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8/8/2019 Sub Prime Mortgage Presentation
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The Sub PrimeSaga
8/8/2019 Sub Prime Mortgage Presentation
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Derivatives are Weapons of MassDestruction
8/8/2019 Sub Prime Mortgage Presentation
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In The Beginning
Companies Like GMAC, Ford Credit and GE FinancedPurchases and Sold Off Loans
Investors Made Good Returns and CompaniesReplenished Their Coffers To Sell More
These Companies Continued The Process and Kept TheFaith of The Investors
A Market Developed For Securitized Debt
8/8/2019 Sub Prime Mortgage Presentation
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What Happened???
Americans Began Buying More Homes
Non-Bank Financial Institutions Began Lending
House Prices Rose Americans Continued to Buy Homes
House Prices Continued to Rise
Etc. Etc. Etc.(Supply andD
emand)
8/8/2019 Sub Prime Mortgage Presentation
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Evolution of the ProcessProspective Homebuyer Wants Loan
The Lender gives loan without checking Credentials at
Subprime rates
The Lender will sell the loan to investment banker who
will create bond to finance the loan
The Investment Banker will then sell the bond
to another investor
The Investment Banker will also sell Credit Default Swap
to another investor to insure the first investor
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What went wr
ong
The whole process happened on the assumption thatHousing prices will always go up so that even if a borrowercannot repay the loan he can sell the House at a higherprice to repay the loan. But when the Housing pricescollapsed the borrower could not repay the loan andhence the lender could not pay the investment banker andhence the Investment Bank could not repay the investorhence the price of credit default swap collapsed and
hence the whole financial world entered crisis.
For example a house which had a worth of $100000 had acredit exposure of nearly $300000 which was three timesthe actual value of the house.
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Fees,
Fees,
Fees
Mortgage Broker Earns a Fee
Lender Earns a Fee
Investment Bank Earns a Fee
Broker Earns a Fee
Servicer Earns a Fee
Investor Earns a Return (Supposedly)
Homebuyer Pays All Fees
8/8/2019 Sub Prime Mortgage Presentation
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Terms and Meanings Sub Prime Mortgage Borrower
Borrower Has Poor Credit, Will Pay Higher Rate
Mortgage Backed Securities Shares of a Pool of Mortgages Sold to Investors Carry High Rates of Interest for Investors
Home Equity Loans Loans for the Difference Between Mortgage and Value of Home
Foreclosures Borrower Takes Title to Home and Sells It to Repay Loan
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The Hou
sing Bubbl
e House Prices Doubled Between 2000 and 2006
Mortgage Backed Securities Tripled 1996-2007
$7.3 Trillion Worth of MBS in Market in 2007
Mortgage Market in 2008 Banks $8 trillion Traditional Bond Holders $7 trillion Securitized Debt $10 trillion
House Price Increases Moderated in 2006
8/8/2019 Sub Prime Mortgage Presentation
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Impac
tof
Pric
e Mo
deratio
n Adjustable Rate Mortgages Began to Reset
Borrowers Could Not Refinance
Borrowers Could Not Afford Higher Payments
Borrowers Went Into Default
Lenders Began Foreclosing on Homes
Prices Began To Fall Borrowers Had Negative Equity in Homes
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Statisiti
cs
By 2008
} 9.2% of Mortgages Were Delinquent or in Foreclosure
8.8 Million Homeowners (10.8%) Negative Equity Unsold Homes Equals 9.8 Times Monthly Sales
4 Million Homes Are Unsold (2.9 Million Are Vacant)
Foreclosure Proceedings on 2.3 Million Homes
7.5 Million Sub Prime Mortgages Worth $1.3 Trillion
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The Abu
ses Adjustable Rate Mortgages Enticed Buyers
They Accounted for 80% of Sub Prime Mortgages
Easy Credit Terms Little or No Due Diligence No Confirmation of Income
Mortgage Originators Misled Borrowers
Credit Rating Agencies In Conflict Issue Credit Ratings on Mortgage Backed Securities Consult With Lenders on What Must Be Done To Get AAA
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The Aftermath
Housing Market Is Devastated Prices Are Down, Housing Starts Are Minimal
Credit Markets Have Frozen Value of Investments Have Deteriorated
Banks Have No Capital, Must Sell More Shares
Companies Cannot Borrow
Layoffs and Corporate Bankruptcies Highest
Massive Government Stimulus
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Derivatives are Weapons of MassDestruction
Derivatives are to be used ethically
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With thanks from
Lijo Jacob
Nikhil UppalPriyanka Sharma
Sachin ChavanSubhadip DasTennison Jomy