Sub Prime Crisis

Topics: Subprime mortgage crisis, Mortgage, Subprime lending Pages: 15 (5874 words) Published: February 16, 2013

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. The economy was at risk of a deep recession after the dotcom bubble burst in early 2000; this situation was compounded by the September 11 terrorist attacks that followed in 2001. In response, central banks around the world tried to stimulate the economy. They created capital liquidity through a reduction in interest rates. In turn, investors sought higher returns through riskier investments. Lenders took on greater risks too, and approved sub-prime mortgage loans to borrowers with poor credit. Consumer demand drove the housing bubble to all-time highs in the summer of 2005, which ultimately collapsed in August of 2006. Housing prices in the United States crested in 2007, following nearly a decade of unprecedented increases fuelled by a perfect storm of easy credit conditions, sub-prime lending, predatory lending and fraudulent underwriting practices. When the housing bubble burst, the consequences were far reaching, affecting home values, home supply retail outlets, home builders, foreclosures and the mortgage, credit, hedge fund and foreign bank markets. The author wishes to analyse the causes and effects of the subprime crisis of 2008 in detail with special focus on the banking regulation. The paper also studies the timeline of the crisis and its impact on India and other developing nations. It provides for certain valuable suggestions for the banking industry to prevent the re occurrence of such a meltdown in the near future. Research Methodology

The Researcher has adopted the doctrinal form of research in completing this project. This form of research was most appropriate as the project is a study of the Sub-prime Crisis in the United States and across the world. Research material used includes works of eminent economists and scholars about the causes and effects of the Sub-prime Crisis. Also, online sources like Investopedia, JSTOR, Google Books, Hein Online and various university sites have been used. No part of this project is plagiarized and it is the original work of the Researcher.

Before delving into the crisis of 2008 and its causes and effects to the economy, the author wishes to explain the relevant definitions for the term sub-prime and connected concepts. The term ‘sub-prime’ is a general classification of borrowers with a tarnished or limited credit history, which was surprisingly a large chunk of the American population. It is classifications of loans offered at rates which are greater than the prime rate to individuals who are unable qualify for prime rate loans. In addition to having higher interest rates than prime-rate loans, sub-prime loans often come with higher fees. A process known as risk-based pricing is used to calculate mortgage rates and terms - the worse your credit, the more expensive the loan. In such a system, lenders end up using a credit scoring system to determine which loans a borrower is interested in and is worthy of investing in it. They carry more credit risk, and as such, have higher interest rates as well. Approximately more than 25% of mortgage originations are classified as sub-prime originations. In some cases, certain borrowers are also classified as sub-prime despite having a good credit history, since...
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