Subprime Mortgage & Crisis

Outline
 What is subprime mortgage?
 How it all started?
 Why it gained importance?
 Formulation of the Bubble
 Burst of the ‘Super-Bubble’
 Credit Crisis – What went wrong?
 Mistakes made by ‘The Big Banks’
 The great collapse
 Is this the End or a new Beginning?
Subprime Mortgage
 Subprime mortgage or subprime
borrowers are individuals who do
not receive loans from banks based
on their FICO scores
 Parameters related to the credit
worthiness of the borrower are
taken into considerations before
granting a loan
Its birth
 Since March 2001, a combination of low
interest rates and easy flow of money
helped to create easy credit conditions
 Housing market was in a boom leading to
more developments of property
 Subprime borrowers took advantage and
purchased houses due to easy credit
 With home prices shooting the roof, it
even encouraged a refinancing boom
Rise to Stardom
 The overall US home ownership increased
from 64% in 1999 to 69% in 20041
 Housing prices soared 124% between
1997 and 20061
 Securitized share of subprime mortgages
increased from 54% in 2001 to 75% in
20061
 Between 1999 & 2005, the average price
of existing homes rose 48%, the 2005
median home price soared to $206,000,
15.5% above previous year2
Source: 1 The Analyst, November 2008e
2
Naomi Shechan Groce, World Socialist Website
Formulation of the Bubble
Partners in Crime:
Sub Prime Sale of
Borrower CDO
Buyers:
Insurance cos.
School boards
Mortgage Commercial Banks
CDS cover
Lender Pension Funds
Hedge Funds
Investment Banks
Credit
Banks Insurer:
ratings
AIG

Rating Agencies:
Investment CDO Moody’s
Banks Tranches S&P
Burst of the ‘Super-Bubble’

Start

Source: Wikipedia
Credit Crisis – What went wrong?
 Originated from a developed economy, US
 Created and aggravated by some of the
largest and sophisticated financial
institutions
 Crisis not spread through defaults on debt
instruments but due to excessive leverage
and widespread securitization
 Regulatory and accounting mechanisms
were ineffective and outright failures
 Traditional economy tools were not
designed to manage credit and liquidity
crisis
Source: An article on ‘The Credit Crisis – What Went Wrong?’ by Robert P Hartwig
Mistakes made by ‘The Big Banks’
The great collapse
 Merrill Lynch acquired by Bank of America
 Bear Stearns and Washington Mutual
acquired by JPMorgan
 Wachovia taken over by Citibank
 Lehman Brothers filed for bankruptcy
 Goldman Sachs and Morgan Stanley
converted into commercial banks
 AIG, Fannie Mae and Freddie Mac have
been nationalized in multi-billion dollar
bailouts by the government
Is this the End or a new Beginning?
 CDS market has grown exponentially to
$62tn from $1tn in 2001
 The CDS trade is similar to the CDO
chain, as the risk gets transferred from
one party to another
 As its traded on the OTC, there is no
regulation and being speculative and
subjective in nature, the risk increases
 Some people are of the view that huge
defaults can be expected in credit card
payments too