The subprime crisis is one of the biggest disasters of the financial system. It originated in the US subprime mortgage market in 2006 and within a year it engulfed the financial sector of USA along with numerous mature economies. The weaker income groups comprising the Afro-Americans and the Hispanics suffered home losses. It is projected that the number of subprime foreclosures will reach 2 million, if measures are not taken to resolve the crisis. This accompanied by the shortage of funds in the mortgage market will result in a significant slowdown in the growth of housings. Business operations and investment activities have been hampered by the lack of flow of funds. The central banks throughout the world resorted to numerous rescue operations to curb the growing threat. The bank rates were cut to increase investor confidence, personal tax rebates were given and liquidity was injected in the market. But, these measures have failed to uplift the market sentiments.
There are a number of issues and puzzles in the subprime crisis which are enlisted as follows: 1)The magnitude of the meltdown and the output and employment loss is disproportionately large compared to the default in the subprime market. The losses of $ 34 billion is insignificant when compared to the $57 trillion US financial system. 2)The failure of the sophisticated risk management techniques comprising the securitization of loans and collateralized debt obligations. 3)The subprime problem took place when the US was enjoying a robust GDP growth and a declining rate of unemployment. For this reason, the slide in the economy is a bit puzzling. 4)Unlike in 2001-02, when the Fed’s policy arrested the recessionary trend following the dotcom bubble burst, in this occasion the Fed’s policy have failed to arrest the economic slide. .
Growth of the subprime market
Subprime lending consists of loans extended to...