1. Origins and evolution of the US subprime mortgage market:
Subprime debts are loans that do not conform to the criteria for “prime” or “conforming” debts, and thus are expected to have a lower probability of full repayment. This assessment is usually made based on the borrower’s credit history and score, debt service-to-income (DTI) ratio, and/or loan-to-value (LTV) ratio. In the United States (US), borrowers with low credit scores, DTIs above 55 percent, and/or LTV ratio over 85 percent are likely to be considered subprime, reflecting the greater difficulty subprime borrowers have in making down-payments and the propensity of these borrowers to extract equity during refinancing. “Alt-A” loans fall into a gray area between prime and subprime
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2. Collateralized debt obligation (CDO) – Origins, benefits and risks
Traditionally, regulated depository institutions such as banks and savings and loan associations used their deposits to fund loans. Because these originators held the loans in their portfolios, they were also exposed to the credit risk, market risk from interest rate fluctuations, and the liquidity risk, giving them incentives to maintain credit quality of their loan portfolios.
To provide greater liquidity and fresh capital to these markets, GSEs bought mortgages from the originators, returning cash proceeds to them. By buying the loans and kept them as portfolio, GSEs also acquired the credit risk, market risk and liquidity risk. However, because they could borrow longer term than depository institutions, they were in a better position to deal with market and liquidity risks. The GSEs could better manage credit risk because they held a mortgage portfolio that was diversified nationwide, which even the largest banks then found difficult to do. Notably, they would only purchase prime
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Australian mortgage market:
In Australia, non-conforming loans are provided by a few specialist non-deposit taking lenders, with Pepper, Bluestone and Liberty Financial accounting for three-quarters of the market. This is in contrast to the U.S. where a wide range of financial institutions can originate subprime loans.
Non-conforming loans in Australia accounted for only about 1 percent of outstanding loans in 2007, compared to the 13 percent share in the U.S. The proportion of newly originated loans in Australia that are non-conforming has also been very low over in recent years, at about 1 to 2 percent, significantly less than the 21 percent share of subprime loans in the U.S. in 2006 (Debelle, 2008).
The interest rate applied to non-conforming loans in Australia is also lower than that of subprime debts in the U.S. All of the above points reflect differences in the features of non-conforming loans in Australia in comparison with subprime loans in the U.S.:
• Australian non-conforming debts are less risky than its equivalents in the U.S. On average, newly approved non-conforming loans only has LTV ratio of about 75 percent, well below the average LTV ratio of 85 percent on US subprime
In addition, the Federal Reserve did badly on supervision of the financial market. Many banks did not have enough ability to value their risk. The Federal Reserve and other supervision institution should require these banks to enhance their ability of risk valuing.
The purchasing power parity implies the following relationship between the home (GB £) and local (US $) costs of debt:
Leading up to the crisis of the housing market, borrowers got mortgages without understanding the terms. Banks were giving out loans to people the banks weren't sure could pay the money back. The closer to the crisis, the higher the frequency of illegitimate loans and mortgages. Because there were so many mortgages on houses that could not be paid back, millions of mortgages were foreclosed on, and the houses we...
A majority of mortgage defaults that Americans used were on subprime mortgage loans, which were high-interest-rate loans lent to people with high risk credit rates (Brue). Despite knowing the risks, the Federal government encouraged major banks to lend out these loans to buyers, in hopes, of broadening ho...
) A mechanics lien are commonly used by subcontractors and suppliers, in this case Rupert would be the subcontractor for Clyde. Clyde could be force to sell his home to pay for the mechanics lien, or pay twice as much than he was originally obligated to pay because of legal fees accrued. Rupert cannot enforce the $200 tune up through a mechanic’s lien, but he can place a lien on Clyde’s property for the $20,000 promised to build the detached garage. This lien places a legal claim against the property that has been built, improved or remodeled. In order to collect the $200 promised for the tune up on Clyde’s car, Rupert will have to file a separate case through small claims court to try and recover the $200. The fees to file this case could
In December 2007, the U.S. entered the third longest recession in its history. According to Britannica, the crisis in the American housing market eventually caused the entire economy to collapse. Mortgage dealers issued mortgages to unqualified families with unfavorable terms (Havermann, n.d.). Companies like Moody’s came into the picture when it was time to rate these mortgage-backed securities. If housing prices continued to rise,
Many banks are failing because people borrowed money to buy goods and to invest in the
Investment banks, Rating agencies and Insurance companies are key components of the financial market. In this presentation, I’m going to explain how these three key roles worked together to create the 2008 financial crisis.
It’s mandatory for all the banks to deposit a certain determined percentage of their assets with the central bank to make sure that the banks’ customer deposits are safe. These percentages are what the central bank adjusts to reduce or increase the banking lending ...
The subprime mortgage crisis is an ongoing event that is affecting buyers who purchased homes in the early 2000s. The term subprime mortgage refers to the many home loans taken out during a housing bubble occurring on the US coast, from 2000-2005. The home loans were given at a subprime rate, and have now lead to extensive foreclosures on home loans, and people having to leave their homes because they can not afford the payments. (Chote) The cause and effect of this crisis can be broken down into five major reasons.
Mortgage loans are a substantial form of revenue for the financial industry. Mortgage loans generate billions of dollars in the financial industry. It is no secret that companies have the ability to make a lot of money by offering a variety of mortgage loan products. The problem was not mortgage loans but that mortgage companies were using unethical behavior to get consumer mortgage loans approved. Unfortunately, the Countrywide Financial case was not an isolated case. Many top name mortgage companies have been guilty of unethical behavior. Just as the American housing market was starting to recover from its worst battering since the Great Depression, a new scandal, an epidemic of flawed or fraudulent mortgage documents, threatens to send not just the housing market but the entire economy back into a tailspin (Nation, 2010).
Renault, Olivier and Arnaud de Servigny, 2002, Default Correlation: Empirical Evidence, Staff report, Standard & Poor’s
The study defines “default” as a risk to the repayment history of borrowers where the borrowers have missed at least three installments in 24 months. This shows a symbol and indication of borrower behavior that will actually default to cease all repayments. This definition does not mean that the borrower had entirely stopped paying the loan and therefore been referred to collection or legal processes; or from an accounting perspective that the loan had been classified as bad or doubtful, or actually written-off (Pearson & Greeff, 2006). While, McMillion (2004) states that default is the risk where the borrower is unable to pay the loans. Default risk increases if a borrower has a large number of liabilities and poor cash flow.
Based on the loan features(interest rates & other charges),eligiblity criteria and services provide the following case study of main players for home loans is given below:
Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.