,and gold; Trinidad and Tobago’s earnings have fallen from the dizzying heights reached duringthe energy crisis, whereas, Guyana and Suriname would have benefited from a rise in the priceof gold, a commodity to which speculators gravitate in times of financial crisis. One other export adversely affected is that of capital. For decades, there has been anunspoken low intensity flight of capital (‘reverse remittances’) to mainly the USA, Canada andBritain by businessmen and individuals wishing to hedge their bets against socio-economic andpolitical instability in the Caribbean. Such holdings of stocks, bonds and real estate would haveexperienced a drop in earnings during the crisis, although these assets are typically held for thelong haul and should eventually recover in value. Whether the capital flight slows down is left tobe seen. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 24 Caribbean
  • 25. 5.0 ConclusionEven the subprime crisis originated in the United States but the consequences were felt andslowdown the whole economic in the world even in the developing countries such as Caribbean.These occurred at a time when developing economies have been enjoying years of goodgrowth and has involved in great depression because of impact from the subprime mortgageloan in US. The crisis has shown how important credit and risk management institutions intoeconomic growth, the appropriate institutions for the correct functioning of the financial sectorand the international financial architecture for mitigating financial crisis. Indeed, the US has introduced the appropriate countercyclical policies that will in alllikelihood reverse further declines in stock and housing prices and that will boost theinvestment and growth. But usually, these depend on the act of national government and theinternational community to interventions and using the fiscal stimulus packages that suitablewith the seriousness of the problem. In Caribbean there are some recommendations to avoidthe impact from US recession which is, the countries must explore alternative markets for theirmain exports to soften the impact of reduced import demand from US and the Caribbeangovernments need became proactive in creating sustainable employment opportunities, otherthan that the diversification of foreign reserves by the region’s central and commercial banksthat means the reserves not only be United States dollar denominated but should consist ofcombination other world currencies. By the way, there are limitations of extant valuation models and the failure of regulatorsto understand the implications of the changing environment for the financial system and there isdifferent design or approach to examine the subprime mortgage market meltdown from atheoretical and practical perspective so these might cause the accuracy in the results ofresearch paper. So the role of government as the intervention is necessary and appropriate tobecame as intermediaries in their country, the government should continuing build theappropriate financial systems and keep working reforming the international financial system. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 25 Caribbean
  • 26. 6.0 ReferencesAntonopoulos, R. (2009). the current economic and financial crisis: a Gender Perpective. The Levy Economics Institute of Bard College, working Paper NO. 562, 3.Baily, M. N., & Elliott, D. J. (2009). The US financial and economic crisis: where does it stand and where do we go from here. Brookings Institution, Jun.ECLAC. (2008). THE UNITED STATES SUBPRIME MORTGAGE CRISIS AND ITS IMPLICATION FOR THE CARIBBEAN. Economic Commission for latin and the Caribbean (ECLAC), 21, 1-11.Jacob, M. A. a. D. (2008). The Sub-prime Problem: causes and lessons. Adelson & Jacob Consulting, LLC, 8, 1.Kamin, S. (1999). The current international financial crisis: how much is new? Board of Governors of the Federal Reserve System International Finance Working Paper No. 636.Michel G. Crouhy, R. A. J. a. S. M. T. (2007). The Subprime Credit Crisis of 07. Credit Crisis.Naude, W. (2009). The Financial Crisis of 2008 and the developing Countries. World Institution for development Economics Research, Discussion Paper No.2009/01, 2-2.Shiller, R. J. (2008). The subprime solution: How todays global financial crisis happened, and what to do about it: Princeton Univ Pr.Spiegel, A. K. R. a. M. M. (2009). CROSS-COUNTRY CAUSES AND CONSEQUENCES OF THE 2008 CRISIS: EARLY WARNING. NATIONAL BUREAU OF ECONOMIC RESEARCH, 55, 10.Stiglitz, J. E. (2009). The current economic crisis and lessons for economic theory. Eastern Economic Journal, 35(3), 281-296.Suhaib Riaz, (2009),"The global financial crisis: an institutional theory analysis", critical perspectiveson international business, Vol. 5 Iss: 1 pp. 26 - 35United Nations. (2008). The United States Subprime Mortgage Crisis and Its Implications For The Caribbean. 1-18. Serena Williams | Cause of the subprime mortgage crisis and its effect towards 26 Caribbean
  • 27. UNHABITAT. (2011). THE SUB PRIME CRISIS, the crisis of over-spending and over-supply. The Global Urban Economic Dialogue Series, 32, 1-22.Vukovic. V. (2010). Political economy of the US financial crisis 2007-2009. Financial Theory and Practice , 1-18.Whalen. R. C. (2008). The Subprime Crisis - Cause, Effect and Consequences . Network Financial Institute, 1-17. Retrieved on 15 April 2012 Retrieved on 13 April 2012. Retrieved on 13 April 2012. Retrieved on 16 April 2012 Retrieved on 16 April 2012 Serena Williams | Cause of the subprime mortgage crisis and its effect towards 27 Caribbean