Discuss the Causes of the Sub-Prime Crisis and the Parties Responsible for Such a Crisis.

2248 Words Feb 25th, 2013 9 Pages
Discuss the causes of the sub-prime crisis and the parties responsible for such a crisis.

Sherman Oh E S
Principles of banking & finance (PBF)
Mr Marvin Ang
26th January 2013

According to www.investopedia.com, the world “subprime” defines to “A classification of borrowers with a tarnished or limited credit history” and that is what led to the titanic crisis of 2008-2009. This essay will explore the events, which eventually led to many mortgage delinquencies and foreclosure of these sub prime borrower’s homes, causing the insurance company AIG and many other banks to foreclose thus forcing bail out money from the American government to prevent the next great depression.

In the past, traditional mortgage loans that could be acquired
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A rating agency was required find out the creditworthiness of an investment. This can apply to any company, bank, government or an investment. There were namely 3 famous rating agencies involved in the crisis namely, Standard & Poor's (S&P), Moody's, and Fitch Group. To give an example of a rating would be like the big internet search company “Google” would be given a rating like AA+ i.e. a high grade. Many of these CDOs however were given good ratings such as AAA+ the highest rating possible given by any rating agency. These CDOs did not deserve the rating as the CDOs were made of mortgages of lenders who were unable to pay their mortgage. The reason for such a high rating was simple. In the past, rating agencies were paid by the buyer to rate the assets they were going to invest in. In 1970s however, the systems changed and now it was the seller that was paying the agency for the ratings, on a per-rating basis. This gave incentives for rating agencies to rate more and be more generous in their rating. A conflict of interest rose and rating agencies were now earning large amount of profit for these CDOs. They were more then happy to rate them. Moody’s earned nearly US$1 billion a year from rating in 2005 and 2006. With an average of $300k per rating why wouldn’t they want to rate more? Aside from that, they had to give a good rating due to

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