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SUBPRIME CRISIS
- 1. SUBPRIME CRISIS K. BALAJI PRASANNA KUMAR
- 2. PRIME LOANS AND SUBPRIME LOANS • PRIME Are the loans that are offered to borrowers with good credit histories and carry lower rates of interests. • SUBPRIME Are the loans given to people with a bad credit rating who are not eligible for prime loans. These are characterized by high interest rates, poor quality collateral etc.
- 3. Why Subprime Loans? • For banks to earn more money from the higher interest rates • To let in the excluded such as the young, the people without a lot of money in the bank to use for a down payment.
- 4. Main Players • The Federal Reserve • Investment banks • Investors • Homebuyers • Rating Agencies
- 6. • In the early 2000’s, federal interest rate was reduced to 1% which made the investors to invest in the Housing industry, which was certified as the best investment by credit rating agencies. • To earn more money, the lenders started giving mortgage loans to subprime borrowers with the hope they can always get their money even if the borrower defaults as the prices of houses facing foreclosure are always rising. • However, the borrowers defaulted on their mortgages rapidly resulting in the increase of the supply of houses, for which there is no enough demand. • This led to decrease in the value of houses.
- 7. Effects of decrease in Housing prices Housing Prices Decreases Negative Equity(Home worth less than mortgage) Homeowners walk away or Foreclosures increase Increased supply of houses Mortgage Payments decline Economic activity slows down and unemployment increases Value of MBS Decline Banks restrict lending Banks Incur Losses Bank capital (loanable funds decrease)
- 8. Effects of the Crisis • Most of the losses were not incurred by homeowners but by the financial system. • Large losses were incurred by the following groups: I. Mortgage lenders: One third of top 30 mortgage lenders have either been acquired or have filed for bankruptcy or have been liquidated. II. Investment banks: Since the housing bubble burst, the five largest U.S. investment banks have either filed for bankruptcy (Lehman Brothers), been acquired by other Firms or become commercial banks subject to greater Regulation. III. Foreign investors (mainly banks and governments) who had invested in mortgage backed securities. IV. Insurance companies: (e.g., AIG) who had sold credit default swaps. Credit default swaps are a type of contract that insures against the mortgage-backed securities.
- 9. Effect on Indian Economy • Exports dropped to $ 1.5 billion in November 2008, from $ 12.7 billion a year ago. • Manufacturing sectors like leather, textile, gems and jewellery have been hit hard because of the slump in the demand. • Tourism industry was also affected. • IT sector was affected as majority of the firms derived 75% of income from US.
- 10. THANKYOU