The subprime mortgage crisis 1


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The subprime mortgage crisis 1

  1. 1. The SubprimeMortgage Crisis Devendra Nikale Role No. 1 Batch 20 ITM EEC, Kharghar
  2. 2. What are subprime mortgages? Typically, those who qualify for the most ideal mortgages with the best interest rates are those with good credit scores and minimal debt. A subprime mortgage is a type of loan granted to individuals with poor credit histories (typically below 600), who would not be able to qualify for conventional mortgages. Subprime mortgages charge interest rates that are above the typical interest rate because of the risk that is involved on the part of the lender.
  3. 3. What are subprime mortgages? There are several different types of subprime mortgages, but the most common is the adjustable rate mortgage (ARM). ARMs can be misleading to subprime borrowers because they initially pay a lower interest rate. After the given period of time, their mortgages are set to a much higher rate. Therefore, their mortgage payments increase dramatically.
  4. 4. How did the housing bubble develop? The housing bubble grew alongside the stock bubble in the mid 1990s. The stock bubble increased the wealth of people, which led them to spend money on consumption including bigger and better houses. The increased demand led house prices to rise. People lost faith in the stock market and thought investing in a home would be a much safer alternative. Also going on at this time was the slow recovery from the 2001 recession. This led the Federal Reserve Board to cut interest rates in an effort to stimulate the economy. Fixed-rate mortgages, as well as other interest rates hit 50 year lows. This was a huge incentive to buy a home. Between 1997 and 2006, the price of the typical American house increased by 124%
  5. 5. Amount of Subprime Mortgages allotted on time scale
  6. 6. 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.
  7. 7. The Subprime Mortgage Crisis Explained: At this point, many who had taken on these subprime mortgages and their interest rates were beginning to “reset” to the higher rates, making their monthly mortgage payments much higher than before. People then began to sell their homes – but there was a problem to doing this. Since the price of homes had severely decreased, they did not have enough money after selling to cover the amount of the mortgage.
  8. 8. The Subprime Mortgage Crisis Explained: If a person could not sell their home, this ultimately left the homeowner with one option, and that was to DEFAULT. When a home is defaulted, this is the first step towards foreclosure. After the notice of default, there is a reinstatement period before the home is put up for auction by the bank. If the defaulted loan isn’t taken care of in a given amount of time, the bank resumes responsibility of the home and is put up for auction.
  9. 9. The Subprime Mortgage Crisis Explained: However, when put in an auction, the bank usually sells the home at a price that is much lower than what it is worth. The amount that they receive in this process gets put towards the borrower’s loan, but the borrower still has to account for the difference that they owe towards the loan. The process of auctioning off these houses creates a increase in supply of homes in the market, which will decrease the home prices. U.S. Housing market: 3 million foreclosures (2008) U.S. Banking sector: $1-$2 trillion net cost of bailout World stock markets: Almost 50% loss in the total capitalization in 2008--$30 trillion of wealth disappeared
  10. 10. The Subprime Mortgage Crisis Explained: Financial Institutions – Write-Downs – Citigroup (USA) - $24.1 bln – Merrill Lynch (USA) - $22.5 bln – UBS AG (Switzerland) - $16.7 bln – Morgan Stanley (USA) - $10.3 – Credit Agricole (France) - $4.8 bln – HSBC (United Kingdom) - $3.4 bln – Bank of America (USA) - $5.28 bln – CIBC (Canada) – 3.2 bln – Deutsche Bank (Germany) - $3.1 bln
  11. 11. Responses to the Crisis US: Bailout Package – around $800 bn Emergency Economic Stabilization Act of 2008 and the Homeowners Affordability and Stability Plan. Former President Bill Clinton and former Federal Reserve Chairman Alan Greenspan indicated they did not properly regulate derivatives, including credit default swaps. A bill called the Derivatives Markets Transparency and Accountability Act of 2009 has been proposed to further regulate the CDS market. This bill provided the authority to suspend CDS trading under certain conditions.
  12. 12. Issues To Rethink Five main topics are important to consider when discussing solutions to the crises: liquidity, solvency, economic stimulus, homeowner assistance, and regulation. Liquidity: Central banks have expanded their lending and money supplies, to offset the decline in lending by private institutions and investors. Solvency: Some financial institutions are facing risks regarding their solvency, or ability to pay their obligations. Alternatives involve restructuring through bankruptcy, bondholder haircuts, or government bailouts Economic stimulus: Governments have increased spending or cut taxes to offset declines in consumer spending and business investment. Homeowner assistance: Banks are adjusting the terms of mortgage loans to avoid foreclosure, with the goal of maximizing cash payments. Governments are offering financial incentives for lenders to assist borrowers. Regulation: rules designed help stabilize the financial system (such as regulating derivatives)
  13. 13. Sources: wikipedia
  14. 14. Thank You