Us Subprime Mortgage Crisis
Autor: sanatb • November 8, 2016 • Essay • 613 Words (3 Pages) • 850 Views
- What is it?
The ‘US Subprime Mortgage Crisis’ refers to the financial meltdown that was observed during the years 2007-09 brought upon by the bursting of the US Housing Bubble; and led to a recession costing more than $22 Trillion to the US economy alone (according to a study published by Government Accountability Office in 2013).
- What caused it?
The crisis was caused due to the interplay of many factors.
In the aftermath of the Tech Bubble and 9/11 attack, the US Fed decreased interest rates to very low level (~1%) to stimulate the economy.
During the Housing Bubble (high demand for real estate coupled with low interest rates), the lenders made easy mortgages to home buyers due to large demand.
Investment Banks (IBs) bought these mortgages from the lenders, re-packaged them together into Financial Instruments known as Collateralized Debt Obligations (CDOs), and further sold them to investors (Pension Funds, Mutual Funds, Sovereign Funds etc.). These CDOs consisted of ‘tranches’ with different risk-return characteristics. The investors lapped up these CDOs as they were looking for investments which yielded a higher rate of return than the Treasury securities issued by the government (which were providing low returns due to low interest rates). This led to a chain of securitization [Borrowers - Lenders – IBs (Re-package) – Investors].
The IBs took high leverage (at the prevailing low interest rates) to buy more and more of the mortgages. This led to a practice of Subprime Lending to house buyers by the lenders to fulfil the high demand. Subprime Lending refers to the practice of extending mortgages to buyers who couldn’t qualify for traditional loans because of a weak credit history or other factors. These subprime mortgages became 20% of the market in 2006 (according to a report by the Washington Post).
When house prices peaked, mortgage refinancing and selling homes became less viable means of settling mortgage debt and mortgage loss rates began rising for lenders and investors
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