Subprime

Topics: Subprime mortgage crisis, Mortgage, Subprime lending Pages: 6 (2011 words) Published: July 9, 2013
In year 2007, United States witnessed the Subprime Mortgage Crisis, which was known as the “Mortgage meltdown”. It triggered a national financial crisis, which led to a tremendous decline is the housing market, rise in foreclosures and the collapse of some leading banks. This essay will look into the various causes of the subprime crisis as well as the parties who are responsible for this economic tragedy.

Years prior to the crisis, United States had large inflow of foreign funds. In 2001 to 2003, The Federal Reserve Board lowered interest rates from about 6.5% to 1.0% in an effort to improve the economy of the United States. This sets off a domino reaction where it allows easier borrowing of funds for corporate or consumer and spurs the economy, which eventually led to the rise of Subprime mortgage loans. As the economy recovered, there was a boom in the housing market, which saw properties prices at its peak between the year 2004 to 2006. Thus, the Federal Reserve started raising its rates from the historically low levels.

As the name of the crisis suggests, “Subprime mortgage loans” contributed mainly to this crisis. Subprime mortgage refers to a type of loan granted to individuals with poor credit histories and due to their lower credit ratings; they were not able to qualify for traditional mortgages as the risk of defaulting on these loans were higher. When housing prices peaked, many Americans wanted to get their dream houses especially when there was easy access to credit. Lenders that funded the mortgage loans then started to offer more loans to high-risk borrowers. Despite being aware of their weak credit histories and high defaulting risk, banks still saw it as a attractive investment opportunity because of its liquidity and the assumption that housing prices were appreciating.

Soon came the burst of the housing bubble. As interest rates started rising, it made borrowers difficult to refinance their loans once the easy initial terms had expired. Subsequently, default rates on the mortgage loans increased, the number of foreclosures increased heavily, resulting in the flood of these foreclosed houses in the market. While the inventory for unsold houses increased, the demand for houses dropped significantly causing property prices to drop sharply. People were not willing to continue paying for a mortgage debt that is even higher than the value of the property. This left the investors and banks that sold these mortgages a pile of worthless properties as well as bad debts in hand.

Major global financial institutions that had invested heavily in these mortgages suffered heavy losses due to debt burdens and insufficient financial cushioning to absorb the defaulted loans. It was so severe that some banks even faced bankruptcy and this questioned the stability of the financial institutions. Predatory lending alongside with the inability of borrowers to repay their mortgage loans resulted in high personal and corporate debt levels. Many Americans were left homeless without a roof over their heads. The Subprime crisis proved to be a huge price to pay for the United States.

In the event of the Subprime crisis, there is no single entity to put the blame on. Instead, a mixture of banks, investors, lenders, buyers, and credit rating agencies caused this mess.

Lenders
As mentioned above, before the crisis occurred there was a high demand for mortgage loans. Traditionally, borrowers will only qualify for a conventional loan from the bank if he has a good credit history. However, with the increase demand for mortgages, a new kind of lender emerges into the market. These lenders actually finance the mortgages and were the ones who ultimately decide to lend funds to the subprime borrowers. They offered loans at a higher interest rate than market rates. The borrowers had bad credit histories, which would mean higher risks and default rates. Despite being fully aware of the risks of such mortgage loans, they...
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