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The SubprimeThe SubprimeMortgage CrisisMortgage CrisisByBy--

ABDUL SHADMANABDUL SHADMAN --0202

SESHADRI IYERSESHADRI IYER --5858

SECTIONSECTION -- FFFF--11

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What are subprime mortgages?What are subprime mortgages? There are several different types of subprimeThere are several different types of subprime

mortgages, but the most common is themortgages, but the most common is the

adjustable rate mortgage (ARM).adjustable rate mortgage (ARM).

ARMs can be misleading to subprimeARMs can be misleading to subprimeborrowers because they initially pay a lowerborrowers because they initially pay a lower

interest rate. After the given period of time,interest rate. After the given period of time,

their mortgages are set to a much higher rate.their mortgages are set to a much higher rate.

Therefore, their mortgage payments increaseTherefore, their mortgage payments increase

dramatically.dramatically.

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The Subprime Mortgage Crisis Explained:The Subprime Mortgage Crisis Explained:

Up until 2006, the housing market in the UnitedUp until 2006, the housing market in the UnitedStates was flourishing due to the fact that it was soStates was flourishing due to the fact that it was soeasy to get a home loan.easy to get a home loan.

Individuals were taking on subprime mortgages,Individuals were taking on subprime mortgages,

with the expectations that the price of their homewith the expectations that the price of their homewould continue to rise and that they would be ablewould continue to rise and that they would be ableto refinance their home before the higher interestto refinance their home before the higher interestrates were to go into effect. 2005 was the peak of therates were to go into effect. 2005 was the peak of the

subprime boom. At this time, 1 in 5 mortgages wassubprime boom. At this time, 1 in 5 mortgages wassubprime.subprime.

However, the housing bubble burst and housingHowever, the housing bubble burst and housingprices had reached their peak. They were now on aprices had reached their peak. They were now on adecline.decline.

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At this point, many who had taken on theseAt this point, many who had taken on these

subprime mortgages and their interest ratessubprime mortgages and their interest rates

were beginning to reset to the higher rates,were beginning to reset to the higher rates,

making their monthly mortgage paymentsmaking their monthly mortgage paymentsmuch higher than before.much higher than before.

People then began to sell their homesPeople then began to sell their homes butbut

there was a problem to doing this. Since thethere was a problem to doing this. Since theprice of homes had severely decreased, theyprice of homes had severely decreased, they

did not have enough money after selling todid not have enough money after selling to

cover the amount of the mortgage.cover the amount of the mortgage.

The Subprime Mortgage Crisis Explained:The Subprime Mortgage Crisis Explained:

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If a person could not sell their home, thisIf a person could not sell their home, thisultimately left the homeowner with oneultimately left the homeowner with oneoption, and that was to DEFAULT.option, and that was to DEFAULT.

When a home is defaulted, this is the first stepWhen a home is defaulted, this is the first steptowards foreclosure.towards foreclosure.

After the notice of default, there is aAfter the notice of default, there is areinstatement period before the home is putreinstatement period before the home is put

up for auction by the bank.up for auction by the bank. If the defaulted loan isnt taken care of in aIf the defaulted loan isnt taken care of in a

given amount of time, the bank resumesgiven amount of time, the bank resumesresponsibility of the home and is put up forresponsibility of the home and is put up for

auction.auction.

The Subprime Mortgage Crisis Explained:The Subprime Mortgage Crisis Explained:

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However, when put in an auction, the bank usuallyHowever, when put in an auction, the bank usuallysells the home at a price that is much lower thansells the home at a price that is much lower than

what it is worth. The amount that they receive in thiswhat it is worth. The amount that they receive in thisprocess gets put towards the borrowers loan, butprocess gets put towards the borrowers loan, butthe borrower still has to account for the differencethe borrower still has to account for the differencethat they owe towards the loan.that they owe towards the loan.

The process of auctioning off these houses creates aThe process of auctioning off these houses creates aincrease in supply of homes in the market, whichincrease in supply of homes in the market, which

will decrease the home prices.will decrease the home prices.

The Subprime Mortgage Crisis Explained:The Subprime Mortgage Crisis Explained:

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"The financial market crisis that erupted in

August 2007 has developed into the largest

financial shock since the Great Depression,

inflicting heavy damage on markets andinstitutions at the core of the financial system."

International Monetary Fund, World EconomicOutlook, April 2008

And then the bubble burst

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SubSub--prime Mortgage Crisisprime Mortgage Crisis

Low interest

rates, excessliquidity

Banks lent

toSub-primeborrowers

Housingboom

CDOs actas booster

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SubSub--prime Mortgage Crisis (cont.)prime Mortgage Crisis (cont.)

Housingprices

skyrocketed

Interestratesrose

CRASH!Borrowersgo bust

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SubSub--prime Mortgage Crisis (cont.)prime Mortgage Crisis (cont.)

Lendersgo bust

CreditCrunch

GlobalRecession?

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How serious is current crisis?How serious is current crisis?

USD16.3 trillion wiped outUSD16.3 trillion wiped out

deep and prolonged recessiondeep and prolonged recession

Major economies slowing downMajor economies slowing down

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All in Serious TroubleAll in Serious Trouble

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Major banks suffered from huge losses.Major banks suffered from huge losses.

Lehman Brothers went out of business.Lehman Brothers went out of business.

Merrill Lynch had to sell itself to Bank of America forMerrill Lynch had to sell itself to Bank of America fora fraction of its former valuea fraction of its former value

Countrywide Financial Corporation, the biggest U.S.Countrywide Financial Corporation, the biggest U.S.mortgage lender, eventually gets taken over bymortgage lender, eventually gets taken over byBank of America.Bank of America.

Housing prices had dropped 20% from their 2006Housing prices had dropped 20% from their 2006

peak, with futures markets signaling a 30peak, with futures markets signaling a 30--35%35%potential drop.potential drop.

Impacts of the Subprime MortgageImpacts of the Subprime Mortgage

Crisis:Crisis:

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Responses to the CrisisResponses to the Crisis

Many programs have been enacted and legislation passed toMany programs have been enacted and legislation passed tohelp those who have been hit the hardest by the crisis. Somehelp those who have been hit the hardest by the crisis. Someexamples include the Emergency Economic Stabilization Actexamples include the Emergency Economic Stabilization Actof 2008 and the Homeowners Affordability and Stability Plan.of 2008 and the Homeowners Affordability and Stability Plan.

Former President Bill Clinton and former Federal ReserveFormer President Bill Clinton and former Federal ReserveChairman Alan Greenspan indicated they did not properlyChairman Alan Greenspan indicated they did not properly

regulate derivatives, including credit default swaps. A billregulate derivatives, including credit default swaps. A billcalled the Derivatives Markets Transparency andcalled the Derivatives Markets Transparency andAccountability Act of 2009 has been proposed to furtherAccountability Act of 2009 has been proposed to furtherregulate the CDS market. This bill would provide theregulate the CDS market. This bill would provide theauthority to suspend CDS trading under certain conditions.authority to suspend CDS trading under certain conditions.

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Where do we go from here?Where do we go from here?

Five main topics are important to consider when discussing solutions to theFive main topics are important to consider when discussing solutions to thecrises:crises:

LiquidityLiquidity

SolvencySolvency

Economic stimulus:Economic stimulus:

Homeowner assistanceHomeowner assistance

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THANK YOUTHANK YOU