PPT on subprime mortgage crisis

2. INTRODUCTION
 The US subprime mortgage crisis that broke out in august 2007 was triggered by
mortgage delinquencies in the US and has escalated into a global financial
crisis.1 Investor confidence sagged off, and Knightian uncertainty2 emerged,
consequently risk premia increased and liquidity was withdrawn from interbank and
credit markets.3 This financial disturbance and the bankruptcies of some banks and
near banks (e.g. insurance companies, hedge funds) triggered contagiously waves of
violent collapses in the financial system.

3. MICROECONOMIC CAUSES
1. Credit User Variable
2. Financial Intermediate Variable
3. Credit Derivative Variable

4. CREDIT USER VARIABLE
 The subprime bubble in the US and other parts of the world was fueled by historically
low interest rates, initiated to soften the massive collapse of the dot.com bubble burst,
and backed by poor lending standards and in particular a mania for purchasing
houses which mirrors the credit user variable.5 Mortgage refinancing was applied by
some credit user, which used the enlarged real estate value driven by the subprime
bubble to refinance their real estates with lower interest rates, and took out additional
mortgage against the added value to use the funds for consumption.6 Latter is one of
the reasons why the USA has been one of the first countries in world history with
negative saving rates, financed by foreign investors, e.g. China, Japan and oil and
commodity producing Countries.79

5.  During the early 21 century recession, which began in 2001 and was boosted by the
September 11, 2001 terrorist attacks, the Americans were asked to invest, declaring
“consumerism” as an act of patriotism.8 The one who linked shopping to patriotism
was the former President Bill Clinton, promoting the phrase “get out and shop”.This
slogan was based on the idea to stimulate future growth by encouraging consumption
in the present. As well the credit card bubble reflects the credit user dilemma,
choosing between present and future consumption

6.  . It is believed that a significant percentage of the baby boom generation is not saving
adequately enough for their retirement. Typically the baby generation planned to use
their increased real estate value as a piggy bank or replacement for a retirement-
savings account. “It’s a change from previous generations when people worked to pay
off the family house so they could hand it down to their children.”10 However, below
the line consumers acted rationally considering the regulative and incentive market
context cheering for and rewarding high consumption, financed by easy and cheap
credit lines and backed by increasing property value.11

8. CREDIT DERIVATIVE
VARIABLE
 Model innovations in financial engineering originated credit derivative contracts in
particular CDOs16 and CDSs which enabled to transform the classical credit
intermediation process with its buy and hold strategy to credit securitization,
transforming future cash flows into tradable securities backed by its own anticipated
cash flows.17 The classical credit intermediation process can be stated as efficient
because financial intermediaries had to audit the current and future solvency of
debtors.18 Financial innovations like CDOs are adding significantly value by enhancing
and controlling better asset liability management or portfolio management in general,
by (1) transforming risk, term and size, (2) diversifying and (3) allocating credit
positions to the respective risk exposure of investors.

9.  The result is a market for tradable CDOs tailored to the needs of
investors.19 Disintermediation was not caused by credit derivatives but by financial
agents that were focused on receiving provisions and boni by the given incentive
schemes, profiting from the information and risk asymmetries during the credit risk
allocation process. In relation to the given regulatory and incentive market conditions
every part in this credit lending chain acted rationally.20 Rational behavior gives not an
excuse for moral hazards, but it shifts more the focus on macroeconomic causes like
for example the easy-credit- lending policy since 2001 or the expansionary fiscal
policies, both demand-sided economic policy instruments are anticipating future
growth to maintain the present level of consumption.21.”2

10.  In contrast to that, supply-sided economic policy tackles regulation and incentive
market conditions, e.g. the pricing of CDSs, which is based on a notional principal
amount, which is estimated by the SEC to be USD 61 trillion or “over four times the
publicly traded corporate and mortgage U.S. debt they are supposed to insure, are
completely unregulated, and have often been contracted over the phone without
documentation Under this given unregulated and in-transparent market conditions,
moral hazard can augment without any constraints. Another major contributor to this
adverse selection and mispricing of credit derivatives were the given incentive
scheme, which fostered moral hazards or in other words a principal agent bias in
reference to subjective judgment, verification and due diligence of the model inputs
and ultimately questioning validity of applied pricing models et all.

11. FINANCIAL INTERMEDIATE
VARIABLE
 Financial intermediates were able to generate loans and transfer the risk to others, a
mayor incentive why lenders offered an increasing range of loans to credit users,
which exposed a high credit default risk. Latter is known as originate and distribute
model and was made possible, because of the securitization processes, investors
who were seeking for mortgage-backed securities (MBS) and rating agencies that
gave investments grade ratings to MBS.12 The trend of disintermediation of financial
intermediates caused a change from the pursued objective of interest rate towards
provision gains.13

12.  Indeed, market observes described that each link in the mortgage credit chain
profited and tried to pass on the risk to the next link.14 Consequently mortgages
standards became to high risky, and moral hazard augmented, due to the fact that the
originate and distribute model diminished the screening and monitoring incentives of
the originating banks.

13.  Impact on Indian economy was not really severe. Considering that a sizable
portion of the Gross domestic product is due to domestic sources with low
dependence on foreign sources. Indian economy at the time of financial crisis had
little exports to the foreign nations. Indian banks had little investment in the us
subprime mortgage and no connection to the stressed financial institutions. (All
the above data is taken considering the 2008 situation of Indian economy)

14.  During the crisis the net worth of Americans declined by 17 trillion dollars
(inflation adjusted) estimated by St. Louis Federal Reserve Bank in 2012, a loss of
26 percent. A study done by, the Federal Reserve Bank of San Francisco in 2018
revealed that gross domestic product was approximately altered by 7 percent i.e.,
7 percent lower than it would have been had the crisis not occurred, due to the
crisis around 7.5 million jobs were lost which led to unemployment rate touching
almost 10% For people around the world, recovery from crisis and the great
recession was slow, millions of families lost their homes, jobs, savings and the
bread earners of these families faced long term unemployment because of which
majority fell into poverty—continued to struggle years after the worst of the
economic turmoil had passed.

15.  On the other hand, the bankers who were responsible for such crisis in the first
place received lavish bonuses for resigning. most of the investment banks and
hedge funds recovered their losses within a couple of years, moreover no American
CEO or other senior executives went to jail they weren’t even prosecuted on
criminal charges. The visible contrast between the elite and the working class of
the society naturally endangered public resentment , which blended in 2011 in the
occupy wall street movement— a move against the system that seemed designed
to serve the interests of the very wealthy—the “1 percent,” as opposed to the “99
percent”—the movement increased awareness of inequality in the United States, a
prospective issue that soon became a theme of Democratic political rhetoric at
both the federal and the state levels.

16. On October 3, 2008, Then President George W. Bush put is
signature on the $700 billion Emergency Economic
Stabilization Act (EESA) of 2008 after Treasury Secretary
Paulson asked Congress to approve a bailout to buy
Mortgage-Backed Securities that were in danger of renege.
consequently, Paulson wanted to take these debts off the
books of the banks, hedge funds, and pension funds that
held them. His goal was to re-establish confidence in the
functioning of the global banking system and end the
financial crisis.

17.  The bill established the Troubled Assets Relief Program which revolved around
the idea of reverse auction but auction was scrapped because of the shortage of
time On October 14, 2008, the Treasury Department used $105 billion in TARP
funds to launch the Capital Purchase Program, which purchased preferred stocks
in the eight banks. By the time TARP expired on October 3, 2010, Treasury had
used the funds in four other areas:2 • $67.8 billion to the $182 billion bailout of
American Investment Group • $80.7 billion to bail out the Three auto companies •
$20 billion to the Reserve for the Term Asset-Backed Securities Loan Facility,
which lent money to its member banks so they could continue offering credit to
homeowners and businesses • $75 billion to help citizens to refinance or
restructure their mortgages with the Homeowner Affordability and Stability Plan
The Treasury disbursed $440 billion of TARP funds in total and, by 2018, it had
put $442.6 billion back. It did this by nationalizing companies when prices were
low and selling them when prices were high, although if we factor in inflation, it
encountered a loss

18. No questions please and don’t give us less
than full marks