brief note on spc

1. Subprime crisis

2. PRESENTATION OUTLINE
• WHAT IS SUBPRIME & PRIME?
• WHAT IS CRISIS?
• Causes of subprime crisis
• How subprime crisis spread?
• Housing bubble burst
• SUBPRIME CRISES Impact on India
• SOLUTIONS GIVEN BY US GOVERNMENT

3. PRIME LOANS AND SUBPRIME LOANS
• 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.
• SUBPRIME- These are the loans that are offered to
borrowers with bankruptcies, defaults, or late payment
histories.

4. WHAT IS CRISIS……???
• An unstable and dangerous situation affecting
an individual, group, community or whole
society.
• Negative changes in the security, economic,
political, social or environmental affairs,
especially when they occur abruptly, with little
or no warning.

6. Large Loan given at
low rate of interest
FINANCIAL INSTITUTUION/
INVESTMENT BANK
Small loans
distributed at high
rate of interest
Money is Invested
HIGH profits

7. THE SUBPRIME MORTGAGE CRISIS EXPLAINED:
• 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.

8. Bankrupt
FINANCIAL INSTITUTUION/
INVESTMENT BANK
Subprime Defaulters
Bankrupt
Investor House

9. HOUSING BUBBLE…

10. What Is a Bubble, Exactly?
In the simplest terms, a bubble is an
overheated market in which there are
too many buyers who are too keen to
buy.
As a result, prices rise way too fast, and
this situation becomes unsustainable.
Eventually, some people realize this and
start to sell out. The whole process goes
into reverse equally rapidly, and the
bubble bursts, with people selling in
panic so that prices plunge.
Particularly those who entered the
market late in the process suffer
substantial losses.

11. HOUSING BUBBLE
 Housing prices 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 !

12. CAUSES
HOME
OWNERSHIP
RESIDENTIAL
REAL ESTATE
AS A SAFE
BUYING FOR
SPECULATION
Since, till 2006 Real Estate
market was increasing.

14. 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.
• Just as rising home prices reinforced the continuing rise in home
prices, falling home prices reinforced the continuing fall in home
prices.

15. Conti……
• The increase in foreclosures added to the inventory of homes
available for sale.
• This further decreased home prices, putting more homeowners
into a negative equity position and leading to more foreclosures.
• The increase in foreclosures also decreased the value of
mortgage-backed securities.
• This made it difficult for investment banks to issue new
mortgage-backed securities, eliminating a major source of
financing for new mortgage loans and contributing to the
continuing decline in home prices.

16. • Most of the losses were not incurred by homeowners but by the
financial system.
• 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.

17. NOTE…….
• The bursting of any housing bubble would be expected to have
a negative effect on the economy for two reasons:
A. Home construction is an important economic activity, and the
decline in home construction would reduce GDP.
B. The decrease in home prices would also reduce household
consumption due to the wealth effect.
 But the bursting of this housing bubble caused more severe and
widespread harm than would be predicted from just these two
reasons.
 As mentioned previously, most of the losses were suffered by
the financial system, not by the homeowners. The bursting of
the housing bubble sent a shock through the entire financial
system.

18. IMPACT ON INDIA .
• The foreign banks started unloading their holding
in INDIAN EQUITIES resulting in fall in the stock
price and weakening the domestic currency .
• Hitting the IT enabled services since a majority
firms derive 75% of revenue from US.
• Manufacturing sectors has to ramp up scale
economies and improve productivity &
operational efficiency .
• The near recession situation in the US has lead to
the loss of demand for Indian exports and hence
there is loss of export earnings in India.

19. • A recession in US has seen some job loss in
India
• The subprime crisis has led to a loss of
confidence in the American stock market
• Investment banks and other financial
institutions are on a job slashing spree to cut
costs
• There will be several implications for the
banking sector Indian banks have to follow
stricter norms while disbursing loans

20. SOLUTIONS GIVEN BY US GOVERNMENT
• To help lower-income people renegotiate their loans
& stay in their homes.
• They hope more money for lower-income families
will be free & shift the balance of power between
borrowers & lenders.
• FHA insure slightly more expensive homes.
• Deutsche Bank estimates that about $400 billion in
subprime loans are scheduled for rate increase of
30% or more.
• To provide the needy financial institutions with the
liquidity that they need.
• ECB is lending at the normal rate.