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    International Finance Final

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    Rishabh Rai
    The document discusses the sub-prime lending crisis that occurred in the late 2000s. It provides background on sub-prime lending and how risky loans were bundled into securities and sold to investors. This obscured the high credit risks of the underlying sub-prime mortgages and fueled a housing bubble. When borrowers started defaulting on their loans in large numbers, it undermined the value of these securities and disrupted the global financial system.

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    International Finance Final

    Uploaded by

    Rishabh Rai
    37 views27 pages
    The document discusses the sub-prime lending crisis that occurred in the late 2000s. It provides background on sub-prime lending and how risky loans were bundled into securities and sold to investors. This obscured the high credit risks of the underlying sub-prime mortgages and fueled a housing bubble. When borrowers started defaulting on their loans in large numbers, it undermined the value of these securities and disrupted the global financial system.

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    The document discusses the sub-prime lending crisis that occurred in the late 2000s. It provides background on sub-prime lending and how risky loans were bundled into securities and sold to investors. This obscured the high credit risks of the underlying sub-prime mortgages and fueled a housing bubble. When borrowers started defaulting on their loans in large numbers, it undermined the value of these securities and disrupted the global financial system.

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    Attribution Non-Commercial (BY-NC)
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    37 views27 pages

    International Finance Final

    Uploaded by

    Rishabh Rai
    The document discusses the sub-prime lending crisis that occurred in the late 2000s. It provides background on sub-prime lending and how risky loans were bundled into securities and sold to investors. This obscured the high credit risks of the underlying sub-prime mortgages and fueled a housing bubble. When borrowers started defaulting on their loans in large numbers, it undermined the value of these securities and disrupted the global financial system.

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    Sub-Prime Lending Crisis

    Rishabh Rai 2010G02 Gunjan Punjabi 2010G03 Neeru Kalra 2010G05 Sameer Kanikdale 2010G06 Jagdish Amrutkar 2010G07 Prasanna Bhuibhar 2010G44

    What is Sub-Prime lending?


    In finance, subprime lending (also referred to as near-prime, non-prime, and second-chance lending) making loans to people who may have difficulty maintaining the repayment schedule. For. e.g, the young, the discriminated-against, the people without a lot of money in the bank to use for a down payment Subprime loans are for persons with blemished or limited credit histories. The loans carry a higher rate of interest than prime loans to compensate for increased credit risk.

    Sub Prime Lending


    The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers. Subprime borrowers have credit ratings that might include: Limited debt experience (so the lender's assessor simply does not know, and assumes the worst) No possession of property assets that could be used as security (for the lender to sell in case of default)

    Sub-Prime lending
    Excessive debt (the known income of the individual or family is unlikely to be enough to pay living expenses + interest + repayment) A history of late or sometimes missed payments so that the loan period had to be extended, failures to pay debts completely (default debt)

    Any legal judgments such as "orders to pay" or bankruptcy (sometimes known in Britain as county court judgments or CCJs).

    How did it Started ?


    In the years leading up to the crisis, significant amounts of foreign money flowed into the U.S. from fast-growing economies in Asia and oil-producing countries.
    This inflow of funds combined with low U.S. interest rates from 20022004 contributed to easy credit conditions, which fueled both housing and credit bubbles. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load The subprime crisis arose from 'bundling' American subprime and American regular mortgages which were traditionally isolated from, and sold in a separate market from prime loans. These 'bundles' of mixed (prime and subprime) mortgages were the basis asset-backed securities so the 'probable' rate of return looked superb (since subprime lenders pay higher premiums, and the loans were anyway secured against saleable real-estate, and so, theoretically 'could not fail'). The inflated house-price bubble burst, property valuations plummeted and the real rate of return on investment could not be estimated, and so confidence in these instruments collapsed, and all were considered to be almost worthless.

    Subprime mortgage crisis


    The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages. The percentage of new lower-quality subprime mortgages rose from the historical 8% or lower range to approximately 20% from 2003 to 2006 For E.g. $500,000 loan at a 4% interest rate for 30 years equates to a payment of about $2,400 a month. But the same loan at 10% for 27 years (after the adjustable period ends) equates to a payment of $4,220 The total cost of the above loan at 4% is $864,000, while the higher rate of 10% would incur a lifetime cost of $1,367,280

    How did it started ?


    Lowest Interest Rate Inflow of FDI Steady Growth of economy Increase demand of homes This promoted higher lending and higher risk taking by new home buyer

    Easy credit conditions

    Fueling of housing market boom and encouraging debt financing

    Increase in home ownership which drove prices higher

    This credit lead to boom and eventually to a surplus unsold homes which caused housing price declining in Mid 2006

    Borrowers were unable to make higher payment and re-financing became more difficult once housing prices began to decline

    Defaulting by borrowers, supply for homes increased

    Leading to downward pressure on housing prices and lowering home owner's equity and also reduced the value of mortgage

    Subprime Lending Crisis

    Risks of the subprime crises


    Credit risks
    Traditionally, the risk of default (called credit risk) would be assumed by the bank originating the loan. However, due to innovations in securitization, credit risk is now shared more broadly with investors.

    Asset price risk:


    Fundamentally derives from the collectibles of subprime mortgage payments, which is difficult to predict due to lack of precedent and rising delinquency rates.

    Liquidity risk
    The amount of commercial paper issued as of October 18, 2007 dropped by 25%, to $888 billion, from the August 8 level.

    Securitization

    Securitization is the process in which certain types of assets are pooled so that they can be repackaged into interestbearing securities. securitization reduced their borrowing costs and, in the case of banks, lowered regulatory minimum capital requirements. Unlike conventional debt, securitization does not inflate a companys liabilities. Instead it produces funds for future investment without balance sheet growth. Financial institutions employ securitization to transfer the credit risk of the assets they originate from their balance sheets to those of other financial institutions, such as banks, insurance companies, and hedge funds.

    Securitization

    Sub-prime model
    s

    Causes of Sub Prime Crises


    Causes proposed include : The inability of homeowners to make their mortgage payments (due primarily to adjustable-rate mortgages resetting, Borrowers overextending, predatory lending, and speculation), overbuilding during the boom period, risky mortgage products, increased power of mortgage originators. Three important catalysts of the subprime crisis were the influx of moneys from the private sector. The banks entering into the mortgage bond market. And the predatory lending practices of the mortgage lenders, specifically the adjustable-rate mortgage

    Causes of Sub Prime Crises


    Mortgage brokers and Under writers
    Mortgage brokers originated 68% of all residential loans in US Sub prime and Alt A loans accounting 42% of the volume Brokers didnt determine whether borrower's could repay the loans Loans generated by Automated under writings Minimal documentation Decision in 30 seconds as opposed to the week

    Causes of Sub Prime Crises


    Securitization as a structured finance process in which assets, receivables or financial instruments are acquired, classified into pools and offered as collateral for third-party investment. Due to securitization, investor appetite for mortgage-backed securities (MBS) and the tendency of rating agencies to assign investmentgrade ratings to MBS, loans with a high risk of default could be originated, packaged and the risk readily transferred to others.

    Causes of Sub Prime Crises


    Credit rating agencies Gave investment-grade ratings to securitization transactions holding subprime mortgages Higher ratings theoretically were due to the multiple, independent mortgages held in the mortgage-backed securities, according to the agencies. Critics claim that conflicts of interest were involved, as rating agencies are paid by those companies selling the MBS to investors, such as investment Banks.

    Causes of Sub Prime Crises


    Borrowers role Obtained ARMS that they could not afford after initial incentive period

    Feds role
    Chronology of regulatory neglect banks and other lenders loosened their standards for making riskier mortgage loans during the housing boom. Greenspan defended his actions, saying that the Fed was not equipped to investigate deceptive lending and that it was not to blame for the housing bubble and its eventual bust.

    legislation like the Community Reinvestment Act, which they claim forces banks to lend to uncreditworthy consumers

    Government and Federal Regulatory Policies

    Impact
    Stock markets On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing above 14,000 for the first time. By Aug. 15, 2007, the Dow had dropped below 13,000.
    14,200 14,000 13,800 13,600 13,400 13,200 13,000 12,800 12,600 12,400 19-Jul-07 20-Jul-07 21-Jul-07 22-Jul-07 23-Jul-07 24-Jul-07 25-Jul-07 26-Jul-07 27-Jul-07 28-Jul-07 29-Jul-07 30-Jul-07 31-Jul-07 1-Aug-07 2-Aug-07 3-Aug-07 4-Aug-07 5-Aug-07 6-Aug-07 7-Aug-07 8-Aug-07 9-Aug-07 10-Aug-07 11-Aug-07 12-Aug-07 13-Aug-07 14-Aug-07 15-Aug-07

    Series1

    Financial institutions Profits at the 8,533 U.S. banks insured by the Federal Deposit Insurance Corporation (FDIC) declined from $35.2 billion to $5.8 billion (83.5 percent) during the fourth quarter of 2007 versus the prior year, due to soaring loan defaults and provisions for loan losses.

    Insurance companies Concern for malicious burning to destroy property as a way to escape from mortgages by some homeowners because they can't or refuse to pay. The FBI reports that malicious burning to destroy property has grew 4% in suburbs and 2.2% in cities from 2005 to 2006. Role of municipal bond "monoline" insurance corporations. Municipal bonds achieve higher debt ratings and suffered a significant loss because of which rating agencies have downgraded the bonds they insured or guaranteed. In turn, this required financial institutions holding the bonds to lower their valuation or to sell them. The impact of such devaluation on institutional investors and corporations holding the bonds (including major banks) has been estimated as high as $200 billion.

    Housing prices (home owners)


    According to the S&P/Case-Shiller housing price index, by November 2007, average U.S. housing prices had fallen approximately 8% from their 2006. The price decline in December 2007 versus the year-ago period was 10.4%. Sales volume (units) of new homes dropped by 26.4% in 2007 versus the prior year.

    Prime borrowers hit hard


    As home prices continue to fall and banks tighten their lending standards, people with prime credit histories now are falling behind on their payments for home loans, auto loans and credit cards.

    Home Equity Falls to New Low


    The Federal Reserve Board reported on March 5, 2008, that Americans percentage of equity in their homes has fallen below 50 percent for the first time on record. Homeowners percentage of equity declined to 47.9 percent in the fourth quarter of 2007the third straight quarter it was under 50 percent.

    Home foreclosures shot up to an all-time high in third quarter 2007. The Mortgage Bankers Association (MBA) in its quarterly snapshot of the mortgage market released on Dec. 6, 2007, reported that the percentage of all mortgages nationwide that started the foreclosure process jumped to a record high of 0.78 percent.

    Lending practices in India


    Credit ratings Banks NPA rules and regulations Process of lending RBI regulations Conclusion about Indian practices

    Conclusion

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