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Subprime crisis and stock markets
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What is Subprime?
Subprime lending can be simply described as lending at a higher rate of interest than normal rate of interest,on loans to people with poor credit history or paying capacity. So basically you are lending money at a higher rate of interest to a person who might not have the capacity to pay you back.A subprime loan is offered at a rate higher than A-paper loans due to the increased risk.(sounds like a catch 22 situation to me. you are asking more money from a person who does not have the paying capacity in the first places!)
Subprime lending includes subprime mortgages, subprime car loans, and subprime credit cards, among others. The term “subprime” refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself.
What are Subprime Mortgages ?
With subprime lending in general, subprime mortgages are usually defined by the type of consumer to which they are made available. According to the U.S. Department of Treasury guidelines issued in 2001, “Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories.”
Subprime mortgages proliferated in the early part of the 21st Century. About 21 percent of all mortgage origination’s from 2004 through 2006 were subprime, up from 9 percent from 1996 through 2004, says John Lonski, chief economist for Moody’s Investors Service. Subprime mortgages totaled $600 billion in 2006, accounting for about one-fifth of the U.S. home loan market.
What is the Subprime Crisis?
The crisis began with the bursting of the housing bubble in the US and high default rates on “subprime” and other adjustable rate mortgages (ARM) made to higher-risk borrowers with lower income or lesser credit history than “prime” borrowers
Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers have begun to refer to as a meltdown. A steep rise in the rate of subprime mortgage foreclosures has caused more than 100 subprime mortgage lenders to fail or file for bankruptcy. Mortgage lenders and home builders fared terribly, but losses cut across sectors, with some of the worst-hit industries, such as metals & mining companies, having only the vaguest connection with lending or mortgages.
However, the crisis has had far-reaching consequences across the world. Sub-prime debts were repackaged by banks and trading houses into attractive-looking investment vehicles and securities that were snapped up by banks, traders and hedge funds on the US, European and Asian markets. When the crisis hit the subprime mortgage industry, those who bought into the market suddenly found their investments near-valueless. With market paranoia setting in, banks reined in their lending to each other and to business, leading to rising interest rates and difficulty in maintaining credit lines. As a result, ordinary, run-of-the-mill and healthy businesses across the world with no direct connection whatsoever to U.S. sub-prime suddenly started facing difficulties or even folding due to the banks’ unwillingness to budge on credit lines.
Lewis “Lewie” Ranieri, formerly of Salomon Brothers, considered the inventor of the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: “This is the leading edge of the storm. … If you think this is bad, imagine what it’s going to be like in the middle of the crisis.”
On August 15, 2007, concerns about the subprime mortgage lending industry caused a sharp drop in stocks across t |
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