Sub Prime Crisis

Securitization Food Chain is the chain of loan payments for mortgage loans. The chain started with home buyers taking out a mortgage loan from lenders. After home buyers would take out a loan the lenders would then sell the mortgage to investment banks. The investment banks combined thousands such as car loans, student loans, credit card debt, and ect. The combination of all the loans was called Collateralized Debt Obligation. Investment banks take the Collateralized Debt Obligation and sell them to investors often misleading the investors to believe the investments where low risk. Risky investments were then made with the depositors money. They did not care about the quality of the mortgage, only maximizing their volume and getting a fee out of

Since mid 1990s, the subprime mortgage market has grown rapidly experiencing a phenomenal 23% compound annual growth rate to 2006. The total subprime loan originations increased from $65 billion in 1995 to $613 billion in 2006. The subprime sector has become a significant sub-sector of the total residential market accounting for 21% of all residential mortgage originations in 2006. Similarly, by year-end 2006, total outstanding balance of subprime loans grew to $1.2 trillion, approximately 12.6% of all outstanding mortgage debt.

In the 1980s, investments banks such as Goldman Sachs, Merrill Lynch, Bear Stearns, JP Morgan, and Morgan Stanley started selling mortgage bonds. Mortgage bonds were a collection of thousands of home mortgages, purchased from lenders, and their associated income streams (monthly payment). To address the fact that some homeowners often refinance their debt when interest rates are low which prematurely pays off the debt, mortgage bonds were stacked into layers called ‘tranches’. The lowest tranche represented mortgages to be paid off early, and the highest layer was the last mortgages to be paid off.

The financial crisis emerged because of an excessive deregulation of business operation of financial institutions and of abusing the securitization mechanism in the absence of clearly defined rules to regulate this area in the American mortgage market (Krstić, Jemović, & Radojičić, 2013). Deregulation gives larger banks the opportunity to loosen underwriting lender guidelines and generate increase opportunity for homeownership (Kroszner & Strahan, 2013). After deregulation, banks utilized many versions of mortgage loans. Mortgage loans such as subprime and Alternative-A paper loans became available for borrowers challenged to find mortgage lenders before deregulation (Elbarouki, 2016; Palmer, 2015). The housing market has been severely affected by fluctuating interest rates and the requirement of large down payment (Follain, & Giertz, 2013). The subprime lending crisis has taken a toll on the nation’s economy since 2007. Individuals who lacked sufficient credit ratings or down payments resorted to subprime mortgages to finance their homes Defaults on subprime and other mortgages precipitated the foreclosure crisis, which contributed to the recent recession and national financial crisis (Odetunde, 2015). Subprime mortgages were appropriate for borrowers with substandard credit and Alternate-A paper loans were

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.

The most commonly known sub-prime finance crisis came into illumination when a sudden rise in home foreclosures in 2006 twirled seemingly out of control in 2007, triggering a nationwide economic crisis that went worldwide within the year. The greatest responsibility is pointed at the lenders who created such problems. It was the lenders who, at the end of the day, lend finances to citizens with poor credit and a high risk of failure to pay. When the Feds inundated the markets with growing capital

In 2008, one of the worst financial crises since the Great Depression occurred. The severity of this collapse cannot be understated as demonstrated by the bankruptcy of Lehman Brothers, the fourth largest investment bank in the US, and with many other financial institutions such as Merrill Lynch and the Royal Bank of Scotland having to be bailed out. In addition, the Global Banking System was within a whisker of collapsing and if it where not for the trillions of dollars invested in the system by national banks then this banking collapse would have lead to economic catastrophe. Therefore, in order to avoid such a calamity from occurring again, it is important to ask the question why did this financial recession occur and what factors contributed towards this downfall? Although there are many reasons as to why this recession occurred it could be argued that securitized lending and shadow banking played the largest role in this economic crisis. It is therefore important to understand what securitized lending and shadow banking means. Securitized lending is the process by which a financial institution such as a bank pools illiquid assets, such as residential and commercial mortgages and auto loans (by which the bank receives from the public through house mortgages and loans), and loans these newly formed short-term bonds to third party investors in exchange for cash or collateral. Since its creation in the 18th century, securitized lending was increasingly popular and very much

Asset backed - securities, which is the name for securitization of mortgages, is where sub-prime mortgages and securitization had a major role in the 2008 financial crisis. After the year 2000 banks became a lot less strict on who they would grant loans to mainly because they wanted to make more money. Banks standards decrease a lot so if someone wanted to apply for a loan and buy a house they would not even have to document their incomes one hundred percent, the client could just state it without full verification. Subprime loans, where banks mortgage loans to people with good or bad credit, is exactly what happened between the years 2000-2006. When the big private corporate companies are mentioned, those are the banks that essentially contributed to causing the crisis. Once the recession finally struck in 2007 those loans as subprime loans that were given out to the citizens with bad credit, they defaulted on those loans eventually leading to the foreclosure of their homes. The banks used securitization during this time to liquidate the mortgages and put all the pressure on the private investor so they would not have to take the hit once the homeowner defaulted. Because banks kept relaxing on the loans, mortgages became in demand so citizens kept applying for loans but they did not realize they all that these corporate banks were

The U.S. subprime mortgage crisis was a set of events that led to the 2008 financial crisis, characterized by a rise in subprime mortgage defaults and foreclosures. This paper seeks to explain the causes of the U.S. subprime mortgage crisis and how this has led to a generalized credit crisis in other financial sectors that ultimately affects the real economy. In recent decades, financial industry has developed quickly and various financial innovation techniques have been abused widely, which is the main cause of this international financial crisis. In addition, deregulation, loose monetary policies of the Federal Reserve, shadow banking system also play

In the new system, an investment banker buys the mortgage from the lender, borrowing millions of dollars to buy thousands of mortgages, and every month he gets payments from homeowners for each of the mortgages. The banker then consolidates all the mortgages and splits the final product into three sections: safe, okay, and risky mortgages, which make up a collateralized debt obligation (CDO). As homeowners pay their mortgages, money flows into each of the sections, with the safe filling first and the risky filling last, contributing to their respective names. Credit agencies stamp the top two safer mortgages with a triple A or triple B rating, which are then be sold to investors who want a safe mortgage, while the risky slice is sold to hedge funds who want a risky investment. The bankers make millions, pay back their loans, and investors also make a worthwhile investment. So pleased are the investors, however, that they want more. Unfortunately, back at the beginning of the cycle, the mortgage broker can no longer find qualified mortgagers

One of the first indications of the late 2000 financial crisis that led to downward spiral known as the “Recession” was the subprime mortgages; known as the “mortgage mess”. A few years earlier the substantial boom of the housing market led to the uprising of mortgage loans. Because interest rates were low, investors took advantage of the low rates to buy homes that they could in return ‘flip’ (reselling) and homeowners bought homes that they typically wouldn’t have been able to afford. High interest rates usually keep people from borrowing money because it limits the amount available to use for an investment. But the creation of the subprime mortgage

The new lackadaisical lending requirements and low interest rates drove housing prices higher, which only made the mortgage backed securities and CDOs seem like an even better investment. Now consider the housing market which had become a housing bubble, which had now burst, and now people could not pay for their incredibly expensive houses or keep up with their ballooning mortgage payments. Borrowers started defaulting, which put more houses back on the market for sale. But there were not any buyers. Supply was up, demand was down, and home prices started collapsing. As prices fell, some borrowers suddenly had a mortgage for way more than their home was currently worth and some stopped paying. That led to more defaults, pushing prices down further. As this was happening, the big financial institutions stopped buying sub-prime mortgages and sub-prime lenders were getting stuck with bad loans. By 2007, some big lenders had declared bankruptcy. The problems spread to the big investors, who had poured money into the mortgage backed securities and CDOs. They started losing money on their investments. All these of these financial instruments resulted in an incredibly complicated web of assets, liabilities, and risks. So that when things went bad, they went bad for the entire financial system. Some major financial players declared bankruptcy and others were forced into mergers, or needed

The U.S. subprime mortgage crisis was a catastrophe affecting both real and financial sectors of the global economy. It was estimated that 2.5 million borrowers had lost their homes due to foreclosures from 2007 to 2009 and whilst another 5.7 million homeowners were at pending risk of foreclosure in the aftermath of the crisis (Williams, 2012). The failures and bailed out of large banking and financial institutions in the US, the UK, Europe and others such as Bear Sterns, Lehman Brothers, Northern Rock, AIG, Freddie Mac, Fannie Mae and etc. including the major collapsed of Iceland’s systemic banking, characterised as one of the largest experienced by any country in economic history, is an emblematic of the excessive and imprudent lending

Moreover, the foreclosure rate varied from only 1.58% on prime loans to an outstanding 12.55% on subprime mortgage loans (Subprime Mortgage, 2016). Due to the collapse in the housing market, foreclosures caused an estimated $71 billion in losses at the end of 2007, as well as, another $32 billion is losses to properties neighboring the foreclosures (Li & Li, 2012). Consequently, investors began to see the risk associated with mortgage backed securities and began purchasing safer investment. The housing bubble burst had a profound effect on financial institutions involved in the securitization of subprime mortgages and as such was the tipping point to the financial crisis.

The word meltdown no longer applies to just nuclear reactors, unruly toddlers or Popsicles and is extended to sub-prime as well. The sub-prime mortgage crisis was a slight tremor that turned into a disaster, threatening to plunge the U.S. economy into its worst recession since the tech bubble in the early 2000s. The only consensus on the issue of who caused the financial sub-prime crisis of 2008 has been that there were many who did. In the instance of sub-prime mortgage woes, there is no single entity or individual to point the finger at. Instead, this mess is a collective creation of the world 's central banks, homeowners, lenders, credit rating agencies and underwriters, and investors.