You are on page 1of 27

SUBPRIME CRISIS

By: Akashdeep Singh

The Subprime Mortgage Crisis

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, 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.

About the crisis


Post 2001, the US government had encouraged US banks to lend money to people, to encourage spending & investing mainly for the purpose of buying houses These banks granted loans to large number of borrowers despite having lower income levels, unsure employment status, unscrupulous credit history, etc. Huge number of borrowers availed of bank credit without evaluating their repayment capacities. The economy was flush with liquidity & stock markets were booming

The crisis began with the bursting of the housing bubble in the US & high default rates on subprime & adjustable rate mortgages (ARM) made to higher-risk borrowers with lower income or lesser credit history than prime.

The bubble burst


A silent storm brewed in international financial markets with origins in the US housing market, which witnessed an unprecedented boom since 2001 The boom was led by rising housing prices, low interest rates & aggravated by financial innovation viz. MBS, CDO and CDS Housing prices in USA began to drop in 2006. Rising interest rates & falling housing prices led to rise in sub prime mortgage delinquencies & resultant foreclosure Result: The housing bubble burst in Aug 2006
Source: Sub Prime Crisis - Presentation by Astha - May 2008

The Housing Bubble and the Crash of 2008


Loan Amount: $100,000 Interest Rate: 1% Rate Adjustments: 3
Month 1 13 25 Beginning Balance Principal Paid 100,000 97,126 95,314 322 472 528 Interest Paid 83 324 397 Interest Rate 1% 4% 5% Total 405 796 925

Sub Prime Crisis

LIQUIDITY OVER

Impact of Sub Prime Crisis in USA

The chart above brings out the irony and shows that underlying sub prime houses are only a small percentage of the total housing market and it was the bubble formed due to financial instruments viz. MBS, CDO and CDS, that caused the real problem

Impact of Sub Prime Crisis in USA


Initial impact was felt in March 2008, when investment bank, Bear Stearns was acquired by J.P. Morgan Chase, a commercial bank, for US$1.2 billion September 2008, witnessed major shakeouts in the US financial sector. The drama began with Lehman Brothers declaring bankruptcy on 15 September 2008, facing a refusal by the federal government to bail it out Washington Mutual is closed by the US government in the largest failure of a US bank. Its banking assets are sold to J.P. Morgan Chase for US$1.9 billion

The problem with investment bank balance sheets is that on the left side nothing is right and on the right side nothing is left

Impact of Sub Prime Crisis in USA


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

Impact of Sub Prime Crisis in USA


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 blln 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 What's the difference between a guy who just lost everything in Las Vegas and an Investment Banker? A tie

Domino Effect across the World


Northern Rock Bank had difficulty finding finance to keep the business going and was nationalised in February 2008 British bank Lloyds TSB Group Plc agrees to buy rival HBOS Plc, (UKs largest mortgage lender) scooping up Britain's biggest home loan lender in an all-share deal which values HBOS at over 12 billion (US$22.3 billion) In September 2008, British bank Bradford & Bingley was nationalised by the UK government, which will take control of the bank's 50bn mortgages and loans, while its savings operations and branches are to be sold to Spain's Santander

Domino Effect across the World


The Dutch operations of Fortis, Europe's largest victim of the credit crisis, have been nationalised in a 16.8 billion (13 billion) deal aimed to calm investors in the troubled banking and insurance group Germany struggled to rescue lender Hypo Real Estate (Mortgage Giant), underlining the challenge facing European leaders, who vowed to restore stability in a banking system hit by the worst crisis since the 1930s In October 2008, the Australian government announced that AU$4 billion was to be raised to fund non-bank lenders that are unable to obtain funding to finance new loans. After industry feedback this was increased to AU$8 billion Japanese financial powerhouse, Nomura Holdings Inc. bought over Lehman's franchise in Europe and Asia Pacific, including Japan and Australia

Domino Effect across the World


Stock markets tanked - Crisis caused panic in the financial markets and investors sold out and withdrew their money, resulting in sharp drop in stock prices Many banks, mortgage lenders, real estate investment trusts & hedge funds suffered significant losses Credit got tighter - banks became extremely careful parting with their capital and decreased lending activities either to business houses, retail customers and even to each other Effect on jobs Many employees lost their jobs, especially in the financial sector

What's the difference between a bond and a bond trader? A bond matures

Domino Effect in India


FII investments increased in most of 2007 in a booming Indian economy, as the Sensex was on its way to a historic peak of over 20,000 points Since the inflow of dollars in the Indian economy increased, the dollar exchange rate decreased In 2008, however, due to the effect of the sub prime crisis, FIIs liquidated their equity investments in a big way leading to a crash in the stock markets Simultaneously international commodity prices, including oil prices, were on a rise due increasing demand for these commodities The combined effect resulted in an increase in the dollar exchange rate

Sequence of events

The Housing Bubble and the Crash of 2008


Other sectors also lost money (real estate, construction, etc.)
This started to affect the stock market when investors lost confidence in the economy

Poland: Part of Eurozone,but has a stable banking sector Ireland: First Eurozone country to slide into recession France: Sluggish economy heading for recession Hungary: -ve credit raing, heavy debts, huge current account deficit

Russia: Fast growing economy with large foreign reserves China: ??? Strained with economic surplus and counterfeit goods Singapore: Prosperous, government guarantee for deposits till 2010

India: Economic slowdown with high inflation and poverty

BUT, the crisis is truly GLOBAL!

Banks pull back:


Banks re-evaluate high-risk loans in the face of potential losses on loans to hedge funds.

As a result, credit is tightened for borrowers across the board, affecting commercial real estate, leveraged buyouts, venture capital lending, mergers and acquisitions, etc.

Ongoing Effects:

Subprime mortgage industry collapses, thousands of jobs are lost Surge of foreclosure activity Housing prices and sales are both down Interest rates rise across the board as the effects of the collapse of the subprime mortgage industry seep into the near-prime and prime mortgage markets Investors lost billions of dollars in securities tied to the subprime mortgage industry, resulting in upheavals throughout the global financial market

Government Action:
To avoid complete market failure and to allow banks to borrow money cheaply, the Federal Reserve, European Central Bank, and their counterparts flood the market with billions of dollars, Euros, and yen in August 2007. The injected government funds are designed to encourage banks to continue making loans rather than conserving cash and making the credit crunch worse. Analysts are concerned that rather than calming the markets and biding time for the crisis to pass, government action will lead to inflation and an international credit crunch that would slow economic growth worldwide.

Steps taken by Indian Govt.


Reduced into CRR to 5.5% Through cut into CRR, There is flow of 120+ thousand crore into Indian market Plan to lift the Ban from PN (i.e. participatory notes) Reduced the Prime Landing Rate by all Public sector Banks Reduced into ATFs price (i.e. aircraft turbine fuel) Planning for putting Ban on short selling.

Who is to Blame?
Lenders: for their predatory lending practices focused on subprime mortgage candidates Mortgage brokers: for steering borrowers to unaffordable loans Appraisers: for inflating housing values Wall Street investors: for backing subprime mortgage loans without first verifying the security of the portfolio Borrowers: for overstating income levels on loan applications and entering into loan agreements they could not afford Government: for lack of oversight

An Example of Subprime Mortgage


Would you like a mortgage that lends you more than the value of your house? Would you like it structured so that your first payments are extra low? If the mortgage weren't structured that way, would you be unable to afford the payments? Are you convinced that real estate prices will continue to rise? Do you have a poor credit history?

Congratulations if you answered "Yes" to most or all of those questions! You're an ideal target for a subprime mortgage lender.

Thank You

You might also like