What is Subprime lending?

What caused 2001 recession?

• Dot Com Bubble

Example. Yahoo, Amazon, ebay, etc

Subprime Crisis and Banking Industry

• 22 banks closed.

• American International Group (AIG) survived by giving the $80 billion bail out money by the USA government

• collapse with Citi Bank with written off bad debts of $60 billion and rescued by the USA government using bail out plan.

Survival of Automobile Biggies

• help from the government to survive by General Motors(GM), Ford and Chrysler.

Overview of the crises

• Large influx of money to U.S. banks and financial institutions along with low interest rates

• Easy Credit, Faulty Assumption of Real Estate Price.

• Inability of borrowers to pay

• Supply exceeded demand

Stages of the crisis

• First, during late 2007, bankrupt of over 100 mortgage lending companies.

• Second, in Q4 2007, massive losses in financial institutions.

• Third, during Q1 2008, merge up of bank JP Morgan with investment bank Bear Stearns with Govt. guarantee.

• Fourth, during September 2008, increase in bankruptcies and mortgage loans.

Subprime market data

• The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007 with over 7.5 million first-lien subprime mortgages outstanding. Approximately 16% of subprime loans with adjustable rate mortgages (ARM) were 90-days delinquent or in foreclosure proceedings as of October 2007, roughly triple the rate of 2005.By January 2008, the delinquency rate had risen to 21% and by May 2008 it was 25%.

Cont.• Between 2004-2006 the share of subprime

mortgages relative to total originations ranged from 18%-21%, versus less than 10% in 2001-2003 and during 2007. Subprime ARMs only represent 6.8% of the loans outstanding in the US, yet they represent 43% of the foreclosures started during the third quarter of 2007. During 2007, nearly 1.3 million properties were subject to 2.2 million foreclosure filings, up 79% and 75% respectively versus 2006.

Cont.

• During 2008, this increased to 2.3 million properties, an 81% increase over 2007. Between August 2007 and September 2008, an estimated 851,000 homes were repossessed by lenders from homeowners. Foreclosures are concentrated in particular states both in terms of the number and rate of foreclosure filings.Ten states accounted for 74% of the foreclosure filings during 2008; the top two (California and Florida) represented 41%. Nine states were above the national foreclosure rate average of 1.84% of households.

Household debt statistics

• In 1981, US private debt was 123 per cent of gross domestic product. By the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent.

• Household debt was 48 per cent of GDP; in 2007, it was 100 per cent

Financial sector debt statistics

• The gross debt of the financial sector rose from 22 per cent of GDP in 1981 to 117 per cent in the third quarter of 2008, while the debt of non-financial corporations rose only from 53 per cent to 76 per cent of GDP

Effect on corporations and investors

• Commercial / Depository bank corporations

• Investment banks, mortgage lenders, and real estate investment trusts

• Insurance companies

• Special purpose entities (SPE)

• Investors

Liquidity risk and the money market funding engine

• Lehman Brothers bankruptcy

• Individual investors lend money to money market funds,

Effect on the Money Supply

• During late 2008, the most liquid measurement of the U.S. money supply (M1) increased significantly

Vicious Cycles

• Cycle One: Housing Market

• Cycle Two: Financial Market and Feedback into Housing Market

What about solution?

Loan modification, pumping money into market may slow down the crisis.

• Establish rescue funds for borrowers facing short-term problems caused by illness, layoffs or other one-time events.

• Establish a bond fund to pay for switching borrowers out of unaffordable ARMs.

• Refinance loans for victims of predatory lending. This would involve working with Fannie Mae, the quasi-governmental corporation.