Possible Exam 3

The mortgage crisis of 2007 marked catastrophe for millions of homeowners who suffered from foreclosure and short sales. Most of the problems involving the foreclosing of families’ homes could boil down to risky borrowing and lending. Lenders were pushed to ensure families would be eligible for a loan, when in previous years the same families would have been deemed too high-risk to obtain any kind of loan. With the increase in high-risk families obtaining loans, there was a huge increase in home buyers and subsequently a rapid increase in home prices. As a result, prices peaked and then began falling just as fast as they rose. Soon after families began to default on their mortgages forcing them either into foreclosure or short sales. Who was to blame for the risky lending and borrowing that caused the mortgage meltdown? Many might blame the company Fannie Mae and Freddie Mac, but in reality the entire system of buying and selling and free market failed home owners and the housing economy.

The company’s finance department had the chance to reduce the company’s weight in mortgage-backed securities. However, it chooses not to. The company’s financial adviser did not evaluate any risk that would emerge in the economic sector of the U.S during that year. Furthermore, the company had an opportunity to identify the consequence that would result due to the falling mortgages; somewhat the company neglected this risk and increased in value of portfolio.

It’s a risk that these investors took where in the end, they were financially hurt by it due to the part of the subprime lenders acting unethically. Not only the subprime lenders, but also the investors because they started to loose their standards once the subprime mortgages were booming and becoming more profitable. The investors were blinded by the profit and not paying attention to the qualities of business and the loans. Once the investors started to loose their standards, that’s when the subprime mortgages were being overlooked in which they were hurt by it.

A number of legislative and economic factors contributed to the growth of the subprime market:

The beginning of the crisis is rooted in banks giving out subprime loans to people who would have not otherwise been given these loans. The banks assumed that these loans could be bundled and the numbers proved that they were safe investments, because enough people would pay their loans back.

According to Bates & Robb (2015), the history of subprime mortgage lending dates back to the early 1970's when the Community Reinvestment Act (CRA) passed. The CRA change the way federally chartered banks loan money in inner-city communities to primarily low income and minority consumers (Schuchter, & Jutte, 2014). The intent of the CRA was not to prevent the financial crisis; however, it did play a role in the mortgage crisis. The original indictment of the statute, however, it failed to insulate low- and moderate-income communities from the harshest impacts of the crisis (Brescia, 2014). The CRA legislation purpose is to generate a response to lending activities that occurred primarily in urban communities, but it also applies to depository

During 2007 through 2010 there existed what we commonly refer to as the subprime mortgage crisis. Through deduction of readings by those considered esteemed in the realm of finance - such as Ben Bernanke - the crisis arose out of an earlier expansion of mortgage credit. This included extending mortgages to borrowers who previously would have had difficulty getting mortgages; this both contributed to and was facilitated by rapidly rising home prices. Pre-subprime mortgages, those looking to buy homes found it difficult to obtain mortgages if they had below average credit histories, provided small down payments or sought high-payment loans without the collateral, income, and/or credit history to match with their mortgage request. Indeed some high-risk families could obtain small-sized mortgages backed by the Federal Housing Administration (FHA), otherwise, those facing limited credit options, rented. Because of these processes, home ownership fluctuated around 65 percent, mortgage foreclosure rates were low, and home construction and house prices mainly reflected swings in mortgage interest rates and income.

27). You now had highly leveraged mortgage loans, with a decreasing 30-year conventional mortgage rate, and rising home prices (Exhibit 1 & 3). According to the National Bureau of Economic Research the trifecta of, “rising home prices, falling mortgage rates, and more efficient refinancing lured masses of homeowners to refinance their homes and extract equity at the same time, increasing systemic risk in the financial system” (Belsie). As home prices continued to rise from 2000-2006 (Exhibit 1), individuals could then refinance their homes, collect their equity, and then use that money to purchase another home with no background information needed. As Michael Lewis mentions in The Big Short, “Steve Eisman’s baby nurse and her sister said they owned six townhouses in Queens. After they bought their first one, and it’s value rose, the lenders came and suggested they refinance and take out $250,000-which they used to buy another” (Lewis, 2010, p. 98). This would eventually happen multiple times as home prices rose until they owned five townhouse. Moving forward, it was the brokers & lenders who would fall next in line of greasing up the doomsday machine. From 2003 to 2006 sub-prime mortgage lending as a percentage of all mortgages originated tripled in quantity, of which for than 75% would be securitized into collateralized debt

One of the primary factors that can be attributed as to have led the recent financial crisis is the financial deregulation allowing financial institutions a lot of freedom in the way they operated. The manifestation of this was seen in the form of:

The problem to be investigated is the ethics and effects of subprime loans on the financial institutions, borrowers and stakeholders. The subprime market was created to provide borrowers with a FICO score below 570 access to home loans. Inopportunely these loans were a major financial risk as most of the borrowers did not have the long-term income to pay for the high interest rate loans. (Jennings, 2012)

There were several things that caused the subprime mortgage crisis of 2008. Research by Ryan Barns (Barns, 2008) supports the idea that the path to mortgage crisis was the result of too little oversight and too much greed. First with the popularity of the World Wide Web in the early 90s, we began to see the emergence of many Internet based companies. This was known as the Dot com “bubble”. These internet companies were growing so rapidly they were making e-commerce millionaires very quickly and everyone wanted in. Many people were investing heavily into internet based companies with the hopes of huge returns. One of the problems with this was that there was no way to determine the actual value of these companies because many of them had no actual product and the stock price vastly outgrew the actual worth, eventually this created

  Contrary to popular belief among some financial analysts, the mortgage crisis of 2008 may have occurred with or without the existence of subprime mortgages. According to the U.S. Census Bureau, 1744 at their peak rose to just over 20% of all home mortgages originated, of which 35% defaulted. Subprime mortgage defaults accounted for approximately 7% of mortgage originated s at their peak. The cumulative defaults of conventional mortgages from vintage pools of 2007 were over 13%, surpassing subprime default rates (see Figure V, Fannie Mae 2013). The credit characteristics of Fannie Mae and Freddie Mac mortgage pools originated between the years 2001-2007 were virtually the same, however

These brokers have neither the credit skills nor the interest to conduct proper payment due of potential homebuyers. Their interest is only in selling the houses as fast as they can. The MBS instruments allowed all financial institutions to transfer the risks to other investors. The dissociation of ownership of assets from risks encouraged poor credit assessment and was fundamental increasing the risks.

In relation to the increase in house’s price, the rise of financial agreements such as mortgage-backed securities (MBS) and collateralized debt obligations (CDO) encouraged investors to invest in the U.S housing market (Krugman, 2009). When housing price declined in the U.S, many financial institutions that borrowed and invested in subprime mortgage reported losses. In addition, the fall of housing price resulted in default and foreclosure and that began to exhaust consumer’s wealth and

In the second half of 2007, the banking industry and financial market showed signs of considerable stress by raising the default rate of mortgage and the decline in the value of residential mortgage-backed securities. This had led to a re-pricing of many debt instruments. By the end of 2007, Citigroup declared that the fair value of its U.S. sub-prime related direct exposure could decline by 20%. This affected Citigroup’s financial results and would incur further losses in the future.