Subprime Final Ppt

7/31/2019 Subprime Final Ppt

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CONTENTS Subprime

Traditional Model Vs Subprime Model

Players in the Game Bubble burst

Crisis Impact

Indian story Bailouts


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SUB PRIME

Subprime lending is a general term that refers to thepractice of making loans to borrowers who do notqualify for market interest rates because of problemswith their credit history or the ability to prove thatthey have enough income to support the monthlypayment on the loan for which they are applying.


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PALYER IN GAME


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Player 1: Federal

Federal kept the interest rate low during much of

1990s and particularly 2001-2005 (low oil prices, andlow inflation prompted the policy), fueling the market

During the 2001-2005, FFR was in the 1% to 3%range, and mostly in the 1% range Federal encouraged

more risky ARM(adjustable rate mortgage) lending


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Player 2: Mortgage Salespersons

Worked on commission based on the number of arms successfullytwisted

Player 3: Primary Lenders

- No incentives for judicious lendingBanks no longer needed to hold on to the mortgage, as use ofmortgage-backed securities made risk taking more appealing

-Use of ARMs with low teaser rates (below market rates for awhile, followed by much higher rates tied to index, LIBOR +

some %). Teaser rates are popular when long-term interest ratesare at historical lows (like much of this period), as they helplenders benefit from ARMs as rates rise

- Net Effect: Many loans were made to NINJAs

(people with No Income, No Jobs or Assets).


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Player 4: Other Financial Institutions

Freddie Mac and Fannie Mae issued many Mortgage

Backed Securities Other financial institutions thattraded in these as well as derivatives based on realestate assets. Many of these were global institutions


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Player 5: Credit rating Agencies and Analysts

-Lack of market for many of these securities, so

models were used to price themInflated ratings, mostly in A range (similar to T-Bills)

-Conflict of Interest: Investment bankers analysts

were rating investment bankers clients (scandal)For example, 3 months prior to its demise, AIG was

rated strong buy (8 analysts), buy(3), hold (10))!!!


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Player 6: Home Buyers (Taking Excessive Risk)

Home buyers were enjoying the ride , new ones were

joining the ride, even if unqualified Home ownershipup from 60% in 1990s to 70%


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How bubble burst led to

crisis??? Step 1 - The housing boom in the US started fading out in

2007 Step 2 - Boom had led to massive increase in supply of

housing Step 3 - Thus House prices started falling Step 4 - This increased the default rate among sub-prime

borrowers Step 5 - These borrowers were no longer able/willing to pay

high price for a house that was declining in value Step 6 Security/Guarantee being the house being bought

, this increased the supply of houses for sale while loweringthe demand, thereby lowering prices even further andsetting off a vicious cycle


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Why housing bubble

burst????


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Financial Institutions Bankruptcy

New Century Financial (USA) Apr. 2, 2007

American Home Mortgage (USA) Aug. 6, 2007 Sentinel management Group (USA) Aug. 17, 2007 Ameriquest (USA) Aug. 31, 2007 NetBank (USA) Sept. 30, 2007 Terra Securities (Norway) Nov. 28, 2007

American Freedom Mortgage Inc. (USA) Jan. 30, 2007


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Home Owners Housing prices down 10.4% in Dec. 07 vs. year-ago

Sales of new homes dropped by 26.4% in 07 vs. 06

By Jan. 2008, the inventory of unsold new homes stood at 9.8 months,the highest level since 1981.

Two million families will be homeless from their homes

Minorities Disproportionate level of foreclosures in minority

46% Hispanics, 55% blacks got higher cost loans


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Country wise ActionUnited kingdom Has lined up a $850-billion rescue plan, May nationalize Royal

Bank of Scotland Will recapitalize banks by up to $88 billion.Abbey, Barclays, HSBC, Lloyds, Standard Chartered, HBOS andNationwide Building Society can draw from an aggregate of $44billion to boost their Tier 1 capital

Bank of England will infuse liquidity of $351 billion throughloans

The government will guarantee $439 billion worth of short-and-

medium term debt Britain has seized control of mortgage lenderBradford & Bingley Earlier this year nationalised Northern Rock Alarm: The total liabilities of Barclays of 1,300 billion (leverage

ratio of over 60),


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Belgium The government took partial control of the struggling

Fortis Bank

France, Belgium and Luxembourg stumped up $93 billionto recapitalize Dexia, a French-Belgian lender that ran uphuge losses in its US operations

Alarm: Fortis Bank's liabilities are several times larger than

the GDP of Belgium (leverage ratio of 33) Iceland

The government has nationalized three of Iceland's biggestbanks Accounts in these banks stand frozen


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United states May pick up ownership in failing US banks (Morgan

Stanley is reported to be one)

Fed ready to lend directly to stressed companiesGermany Has guaranteed all bank deposits Has organized a credit lifeline of euros 35 billion for blue-

chip commercial real estate lender Hypo Real EstateHolding Alarm: The total liabilities of Deutsche Bank (leveraging

ratio of over 50) amount to 2,000-billion euro, which ismore than 80 per cent of the GDP of Germany


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Singapore Eased monetary policy for the first time since 2003 after

sinking into its first recession in six years, hit by the

meltdown in financial markets. The government revised its 2008 growth forecast to

around 3 per cent from an earlier estimate of 4 to 5

Italy

Uni Credit Bank has announced plans to raise its capitalratio by spinning of property assets

Ireland

Has guaranteed all bank deposits


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Spain Will spend 50 billion Euros ($68 billion) to buy bank

assets, almost a third of the proposed 2009 central

government budgetJapan Yamato Life Insurance failed with $2.7 billion in debt The government may revive a bank-rescue law of the 1990s

banking crisis Tokyo may set up a $100-billion fund to prop up smaller

lenders Alarm: Real estate companies are folding up, forcing

regional banks to raise reserves against bad loans


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Impact of Subprime Crisis in India No direct impact:

Structured finance undeveloped

No deleveraging On the contrary India and China were seen as saviors

of a decoupling global economy

Result: Capital inf lux, currency appreciation, stock

market boom


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The second round effect of Sub Prime + spike in oilprices was devastating for Asian countries, includingIndia

But for the macroeconomic cushion of low externaldebt Ratio and fiscal deficits and comfortable reservesthis had the ingredients of a classic currency crisis


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The Devastation Oil shock worsening current account balance Indias merchandise trade deficit in April-July 2008

increased by 50%

BRIC may split prospects of Brazil/Russia brightened&that of India/China darkened Sharp increase in inflation food & oil the culprits Governments could no longer fully insulate consumers

from increase in retail oil prices

Spike in food prices through biofuels link Higher weightage of food and oil in the consumption

basket of developing world July 2008- CPI at 9.41% and WPI at 12%+


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Increase in fiscal deficit Government absorbed part ofthe increase in oil and food prices lower savings

EACs estimate of off balance sheet deficit on account of risingfood and oil prices 4.5% of GDP

Threat of credit downgrade

Decline in Capital flows Sharp decline in stock market capitalization and bearish markets Rupee under pressure feeds inflation

Decline in Growth [EACs estimate for 2007-08 : 7.7%] Rising interest rates hurt consumption and investment Rise in fiscal deficit and decline in corporate profits result in fall

in savings


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Bailout Government/central bank credit (liquidity) helps banks

pay their debts and may unfreeze credit markets

But, bailouts create moral hazard for borrowers andcreditors


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Outcomes


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Internet & media resources:http://en.wikipedia.org/wiki/Causes_of_the_United_States_housing_bubblehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisis#Housing_downturn http://news.bbc.co.uk/2/hi/business/7073131.stm

Book and papers 'The Subprime Solution, by Robert Shiller http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1112467 http://www.nera.com/image/SEC_SubprimeSeries_Part_II_FINAL_2-08.pdf http://www.nera.com/image/SEC_SubprimeSeries_Part1_June2007_FINAL.pdf

(Accounting is responsible for the crisis?!) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1108556 (Michael Brennan)

http://ideas.repec.org/p/fip/fednsr/318.html (understandingsecuritization)
http://en.wikipedia.org/wiki/Causes_of_the_United_States_housing_bubblehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisishttp://news.bbc.co.uk/2/hi/business/7073131.stmhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1112467http://www.nera.com/image/SEC_SubprimeSeries_Part_II_FINAL_2-08.pdfhttp://www.nera.com/image/SEC_SubprimeSeries_Part1_June2007_FINAL.pdfhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1108556http://ideas.repec.org/p/fip/fednsr/318.htmlhttp://ideas.repec.org/p/fip/fednsr/318.htmlhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1108556http://www.nera.com/image/SEC_SubprimeSeries_Part1_June2007_FINAL.pdfhttp://www.nera.com/image/SEC_SubprimeSeries_Part_II_FINAL_2-08.pdfhttp://www.nera.com/image/SEC_SubprimeSeries_Part_II_FINAL_2-08.pdfhttp://www.nera.com/image/SEC_SubprimeSeries_Part_II_FINAL_2-08.pdfhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1112467http://news.bbc.co.uk/2/hi/business/7073131.stmhttp://en.wikipedia.org/wiki/Subprime_mortgage_crisishttp://en.wikipedia.org/wiki/Causes_of_the_United_States_housing_bubble

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Subprime Final Ppt

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