U.s. Subprime Mortgage Crisis

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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…show more content…
that has been in upward trend until 2006 and so did the mortgage origination volume. Source: S&P Case-Shiller, Inside Mortgage Finance in Sanders (2008)
Further supported by The National Homeownership Strategy, which targeted banking industry to enhance the availability of affordable housing via creative financing (Whalen, 2008), mortgage brokers and lenders aggressively extended financings to the subprime borrowers without adequate risk assessments on borrowers’ credit ratings and leverage ratios. Incomplete and fraudulent loan application documentations thus, became a norm. Subprime borrowers generally refer to borrowers with lack of creditworthiness, insufficient base income and high credit dependency. Lenders therefore, imposed higher interest rates on mortgages extended to these high-risk borrowers, which eventually reduced their repayments capacity. At the same time, it was perceived by many lenders that housing prices would keep rising, hence, the collateral valuation too, thus probability of default was considered as low. The loans, which were priced using the Adjustable-Rate-Mortgages (ARM), basically offers low initial ‘teaser’ rates, which applies over a certain period and resets to higher rates upon expiration of the adjustment period (Gapper, 2007). The innovation was intended to allow access by the poor into the fold i.e. formal finance by enabling these borrowers to establish some credit profile with the bank, which would
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