Subprime lending can be described as lending at a higher rate of interest than normal rate of interest, on loans to people with poor paying capacity. It includes subprime mortgages, subprime car loans, & subprime credit cards.
It is also called as “Subprime Loans” which is one that is offered at an interest rate higher loans due to the increased risk.
SUBPRIME CRISISThe crisis began with the bursting of thehousing bubble in the US & high default rateson “subprime” & “adjustable rate mortgages(ARM)” made to higher-risk borrowers withlower income or lesser credit history than“prime”.
It all started in 2006 with US Market tumbling down dueto defaults by the subprime borrowers.Increase in interest rates and simultaneously fall inproperty prices, hit the market leading to subprimemortgage crisis. Between the years 2000-2005, Lowinterest rates, high property prices.In 2005, the property prices started falling, interest ratesstarted touching the roof top, leaving no room for thesubprime borrowers.In 1994, less than 5% of total mortgages were subprime inUS. But within 2005, that figure went up to 20%.However, in 2005, the rates of interest began toincrease. Therefore, demand for home came down whichalso brought down the property prices leading to start ofsubprime crisis.
Subprime Borrowers For poor credit history Limited income Subprime Lenders Greater risks High returns
The Housing Downturn Excess supply of home inventory Sales volume of new homes dropped Reduced market prices (10.4% 12/06-12/07) Borrowers Difficulties in re-financing Begin to default on loans Walk away from properties
Stock Market 08/15/07 Dow Jones had dropped below 13,000 from July’s 14000 First 3 weeks of 08, the Dow Jones Industrial Average fell 9% 1/18/08 Dow Jones/0.5%, S&P 500/0.6%, and NASDAQ/0.3% 01/21/08 (black Monday) the world’s biggest falls since Sept. 11, 2001 Home Owners Housing prices down 10.4% in Dec. 07 vs. year-ago Sales of new homes dropped by 26.4% in 07 vs. 06 By Jan. 2008, the inventory of unsold new homes stood at 9.8 months, the highest level since 1981. Two million families will be evicted from their homes Economy Condition Low GDP growth rate Business close out or lose money (banks, builders etc.) Weak financial market Low consumer spending Lose jobs
US Federal Reserve provided an emergency loan of US$85 billion to insurance major, American International Group (AIG), which will be repaid by selling off assets of AIG Investment bank, Merill Lynch was acquired by Bank of America in September 2008 for $50 billion US Federal Reserve granted approval to investment banks, Goldman Sachs and Morgan Stanley to convert themselves into commercial banks US Treasury Department confirmed that both Fannie Mae and Freddie Mac, would be placed into conservatorship with the government taking over their management
Wachovia Corp agrees to sell most of its assets to Citigroup Inc in a deal brokered by regulators. However, Wells Fargo, a commercial bank, drafted an agreement to acquire assets of Wachovia for US$15.1 billion. The deal forced Wachovia to backtrack from the Citigroup deal worth US$2.2 billion which was backed by the US Government . US Government releases a US$700 billion bailout package for its financial industry. Dow Jones posts its largest point decline ever while the S&P 500 had its worst day since 1987 with an 8.8% drop
o Investors will be very cautious to act oLack confidence in stock/bound marketo Consumer spending will slowdown oLack of cash or unwilling to spendo World economy may slip into recession oU.S. economy condition will affect global economyo GDP growth will be low oLose businesses, Lose jobs, Economy slow downo Financial market oMay take long time to recovero Unemployment rate may be high oSlow economy increase unemployment rateo Exports will decrease in China, Korea, Taiwan oGDP growth heavily depends on export
Too many financial institutions breakdown as a result of reckless lending. Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system.