The Subprime Mortgage

Crisis

Shiraz KuwailidBSC-PLY-MGT-14.1-059

What are subprime mortgages?

•A subprime mortgage is a type of loan granted to individuals with poor credit histories and who would not be able to qualify for conventional mortgages.

•Subprime mortgages charge interest rates that are above the typical interest rate because of the risk that is involved on the part of the lender.

The Crisis - Beginning• In the 1980’s the financial industry exploded, the investment banks

went public.

The Crisis - Beginning• This lead to the inflow of huge amounts of stock holder money,

people on Wall-Street started getting rich.

The Crisis - Beginning• When you start getting rich, you want to be richer and richer…• This lead to the de-regulation of the financial industry of USA,

allowing them to make risky investments with their depositors money.

The Crisis - Beginning• Investment banks grew larger and STRONGER• Investment banks could manipulate stock prices, the way they wish

The Crisis - Beginning• In 1990’s de-regulation and advancement in technology lead to an

explosion of complex financial products called “DERIVATIVES”• Worst of all, DERIVATIVES aren’t regulated and it was further

enacted that regulation of derivatives were banned

The Crisis - Beginning• Rise of 5 giant investment banks

1.Goldman Sachs2.Morgan Stanley3.Lehman Brothers4.Merrill Lynch5.Bear Stearns

The Crisis - Beginning

•Rise of 2 giant financial conglomerates

1.Citi Group2.JP Morgan

The Crisis - Beginning• Old System of mortgage

The Crisis - Beginning• Creation of the Securitization Food Chain which connected trillions of

dollars worth of mortgages and other loans with investors all over the world

The Crisis - Beginning• Creation of Collateralized Debt Instruments (CDO’s)

The Crisis - Beginning• When home owners pay their mortgages, the money went to

investors all over the world

The Crisis - Beginning• The investment banks paid rating agencies to evaluate the CDO’s• Many of them were given a AAA rating, making these investments

popular with retirement funds

The Crisis - Beginning

• Lenders didn’t care anymore whether a borrower could repay, so they started making riskier loans

• Investment banks didn’t care either, the more CDO’s they sold, the higher their profits

• And the rating agencies which were paid by the investment banks, had no liability if their ratings of CDO’s proved wrong

The Crisis - Beginning• Mortgage loans made each year quadrupled!

The Crisis – The Beginning• Increase in subprime mortgages• Subprime mortgage CDO’s still received AAA ratings

The Crisis – The Bubble• Since anyone can get a mortgage, home purchases and housing

prices skyrocketed• The result was the biggest financial bubble in history

The Crisis – The Bubble• Countrywide Financial Corp, the largest subprime lender issued $97

billion worth of loans• It made over $11 billion in profits as a result

The Crisis – The Bubble• Wall-Street annual cash bonuses skyrocketed.• Traders and CEO’s became enormously wealthy during the bubble

The Crisis – The Bubble• Lehman Brothers was a top underwriter in subprime lending• They made $106 billion in two years from 2005-2006

The Crisis – The Bubble• On 24th April, 2004 the SEC lifted the leverage limits on investment

banks

The Crisis – The Bubble• Credit Default Swaps – If EVERYTHING went WELL

The Crisis – The Bubble• Credit Default Swaps – If SOMETHING went WRONG

The Crisis – The Burst• Subprime mortgages started defaults• Securitization Food Chain started the negative effect• Home owners started selling their homes

The Crisis – The Burst• 18th March, 2008 – Bear Stearns runs out of cash. It was bought by JP

Morgan Chase for $2 per share

• 07th September, 2008 – Federal Reserve takes over Fannie Mae & Freddie Mac

• 09th September, 2008 – Lehman Brothers announces record loss of $3.2 billion and its stock collapsed

• 12th September, 2008 – Lehman Brothers runs out of cash

• 14th September, 2008 – Merrill Lynch is acquired by Bank of America

The Crisis – The Burst• Lehman Brothers, one of the largest investment banks in USA signs

for bankruptcy

The Crisis – The Burst• Midnight (0000H) – 14th September, 2008 – Lehman Brothers signed

for bankruptcy

• 15th September, 2008 – New York Stock Exchange drops

• 16th September, 2008 – London Stock Exchange, Japanese Stock Exchange and Hong Kong Stock Exchange drops

• 17th September, 2008 – AIG runs out of cash. Government acquires AIG on the same date

The Crisis – The Burst• 04th October, 2008 - $700 billion bailout bill passed• Unemployment in USA & Europe exceed 10% within 3 months

The Crisis – Globally

• US bound investors started to pull out their capital from the developing economies in the other regions

• This resulted in major shortage of credit to fuel the potential developing nations

• Interest rates skyrocketed and availability of credit became scarce

The Crisis – Conclusion

•If the derivatives were regulated soon as they were introduced, the whole financial crisis and the recession could have been avoided