Subprime Mortgage Crisis

The Subprime mortgage crisis is defined as economic problem in the banking system manifesting through liquidity. The problem is owned to foreclosures and is accelerated in the United States in 2006. In such a way, this problem has caused global financial crisis in 2007-2008. The US housing bubble in the USA became the first step in crisis development leading to higher default rates on subprime and, as a result, to adjustable mortgage rates. Borrowers with less credit history appeared to be at higher risk than borrowers with higher income and credit history.

Constantly rising housing prices made borrowers re-evaluate mortgage rates as they realized they were definitely able to re-finance and establish more favourable terms for them. (Demyanik, 2008) Nevertheless, with decrease in prices during the period of 2006-2007 such re-financing became hardly possible. Consequently, foreclosure activity along with ongoing default increased at once having caused increase in adjustable mortgage rates. It is reported that in 2007 more than one million of American housing properties underwent foreclosure activities.

The Wall Street Journal reported that Alan Greenspan, the former Chairman of Federal Reserve, argued that mortgage crisis appeared to be similar to the crisis of 1987-1988. Further, on August, 13, 2007, the Associated Press defined the current state of the financial market as market, where foreign and domestic financial investors are waiting for the next dropping of process as “an overheated housing market and an overextended consumer” are swiftly emerging. (Demyanik, 2008)

Many economic analysts argue that the subprime mortgage crisis isn’t limited to subprime niche only, because “the rapidly increasing scope and depth of the problems in the mortgage market suggest that the entire sector has plunged into a downward spiral similar to the subprime woes whereby each negative development feeds further deterioration”. (Demyanik, 2008) Analysts call it vicious cycle and they predict that the crisis will worsen with time. In the middle of the March, 2008, it was reported that recession was likely to happen because the self-feeding downturn was showing knowing signs of new mortgage crisis.

Losses on subprime CDO are claimed to be about $148 billion. In March, 2008, they are estimated between $350-600 billion. Alan Greenspan tells about the current state of the mortgage crisis: “The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities” .

(Demyanik, 2008) It is necessary to underline that mortgage lenders appeared the first who were strongly affected by credit crisis. The reason is simple – borrowers became unable to make payments. Moreover, they were unwilling to make them. Financial institutions and major banks reported that their losses amounted more than $200 billions in 2008. Consequently, mortgage lenders are trying nowadays to pass the rights to protect their mortgage payments and to decrease default risk with the help of mortgage-backed securities.

Institutional investors, as well as individual and corporate ones are facing huge losses with the decrease in mortgage assets. Finally, economic growth is also affected by subprime mortgage crisis as fewer loans leads to fewer investments by consumer spending and businesses which are the primary drivers of country’s economic stability. (Demyanik, 2008) Affect of Subprime Mortgage Crisis Firstly, it is necessary to analyze the effect of the crisis on financial institutions and their financial statements. It goes without saying that subprime mortgage crisis has caused significant losses.

Many banks and real estate investment trusts report significant losses stressing that it is a result of mortgage payment default along with devaluation of mortgage assets. On April3, 2008 it was reported that financial institutions were re-evaluating losses downing them to $210 billion. Nevertheless, the figures are shocking. Further, annual profits of about 9,000 of American banks dramatically declined to 5. 8billion compared with $35. 2 billion during normal functioning. The reason was soaring loan defaults and loan losses. Analysts say it can be defined as the worst bank performance in since 2006.

Many financial institutions reported possibilities to go bankrupt. Even top management of institution didn’t manage toe escape crisis affect following up with merger deals. Additionally, Bear Stearns asked for emergency assistance from the Central bank. For example, Indian banks appeared to be also affected by the US crisis. The second largest bank in the country experienced losses of about $263 billion in investment exposures and loans. Nevertheless, Bank of Baroda and State Bank of India refused to report their losses. (Demyanik, 2008) Secondly, individuals, especially, women and minorities, became also affected by subprime mortgage crisis.

In some minority regions the level of foreclosures appeared to be disproportional. In particular, about 55% of African Americans about 45% of Hispanics suffered from higher-cost loams, whereas only about 17% of Asians and white populations were subjected to such increase. Therefore, many individuals suffered from increased mortgage rates. Individual lenders suffered as well, as they were unwilling to make payments and loans. In many cases, they were unable to make payments because of significant losses and no guarantees they will get their money back.

Moreover, price changes were observed in housing market and people weren’t aware what to do: either to buy or not to buy. Nevertheless, prices are falling and they are expected to decline further. (Demyanik, 2008) The prospects on future are promising for both financial institutions and individuals. Very large losses are expected results of such crisis. The US economy needs period of protracted adjustments as it will give an opportunity to get back to business and economic and financial stability. (Demyanik, 2008)

References

  • Demyanik, Yuliya. (2008, February 28). Understanding the Subprime Mortgage Crisis.  http://papers.ssrn.com