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SUB PRIME MORTGAGE CRISIS
CONTENTS
1. BACKGROUND INFORMATION 1.1 INRUDUCTION TO SUBPRIME PRIME MORTGAGE MARKET 1.2 INRUDUCTION TO SUBPRIME PRIME MORTAGAGE CRISIS 2. CAUSES AND RISK OF SUBPRIME CRISIS 2.1 RISKS INVOLVED IN THE SUBPRIME CRISIS 2.2 CAUSES OF THE CRISIS 3. IMPACTS 3.1 EFFECT OF CRISIS ON WORLD MARKET 3.2 IMPACT ON CORPORATIONS AND INVESTORS 3.3 IMPACT ON STOCK MARKETS 3.4 IMPACT ON FINANCIAL INSTITUTIONS 3.5 IMPACT ON INSURANCE COMPANIES 3.6 IMPACT ON HOME OWNERS 3.7 IMPACT ON MINORITIES 3.8 SPECIFIC IMPACTS BY FIRM OR SECTOR 4. ACTIONS TO MANAGE THE CRISIS 5. SOME IMPORTANT TIME LINES 5.1 SUBPRIME CRISIS IMPACT TIMELINE 5.2 CENTRAL BANK RESPONSE TIMELINE 6. LIST OF ENTITIES INVOLVED IN 2007 FINANCE CRISES
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1. BACKGROUND INFORMATION
1.1 INRUDUCTION TO SUBPRIME PRIME MORTGAGE MARKET
Before discussing what is Subprime mortgage crisis, first will understand what does meant by subprime mortgage Usually financial institution classifies the borrower into 3 types Prime borrower Subprime borrower Equity class borrower
Subprime lending
Subprime lending (also known as B-paper, near-prime, or second chance lending) is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. The phrase also refers to banknotes taken on property that cannot be sold on the primary market, including loans on certain types of investment properties and certain types of self-employed persons. Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with subprime applicants. A subprime loan is offered at a rate higher than A-paper loans due to the increased risk. Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others. The term "subprime" refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself. Subprime lending is highly controversial. Opponents have alleged that subprime lenders have engaged in predatory lending practices such as deliberately lending to borrowers who could never meet the terms of their loans, Page 2
thus leading to default, seizure of collateral, and foreclosure. There have also been charges of mortgage discrimination on the basis of race. Proponents of subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market. The controversy surrounding subprime lending has expanded as the result of an ongoing lending and credit crisis both in the subprime industry, and in the greater financial markets which began in the United States. This phenomenon has been described as a financial contagion which has led to a restriction on the availability of credit in world financial markets. Hundreds of thousands of borrowers have been forced to default and several major American subprime lenders have filed for bankruptcy. Background Subprime lending evolved with the realization of a demand in the marketplace and businesses providing a supply to meet it. With bankruptcies and consumer proposals being widely accessible, a constantly fluctuating economic environment, and consumer debt loan on the rise, traditional lenders are more cautious and have been turning away a record number of potential customers.[citation
needed]
Statistically, approximately 25% of the population of the
United States falls into this category. In the third quarter of 2007, Subprime ARMs only represent 6.8% of the mortgages outstanding in the US, yet they represent 43.0% of the foreclosures started. Subprime fixed mortgages represent 6.3% of outstanding loans and 12.0% of the foreclosures started in the same period.
Definition
While there is no official credit profile that describes a subprime borrower, most in the United States have a credit score below 723. Fannie Mae has lending guidelines for what it considers to be "prime" borrowers on conforming loans. Their standard provides a good comparison between those who are Page 3
"prime borrowers" and those who are "subprime borrowers." Prime borrowers have a credit score above 620 (credit scores are between 350 and 850 with a median in the U.S. of 678 and a mean of 723), a debt-to-income ratio (DTI) no greater than 75% (meaning that no more than 75% of net income pays for housing and other debt), and a combined loan to value ratio of 90%, meaning that the borrower is paying a 10% down payment. Any borrower seeking a loan with less than those criteria is a subprime borrower by Fannie Mae standards.
Subprime borrowers
Subprime offers an opportunity for borrowers with a less than ideal credit record to gain access to credit. Borrowers may use this credit to purchase homes, or in the case of cash out refinance, finance other forms of spending such as purchasing a car, paying for living expenses, remodeling a home, or even paying down on a high interest credit card. However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates. On a more positive note, subprime lending (and mortgages in particular), provide a method of "credit repair"; if borrowers maintain a good payment record, they should be able to refinance back onto mainstream rates after a period of time. Credit repair usually takes twelve months to achieve; however, in the UK, most subprime mortgages have a two or three-year tie-in, and borrowers may face additional charges for replacing their mortgages before the tie-in has expired. Generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following: Two or more loan payments paid past 30 days due in the last 12 months, or one or more loan payments paid past 90 days due the last 36 months; Judgment, foreclosure, repossession, or non-payment of a loan in the prior 48 months; Bankruptcy in the last 7 years;
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Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of less than 620 (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood.
Background information
Subprime lending is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history or the inability to prove that they have enough income to support the monthly payment on the loan for which they are applying. The word Subprime refers to the credit-worthiness of the borrower (being less than ideal) and does not refer to the interest rate of the loan. Subprime loans or mortgages are risky for both creditors and debtors because of the combination of high interest rates, bad credit history, and murky personal financial situations often associated with subprime applicants. A subprime loan is one that is offered at an interest rate higher than A-paper loans due to the increased risk. Subprime, therefore, is not the same as "Alt-A", because Alt-A loans qualify for the "Arating" by Moody's or other rating firms, albeit for an "alternative" means. 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 of 2008, the delinquency rate had risen to 21%. Number of U.S. Household Properties Subject to Foreclosure Actions During 2007, By Quarter Subprime ARMs only represents 6.8% of the loans outstanding in the US, yet they represent 43.0% of the foreclosures started during the third quarter of 2007. A total of nearly 446,726 U.S. household properties were subject to some sort of foreclosure action from July to September 2007, including Page 5
those with prime, alt-A and subprime loans. This is nearly double the 223,000 properties in the year-ago period and 34% higher than the 333,627 in the prior quarter. This increased to 527,740 during the fourth quarter of 2007, an 18% increase versus the prior quarter. For all of 2007, nearly 1.3 million properties were subject to 2.2 million foreclosure filings, up 79% and 75% respectively versus 2006. Foreclosure filings including default notices, auction sale notices and bank repossessions can include multiple notices on the same property. The estimated value of subprime adjustable-rate mortgages (ARM) resetting at higher interest rates is U.S. $400 billion for 2007 and $500 billion for 2008. Reset activity is expected to increase to a monthly peak in March 2008 of nearly $100 billion, before declining. An average of 450,000 subprime ARM are scheduled to undergo their first rate increase each quarter in 2008.
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1.2 INRUDUCTION TO SUBPRIME PRIME MORTAGAGE CRISIS
The crisis began with the bursting of the United States housing bubble.
A slowing US economy, high interest rates, unrealistic real estate prices, high inflation and rising oil tags together led to a fall in stock markets, growth stagnation, job losses, lack of consumer spending, a virtual halt to new jobs, and foreclosures and defaults. Sub-prime homeowners began to default as they could no longer afford to pay their EMIs. A deluge of such defaults inundated these institutions and banks, wiping out their net worth. Their mortgage-backed securities were almost worthless as real estate prices crashed. The moment it was found out that these institutions had failed to manage the risk, panic spread. Investors realized that they could hardly put any value on the securities that these institutions were selling. This caused many a Wall Street pillar to crumble as defaults kept rising, these institutions could not service their loans that they had taken from banks. So they turned to other financial firms to help them out, but after a while these firms too stopped extending credit realizing that the collateral backing this credit would soon lose value in the falling real estate market. Now burdened with tons of debt and no money to pay it back, the bank of these financial entities broke, leading to the current meltdown The problem worsened because institutions giving out sub-prime home loans could easily securities it. Once an institution securitizes a loan, it does not remain on the books of the institution. Hence that institution does not take the risk of the loan going bad. The risk is passed onto the investors who buy the financial securities issued for securitizing the home loan. Another advantage of securitization, which has now become a disadvantage, is that money keeps coming in.
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Once an institution securitizes the first lot of home loans and repays the bank it has borrowed from, it can borrow again to give out loans. The bank having been repaid and made its money does not have any inhibitions in lending out money again Given the fact that institutions giving out the loan did not take the risk, their incentive was in just giving out the loan. Whether the individual taking the home loan had the capacity to repay the loan or not, wasn't their problem. Thus proper due diligence to give out the home loan was not done and loans were extended to individuals who are more likely to default. Other than this, greater the amount of loan that the institution gave out, greater was the amount it could securitize and, hence, greater the amount of money it could earn. After borrowers started defaulting, it came to light that institutions giving out loans in the sub-prime market had been inflating the incomes of borrowers, so that they could give out greater amount of home loans. By giving out greater amounts of home loan, they were able to securitize more, issue more financial securities and earn more money. Quite a vicious cycle, eh? And so the story continued, till the day borrowers stop repaying. Investors who bought the financial securities could be serviced.
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The diagram explains how new model (i.e. Subprime model) leads to mortgage crisis How it went wrong
Traditionally, banks have financed their mortgage lending through the deposits they receive from their customers. This has limited the amount of mortgage lending they could do. And also Percentage of default and loss suffered by financial institution could be very minimal and there are only 2 players Viz, financial institutions and investors In recent years, banks have moved to a new model where they sell on the mortgages to the bond markets. This has made it much easier to fund additional borrowing, But it has also led to abuses as banks no longer have the incentive to check carefully the mortgages they issue. And the flow chart looks like multiple layer and number of entity involved in this system, one Player defaulted whole system Page 9
get disturb. In present crisis Subprime borrower defaulted their payment installment due to fall in the prices of house and lands what they owned, fall in the price leads to fall in the bond issued by financial institution which linked to subprime mortgage so in this way all players who ever involved in this new model all are suffered huge loss
Subprime mortgage crisis:

The subprime mortgage crisis was a sharp rise in home foreclosures which started in the United States in late 2006 and became a global financial crisis during 2007 and 2008. The crisis began with the bursting of the housing bubble in the U.S. and high default rates on "subprime" and other adjustable rate mortgages (ARM) made to higher-risk borrowers with lower income or lesser credit history than "prime" borrowers. Loan incentives and a long-term trend of rising housing prices encouraged borrowers to assume mortgages, believing they would be able to refinance at more favorable terms later. However, once housing prices started to drop moderately in 2006-2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as ARM interest rates reset higher. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% versus 2006. As of December 22, 2007, a leading business periodical estimated subprime defaults would reach a level between U.S. $200-300 billion. The mortgage lenders that retained credit risk (the risk of payment default) were the first to be affected, as borrowers became unable or unwilling to make payments. Major banks and other financial institutions around the world have reported losses of approximately U.S. $140 billion as of February 2008, as cited below. Due to a form of financial engineering called securitization, many mortgage lenders had passed the rights to the mortgage payments and related credit/default risk to third-party investors via mortgage-backed securities (MBS) Page 10
and collateralized debt obligations (CDO). Corporate, individual and institutional investors holding MBS or CDO faced significant losses, as the value of the underlying mortgage assets declined. Stock markets in many countries declined significantly. The widespread dispersion of credit risk and the unclear impact on financial institutions caused lenders to reduce lending activity or to make loans at higher interest rates. Similarly, the ability of corporations to obtain funds through the issuance of commercial paper was impacted. This aspect of the crisis is consistent with a credit crunch. The liquidity concerns drove central banks around the world to take action to provide funds to member banks to encourage the lending of funds to worthy borrowers and to re-invigorate the commercial paper markets. The subprime crisis also places downward pressure on economic growth, because fewer or more expensive loans decrease investment by businesses and consumer spending, which drive the economy. A separate but related dynamic is the downturn in the housing market, where a surplus inventory of homes has resulted in a significant decline in new home construction and housing prices in many areas. This also places downward pressure on growth. With interest rates on a large number of subprime and other ARM due to adjust upward during the 2008 period, U.S. legislators and the U.S. Treasury Department are taking action. A systematic program to limit or defer interest rate adjustments was implemented to reduce the impact. In addition, lenders and borrowers facing defaults have been encouraged to cooperate to enable borrowers to stay in their homes. The risks to the broader economy created by the financial market crisis and housing market downturn were primary factors in the January 22, 2008 decision by the U.S. Federal reserve to cut interest rates and the economic stimulus package signed by President Bush on February 13, 2008. [7] [8] [9]Both actions are designed to stimulate economic growth and inspire confidence in the financial markets.
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Typical model of Subprime crisis in United States of America:
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2. CAUSES AND RISK OF SUBPRIME CRISIS

The reasons for this crisis are varied and complex. Understanding and managing the ripple effect through the world-wide economy poses a critical challenge for governments, businesses, and investors. Due to innovations in securitization, the risks related to the inability of homeowners to meet mortgage payments have been distributed broadly, with a series of consequential impacts. The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments; poor judgment by either the borrower or the lender; inappropriate mortgage incentives, and rising adjustable mortgage rates. Further, declining home prices have made re-financing more difficult.
2.1 RISKS INVOLVED IN THE SUBPRIME CRISIS

There are three primary risk categories involved: Credit risk: 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, because the rights to these mortgage payments have been repackaged into a variety of complex investment vehicles, generally categorized as mortgage-backed securities (MBS) or collateralized debt obligations (CDO). A CDO, essentially, is a repacking of existing debt, and in recent years MBS collateral has made up a large proportion of issuance. In exchange for purchasing the MBS, third-party investors receive a claim on the mortgage assets, which become collateral in the event of default. Further, the MBS investor has the right to cash flows related to the mortgage payments. To manage their risk, mortgage originators (e.g., banks or mortgage lenders) may also create separate legal entities, called specialpurpose entities (SPE), to both assume the risk of default and issue the MBS. The banks effectively sell the mortgage assets (i.e., banking accounts Page 13
receivable, which are the rights to receive the mortgage payments) to these SPE. In turn, the SPE then sells the MBS to the investors. The mortgage assets in the SPE become the collateral. Asset price risk: CDO valuation is complex and related "fair value" accounting for such "Level 3" assets is subject to wide interpretation. This valuation fundamentally derives from the collectibility of subprime mortgage payments, which is difficult to predict due to lack of precedent and rising delinquency rates. Banks and institutional investors have recognized substantial losses as they revalue their CDO assets downward. Most CDOs require that a number of tests be satisfied on a periodic basis, such as tests of interest cash flows, collateral ratings, or market values. For deals with market value tests, if the valuation falls below certain levels, the CDO may be required by its terms to sell collateral in a short period of time, often at a steep loss, much like a stock brokerage account margin call. If the risk is not legally contained within an SPE or otherwise, the entity owning the mortgage collateral may be forced to sell other types of assets, as well, to satisfy the terms of the deal. In addition, credit rating agencies have downgraded over U.S. $50 billion in highly-rated CDO and more such downgrades are possible. Since certain types of institutional investors are allowed to only carry higher-quality (e.g., "AAA") assets, there is an increased risk of forced asset sales, which could cause further devaluation. Liquidity risk: A related risk involves the commercial paper market, a key source of funds (i.e., liquidity) for many companies. Companies and SPE called structured investment vehicles (SIV) often obtain short-term loans by issuing commercial paper, pledging mortgage assets or CDO as collateral. Investors provide cash in exchange for the commercial paper, receiving money-market interest rates. However, because of concerns regarding the value of the mortgage asset collateral linked to subprime and Alt-A loans, the ability of many companies to issue such paper has been significantly affected. The amount of commercial paper issued as of October 18, 2007 dropped by 25%, to $888 Page 14
billion, from the August 8 level. In addition, the interest rate charged by investors to provide loans for commercial paper has increased substantially above historical levels.
2.2 CAUSES OF THE CRISIS The housing downturn

Subprime borrowing was a major contributor to an increase in home ownership rates and the demand for housing. The overall U.S. homeownership rate increased from 64 percent in 1994 (about where it was since 1980) to a peak in 2004 with an all time high of 69.2 percent. This demand helped fuel housing price increases and consumer spending. Between 1997 and 2006, American home prices increased by 124%. Some homeowners used the increased property value experienced in the housing bubble to refinance their homes with lower interest rates and take out second mortgages against the added value to use the funds for consumer spending. U.S. household debt as a percentage of income rose to 130% during 2007, versus 100% earlier in the decade. A culture of consumerism is a factor. In the early 2000s recession that began in early 2001 and which was exacerbated by the September 11, 2001 terrorist attacks, Americans were asked to spend their way out of economic decline with "consumerism... cast as the new patriotism". This call linking patriotism to shopping echoed the urging of former President Bill Clinton to "get out and shop" and corporations like General Motors produced commercials with the same theme. Existing Homes Sales, Inventory, and Months Supply, By Quarter Overbuilding during the boom period, increasing foreclosure rates and unwillingness of many homeowners to sell their homes at reduced market prices have significantly increased the supply of housing inventory available. Sales volume (units) of new homes dropped by 26.4% in 2007 versus the prior year. By January 2008, the inventory of unsold new homes stood at 9.8 months based on Page 15
December 2007 sales volume, the highest level since 1981. Further, a record of nearly four million unsold existing homes were available. This excess supply of home inventory places significant downward pressure on prices. As prices decline, more homeowners are at risk of default and foreclosure. 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 peak. However, there was significant variation in price changes across U.S. markets, with many appreciating and others depreciating. The price decline in December 2007 versus the year-ago period was 10.4%. As of February 2008, housing prices are expected to continue declining until this inventory of surplus homes (excess supply) is reduced to more typical levels. THE HOUSING PRICE CRASH
Graph clearly denote the bursting of the housing bubble and crash of housing prices
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A variety of factors have contributed to an increase in the payment delinquency rate for subprime ARM borrowers, which recently reached 21%, roughly four times its historical level. Chart clearly says the rise in delinquency and foreclosures.
Role of borrowers
Easy credit, combined with the assumption that housing prices would continue to appreciate, also encouraged many subprime borrowers to obtain ARMs they could not afford after the initial incentive period. Once housing prices started depreciating moderately in many parts of the U.S. (see United States housing market correction and United States housing bubble), refinancing became more difficult. Some homeowners were unable to re-finance and began to default on loans as their loans reset to higher interest rates and payment amounts. Other homeowners, facing declines in home market value or with limited accumulated equity, are choosing to stop paying their mortgage. They are essentially "walking away" from the property and allowing foreclosure, despite the impact to their credit rating. Mortgage fraud by borrowers from US Department of the Treasury Page 17
Misrepresentation of loan application data is another contributing factor. In a January 13, 2008 column in the New York Times, George Mason University economics professor Tyler Cowen wrote, "There has been plenty of talk about 'predatory lending,' but 'predatory borrowing' may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default. Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers." US Department of the Treasury suspicious activity report of mortgage fraud increased by 1,411 percent between 1997 and 2005.
Role of financial institutions

A variety of factors have caused lenders to offer an increasing array of higher-risk loans to higher-risk borrowers. The share of subprime mortgages to total originations was 5% ($35 billion) in 1994, 9% in 1996, 13% ($160 billion) in 1999 , and 20% in 2006. A study by the Federal Reserve indicated that the average difference in mortgage interest rates between subprime and prime mortgages (the "subprime markup" or "risk premium") declined from 2.8 percentage points (280 basis points) in 2001, to 1.3 percentage points in 2007. In other words, the risk premium required by lenders to offer a subprime loan declined. This occurred even though subprime borrower and loan characteristics declined overall during the 2001-2006 period, which should have had the opposite effect. The combination is common to classic boom and bust credit cycles.
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In addition to considering higher-risk borrowers, lenders have offered increasingly high-risk loan options and incentives. One example is the interestonly adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest (not principal) during an initial period. Another example is a "payment option" loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal. Further, an estimated one-third of ARM originated between 2004-2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment. Some believe that mortgage standards became lax because of a moral hazard, where each link in the mortgage chain collected profits while believing it was passing on risk.
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Role of securitization
Securitization is a structured finance process in which assets, receivables or financial instruments are acquired, classified into pools, and offered as collateral for third-party investment. There are many parties involved. Due to securitization, investor appetite for mortgage-backed securities (MBS), and the tendency of rating agencies to assign investment-grade ratings to MBS, loans with a high risk of default could be originated, packaged and the risk readily transferred to others. Asset securitization began with the structured financing of mortgage pools in the 1970s. The securitized share of subprime mortgages (i.e., those passed to third-party investors) increased from 54% in 2001, to 75% in 2006. Alan Greenspan stated that the securitization of home loans for people with poor credit not the loans themselves were to blame for the current global credit crisis.
Borrowing Under a Securitization Structure
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Role of mortgage brokers

Mortgage brokers don't lend their own money. There is not a direct correlation between loan performance and compensation. They have big financial incentives for selling complex, adjustable rate mortgages (ARM's), since they earn higher commissions. According to a study by Wholesale Access Mortgage Research & Consulting Inc., in 2004 Mortgage brokers originated 68% of all residential loans in the U.S., with subprime and Alt-A loans accounting for 42.7% of brokerages' total production volume. The chairman of the Mortgage Bankers Association claimed brokers profited from a home loan boom but didn't do enough to examine whether borrowers could repay.
Role of mortgage underwriters

Underwriters determine if the risk of lending to a particular borrower under certain parameters is acceptable. Most of the risks and terms that underwriters consider fall under the three Cs of underwriting: credit, capacity and collateral. See mortgage underwriting. In 2007, 40 percent of all subprime loans were generated by automated underwriting. An Executive vice president of Countrywide Home Loans Inc. stated in 2004 "Prior to automating the process, getting an answer from an underwriter took up to a week. "We are able to produce a decision inside of 30 seconds today. ... And previously, every mortgage required a standard set of full documentation." Some think that users whose lax controls and willingness to rely on shortcuts led them to approve borrowers that under a less-automated system would never have made the cut are at fault for the subprime meltdown.
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Role of government and regulators

Some economists claim that government policy actually encouraged the development of the subprime debacle through legislation like the Community Reinvestment Act, which they say forces banks to lend to otherwise uncreditworthy consumers. Economist Robert Kuttner has criticized the repeal of the Glass-Steagall Act as contributing to the subprime meltdown. A taxpayerfunded government bailout related to mortgages during the Savings and Loan crisis may have created a moral hazard and acted as encouragement to lenders to make similar higher risk loans. Some have argued that, despite attempts by various U.S. states to prevent the growth of a secondary market in repackaged predatory loans, the Treasury Department's Office of the Comptroller of the Currency, at the insistence of national banks, struck down such attempts as violations of Federal banking laws. In response to a concern that lending was not properly regulated, the House and Senate are both considering bills to regulate lending practices.
Role of credit rating agencies

Credit rating agencies are now under scrutiny for giving investment-grade ratings to securitization transactions holding subprime mortgages. Higher ratings are theoretically due to the multiple, independent mortgages held in the MBS per the agencies, but critics claim that conflicts of interest were in play.
Role of central banks

Central banks are primarily concerned with managing the rate of inflation and avoiding recessions. They are also the lenders of last resort to ensure liquidity. They are less concerned with avoiding asset bubbles, such as the housing bubble and dotcom bubble. Central banks have generally chosen to react after such bubbles burst to minimize collateral impact on the economy, Page 22
rather than trying to avoid the bubble itself. This is because identifying an asset bubble and determining the proper monetary policy to properly deflate it are not proven concepts. There is significant debate among economists regarding whether this is the optimal strategy. Federal Reserve actions raised concerns among some market observers that it could create a moral hazard. Some industry officials said that Federal Reserve Bank of New York involvement in the rescue of Long-Term Capital Management in 1998 would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf. A potential contributing factor to the rise in home prices was the lowering of interest rates earlier in the decade by the Federal Reserve, to diminish the blow of the collapse of the dot-com bubble and combat the risk of deflation.
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3. IMPACTS
3.1
EFFECT OF CRISIS ON WORLD MARKET
The subprime crisis in the US, following the collapse of the housing sector boom, has sent ripples through the economies of many countries. During the high demand period for housing loans in the US, when the real estate sector was booming, people with a bad credit history, and a higher chance of defaulting on on their payments, were provided loans at higher-than-normal interest rates (sub-prime rates). A decline in economic activity in the US resulted in lower disposable incomes and hence a decline in demand. Simultaneously there was a rise in supply due to repayments and foreclosures arising out of a higher interest rate. This triggered the subprime crisis. Over the last few months, the world has been hit by the heat of the US subprime crisis. It was initially thought by some that other major world economies would not be significantly affected. However, the crisis is quickly becoming a problem, affecting major economies worldwide both directly and indirectly. Major banks of the U.S have been affected. Lehmann brothers have filed from bankruptcy. Merill lynch has been taken over by Bank of America. The government has come out with a $700 billion package to aid failing investments banks. Fannie Mae and Freddie Mac and AIG have been bailed out by the government. Moreover, financial markets throughout the world have crashed with intense liquidity crunch. This has affected all major economies of the world and is now spreading its wings to emerging economies.
Indirect economic effects

The subprime crisis had a series of other economic effects. Housing price declines left consumers with less wealth, which placed downward pressure on consumption. Certain minority groups received a higher proportion of subprime loans and experienced a disproportional level of foreclosures. Home related crimes including arson increased.] Job losses in the financial sector were Page 24
significant, with over 65,400 jobs lost in the United States as of September 2008. The sudden lack of credit also caused a slump in car sales. Ford sales in October 2008 were down 33.8% from a year ago, General Motors sales were down 15.6%, and Toyota sales had declined 32.3%. One in five car dealerships are expected to close in fall of 2008
What was the effect on the Swiss bank?

Swiss bank had shares or stakes in many companies now all of them have been beaten down completely so this loss has to b faced by Swiss bank also Effect on UNITECH Unitech an Indian company which builds luxury apartments had small stake in Lehman brother because of that stake it has to face 2000cr loss in Jan Unitech price was 500 now it is 40.
Impact Negative Affects

The banks have to survive for existence now. They have leveraged more than their capital .Which resulted in bad loans bad debts Major Cash crunch in the US especially which will lead to crash crunch all over the world. (no money) The banks have lost trust in each other and arent lending to each other Credit crunch- dont have enough money to lend to People any more. The crises have lead to re engineering, which will lead to job losses. Rate of interest is cut so it will impact the common man Equity market is falling so the capital of individuals is getting eroded. Also has lead to physiological problems Example a person in the US lost 1.6 million he killed himself and his family. The economic meltdown has ruined people. They invested their live saving and all of it just vanished in a second leading to physiological problems Page 25
Capital eroding of both individuals as well as companies Down turn in the economies purchasing power goes down. This will lead to major down turn in the economies of India and china who r the major exporters to the US and Europe. People who once earned handsome salaries suddenly have had 50 percent cuts and not only that they have a fear of losing their jobs. Top personnel are jobless in the states.
Governments bail out banks to avert global meltdown

Governments across the world moved on Monday to shore up confidence in the tottering global financial system with a slew of bank bailout worth hundreds of billions of dollars. The moves were designed to stave off the world's worst financial crisis in nearly 80 years, which comes against a background of declining global economic growth to raise the threat of widespread recession. Britain would spend up to 37 bn pounds ($63.95 billion) buying into top UK banks. The French government will also create a 40 bn euro ($54.89 bn) fund to take stakes in banks, Germany will launch a rescue plan including a fund to provide up to 400 billion Euros ($548.9 billion) in guarantees for banks, .In a joint announcement with the U.S. Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank said they would meet all bids from commercial banks at a fixed interest rate. The moves followed a weekend of crisis talks in the United States and Europe in which governments pledged to support the financial system, which has moved to the brink of collapse as it suffers from both steep losses in the credit market and a lack of trust in lending that has frozen the flow of capital. The need for bailouts has become particularly trenchant as a background of a global economic slowdown, with many countries facing recession. Page 26
The crisis has swept across financial markets, sending many stock markets into free fall. MSCI's main world stocks index, for example, has lost a quarter of its value since the beginning of October. Equity investors appeared to be comforted by the government bailouts. "The recovery process is likely to be very long winded and will likely take about as long as the crisis has taken thus far." Money markets -- the heart of the credit crisis -- eased but remained tight. Three month dollar rates were some 4 percentage points higher than expectations the Federal Reserve will cut interest rates to at least 1.25 percent
Rising dollar, global slowdown quash impact of falling oil

In spite of easing in crude oil price from record highs and rupee depreciating to a two-year low against the US dollar, Indian stock market continue to be beaten down on rising fears of global recession. Strengthening of the dollar has contributed significantly to the current bout of rupee depreciation. This depreciation, which will hurt imports and external commercial borrowings, will not help inflation come down. Costly imports means higher cost of production,
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BAILOUT BY THE U.S GOVERNMENT

Government bailouts
Northern Rock had difficulty finding finance to keep the business going and was nationalized on 17 February 2008. As of October 8th, 2008, UK taxpayer liability for the bank had climbed to 87Bn ($150Bn) according to Robert Chote, director of the Institute for Fiscal Studies
Bear Stearns was acquired in March 2008 by J.P. Morgan Chase for $1.2 billion In order for the deal to go through, the Fed issued a nonrecourse loan of $29 billion to Bear Stearns
In September 2008, the Treasury Department confirmed that both Fannie Mae and Freddie Mac would be placed into conservatorship with the government taking over management of the pair. The two GSEs have outstanding more than US$ 5 trillion in mortgage backed securities (MBS) and debt
Merrill Lynch was acquired by Bank of America in September 2008 for $50 billion. Scottish banking group HBOS agreed on 17 September 2008 to be acquired by UK rival Lloyds TSB in an emergency takeover after its share price experienced significant falls amid fears over its exposure to toxic debt. The deal was encouraged by the UK government, who agreed to waive competition rules to allow the takeover to go ahead
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Lehman Brothers declared bankruptcy on 15 September 2008, facing a refusal by the federal government to bail it out. Treasury Secretary Hank Paulson cited moral hazard as a reason for not bailing out Lehman Brothers
In September 2008, The Federal Reserve provided an emergency loan of $85 billion to AIG, which will be repaid by selling off assets of the company. This intervention gave the US government a 79.9% equity stake at AIG. Just over three weeks later the Fed reported that AIG had drawn down $70.3 billion of that $85 billion facility and AIG announced that it may tap an additional $37.8 billion in secured funding from the Federal Reserve
In September 2008, Washington Mutual declared bankruptcy. The United States Office of Thrift Supervision (OTS) announced that it was seizing WaMu and would sell most of its functional assets to J.P. Morgan Chase.
On 29 September 2008, British bank Bradford & Bingley was nationalized by the UK government. The government will take control of the bank's 50bn mortgages and loans, while its savings operations and branches are to be sold to Spain's Santander. In October 2008, The Australian government announced that AU$4 billion was to be raised to fund non-bank lenders that are unable to obtain funding to finance new loans. After industry feedback this was increased to AU$8 billion.
Indian Bailout
Communist Party of India today strongly opposed any bailout package for Indian corporate, saying it would enrich the private sector. The Left party also warned the UPA government against forging any economic understanding with the United States to help India come out of the current economic meltdown, claiming ''it will weaken India''. Speaking on ''Financial Meltdown : Lessons from Sub-Prime Crisis'', CPI National Secretary D Raja also Page 29
cautioned Reserve Bank to stop relaxing its monetary policies as these would directly benefit private trade and widen financial disparities across the social spectrum in the country. In a keynote address organized by industry chamber Assocham, the communist leader said the government should directly intervene with ''nationalization threat'' in those utilities which intend to lay off people. ''The Prime Minister should come forward with a threat of nationalization against those utilities in private sector that have secret plans to downsize their workforce with an intended purpose to further accelerate their profits on pretext of slowdown,'' said Raja. Opposing any bailout package for private sector, he said if any such package was in offing, it should go to public sector which has kept the country largely insulated from global financial crisis. The Left leader sought democratization of multilateral institutions such as International Monetary Fund, World Bank and Asian Development Bank which, he said, are controlled by the United States. The economic and military hegemony of US should no longer be allowed to influence India as it is one of the most vibrant democracy in the world which would shortly become another economic superpower after China,'' Raja said. The communist leader said economic slowdown will last longer in India if public investments in agriculture and infrastructure are not increased. Mr. Russell Green from the US Embassy, World Bank economist Deepak Dasgupta, Assocham vice president Dilip Modi among others also spoke at the interactive session. Barring Mr. Raja, all panelists present were hopeful that India would be able to manage the current crisis as its financial fundamentals are sound.
system
is well regulated and its economic
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Indian finance ministers comment on bail out?

New Delhi, Sep 30 Amid fears of global financial meltdown hitting India, Finance Minister P Chidambaram today assured investors that Indian market is "sound and attractive" and promised them to take necessary action if needed. "There is nothing to worry about the Indian market. We are suffering the consequences of turbulence around the world. Basically, Indian market is a sound, attractive and well regulated market", he told reporters. The government is monitoring the situation round-the- clock, he said, adding "the regulations that are in place are adequate. But if the regulations are to be tweaked we will do so". He further added that steps would to be taken, if needed, for smooth functioning of the market. Commenting on withdrawal of FIIs from equity market, he said, "FIIs are selling but I do not think all FIIs are selling nor do I think they are selling all the time." They are selling because they have got payment obligations, he said, adding, "some FIIs are buying and perhaps more FIIs will buy having regard to the fact that India is still is a very attractive market to invest and Indian market is a well regulated market". Referring to the rejection of 700 billion-dollar bailout package by the US House of Representatives, Chidambaram said, "bailout package is a concern of US Congress and the US Government. It is agreed by everyone that bailout is necessary. How the Congress will reconcile to the views of two major political parities, it is not for me to comment." He said, "Of course, we will be greatly helped if a bailout package is quickly approved by the US Congress.
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US recession turns into an Indian headache

FOR MORE than a year now, the US dollar has been falling in value against other currencies due to faltering real estate prices, sub-prime meltdown, excessive consumer debt and skyrocketing imported energy prices. And when the dollar drops, it has economic insinuations for all of us. But how serious is it? At a meeting of finance ministers in France, US treasury secretary, John Snow, made the seemingly casual comment that the recent drop has been modest. But that prompted the further dumping of dollars on world currency markets, driving the value even lower. Investors worldwide are becoming skeptical and have started pulling their money out of the United States. They have realized that the people and the country cannot live beyond their means in the long term. The US dollars exchange rate is starting to crumble as a result of this withdrawal. Gone are the days when an American finance minister could boast, The dollar is our currency, but its your problem. Now or never? One has to reap what one sows; the industry watchers see a significant linkage between the rising work hours, layoffs, pink slips, downsizing, termination or workforce reduction call it by any name and the recent appreciation of the rupee against the US dollar, which has impacted the bottom lines. According to various reports, the information technology (IT) sector is facing and moving further towards a recession. Every IT organization, whether small or big, is reducing its workforce. So, in order to offset this quandary, recently the Indian job market has been flooded with news like TCS laying-off 500 employees, Yahoo! Asking 45 employees to leave, IBM laying off more than 700 employees from its Indian offices etc. The average salaries offered and the average annual hike in the salaries in the IT sector have also seen a downfall. TCS, the leader in Page 32
the software service providers in India, have reduced the variable pay or the incentives of its employees for the first quarter of 2008 by 1.5 per cent. Justifying the lay-offs, most of the organizations argue that the employees were asked to leave (not fired) because of the regular termination of services of workers performing below expectations and not related to a widely anticipated contraction in spending on information technology by customers in America. The average salaries being offered in the industry have also come down in the sector. Similarly, all the organizations are undertaking the cut in salaries of the employees for various reasons, which remains a deep sea clandestine. In the IT sector, the latest news of layoffs has come from almost all the sectors of the industry. I think the US economy may bounce back and there is no conclusive evidence of recession in that economy. However, if there is slowdown in the US, Europe and other parts of the world, it will affect our exports, Finance Minister P Chidambaram said in Davos. India is worried although the official financial ministry keeps saying there is no problem if America hits a recession. Since the 1990s, India has transformed itself into a trading nation instead of a producing nation. Indian oligarchs bring in western goods and services and package them to sell the same to hungry and poor native Indians eager to get a piece of the American Dream. It sells men and women to the American and European companies by the name of information technology and business process outsourcing. It is nothing but slave trading of the present age. With the American economy in a severe depression, India Inc is getting wiped out. These yuppies on the high Indian oligarchs even bought American and European companies. They will soon find they lost it all as the western world is faced with economic meltdown and depression. In conclusion, India finally realizes what a blunder it committed by becoming a trading nation rather than a producing nation. The slump in the market is not the result of poor fundamentals in these countries but of the slouch in Americas Page 33
economy, especially its sub-prime housing market where defaults and foreclosures have been on the rise. The institutions rolling under the knock-on effects of that crisis are selling out in Asian markets to find the money to rebalance their capital structures or meet their commitments. On hearing the climb in the Indian rupee value, the Indians should be as happy as Larry. But, this has made the Indians only sadder than ever, which implies how much we are dependable on the American economy! Most of the IT companies in India have 90 per cent of their clients from America. The craze for the software jobs is increasing day by day amongst the people in India. Thus, the other opportunities in India are side stepped for various reasons. Even though Chinas economy is related to that of Americas, we know China presents opportunities and challenges for the rest of the world. A misunderstood land of contrasts, conflicts and confusion, China appears to some analysts to be on the verge of world supremacy. Others believe that China will collapse under the weight of an overheated economy and difficult environmental problems. China which is a restless giant provides opportunities for all not only in the IT field, but also in other core manufacturing fields. So, its in the hands of the government and the companies and the people to exact this set back. The government and the IT giants should work together to handle such kind of money appreciation and depreciation. And, China can be the best example to take for their extraordinary developments in flourishing industries in all fields giving equal importance to all sectors, thus benefiting everybody. Example isnt another way to teach, it is the only way to teach.
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3.2 Impact on corporations and investors

Average investors and corporations face a variety of risks due to the inability of mortgage holders to pay. These vary by legal entity. Some general exposures by entity type include:
Bank corporations: The earnings reported by major banks are adversely affected by defaults on mortgages they issue and retain. Companies value their mortgage assets (receivables) based on estimates of collections from homeowners. Companies record expenses in the current period to adjust this valuation, increasing their bad debt reserves and reducing earnings. Rapid or unexpected changes in mortgage asset valuation can lead to volatility in earnings and stock prices. The ability of lenders to predict future collections is a complex task subject to a multitude of variables.
Mortgage lenders and Real Estate Investment Trusts: These entities face similar risks to banks. In addition, they have business models with significant reliance on the ability to regularly secure new financing through CDO or commercial paper issuance secured by mortgages. Investors have become reluctant to fund such investments and are demanding higher interest rates. Such lenders are at increased risk of significant reductions in book value due to asset sales at unfavorable prices and several have filed bankruptcy.
Special purpose entities (SPE): Like corporations, SPE are required to revalue their mortgage assets based on estimates of collection of mortgage payments. If this valuation falls below a certain level, or if cash flow falls below contractual levels, investors may have immediate rights to the mortgage asset collateral. This can also cause the rapid sale of assets at unfavorable prices. Other SPE called structured investment vehicles (SIV) issue commercial paper and use the proceeds to purchase Page 35
securitized assets such as CDO. These entities have been affected by mortgage asset devaluation. Several major SIV are associated with large banks.
Investors: Stocks or bonds of the entities above are affected by the lower earnings and uncertainty regarding the valuation of mortgage assets and related payment collection. Many investors and corporations purchased MBS or CDO as investments and incurred related losses.
3.3 Impact on stock markets

On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing above 14,000 for the first time. By August 15, the Dow had dropped below 13,000 and the S&P 500 had crossed into negative territory year-to-date. Similar drops occurred in virtually every market in the world, with Brazil and Korea being hard-hit. Large daily drops became common, with, for example, the KOSPI dropping about 7% in one day, although 2007's largest daily drop by the S&P 500 in the U.S. was in February, a result of the subprime crisis. Black Monday has pushed the Indian benchmark among the worst performing stock indices in 2008. The year-to-date return for the BSE Sensex is a negative 13.55 per cent and the Nifty is down 15.47 per cent for the same period. In comparison, the US Dow Jones Industrial Average slipped 8.79 per cent, NASDAQ 11.77 per cent and the diversified S&P-500 has tumbled 9.75 per cent this year. While the US benchmarks have been declining since mid-December, the Indian equities were able to withstand the bears onslaught till now. But large-scale selling by foreign institutional investors over the past week has shaken the confidence on Indian bourses too.
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European stock indices such as UKs FTSE, Germans Dax and Frances CAC have tumbled as much as the Indian bourses. Hong Kongs Hang Seng also witnessed a sharp fall of 14.5 per cent in the year so far. Major markets were pummeled, led by banks and mining companies, as concern that the US will fall into a recession caused major panic among global investors. Even emerging markets Brazil, South Korea, Mexico and Russia, have witnessed a fall in the range of 10-13 per cent this year. Despite domestic problems, Indian neighbors Pakistan and Sri Lanka have performed better than most of the countries. Karachis index dipped only 2.02 per cent. Thanks to strong crude prices, West Asian stock indices in Amman (Jordan), Kuwait, Abu Dhabi have generated positive returns in 2008. Among others markets, Ecuador, Mauritius and Nigeria are also in the positive zone. Mortgage lenders and home builders fared terribly, but losses cut across sectors, with some of the worst-hit industries, such as metals & mining companies, having only the vaguest connection with lending or mortgages.
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Stock indices throughout the week
3.4 Impact on financial institutions

Many banks, mortgage lenders, real estate investment trusts (REIT), and hedge funds suffered significant losses as a result of mortgage payment defaults or mortgage asset devaluation. As of February 19, 2008 financial institutions had recognized subprime-related losses or write-downs exceeding U.S. $150 billion. Other companies from around the world, such as IKB Deutsche Industriebank have also suffered significant losses and scores of mortgage lenders have filed for bankruptcy. Top management has not escaped unscathed, Page 38
as the CEOs of Merrill Lynch and Citigroup were forced to resign within a week of each other. Various institutions follow-up with merger deals.
Write-downs on the value of loans, MBS and CDOs by Financial institution
Company Citigroup Merrill Lynch UBS AG Morgan Stanley Crdit Agricole HSBC Bank of America Deutsche Bank Barclays Capital Bear Stearns Swiss Re Lehman Brothers JP Morgan Chase Goldman Sachs Credit Suisse Socit Gnrale BNP Paribas
Business Type investment bank investment bank investment bank investment bank Bank Bank Bank investment bank investment bank investment bank re-insurance investment bank investment bank investment bank bank investment bank bank
Loss (Billion $) $24.1 bln [65] [66] [67] $22.5 bln [68] [69] $18.7 bln [70] [71] $10.3 bln [72] [73] $4.8 bln [74] $3.4 bln [75] $5.28 bln [76] $3.1 bln [78] [79] $3.1 bln [80] $2.6 bln [81] [82] $1.07 bln [86] $2.1 bln [87] [88] $2.9 bln [90] [91] $1.5 bln [92] [93] $3.7 bln [96] $3.0 bln [109] [110] $0.870 bln [111] [112]
Businesses filing for bankruptcy
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Business New Century Financial American Home Mortgage Sentinel Management Group Ameriquest NetBank Terra Securities American Freedom Mortgage Inc
Type subprime lender mortgage lender investment fund subprime lender on-line bank securities subprime lender
Date April 2, 2007 August 6, 2007 August 17, 2007 August 31, 2007 September 30, 2007 November 28, 2007 January 30, 2007
3.5 Impact on insurance companies

There is concern that some homeowners are turning to arson as a way to escape from mortgages they can't or refuse to pay. The FBI reports that arson grew 4% in suburbs and 2.2% in cities from 2005 to 2006. As of Jan 2008, the 2007 numbers were not yet available. Impact on municipal bond "monoline" insurers Secondary cause and effect of the crisis relates to the role of municipal bond "monoline" insurance corporations. By insuring municipal bond issues, those bonds achieve higher debt ratings. However, these insurers used premiums to purchase CDO investments and have suffered significant losses, which bring their ability to insure bonds into question. Unless these insurers obtain additional capital, rating agencies may downgrade the bonds they insured or guaranteed. In turn, this may require financial institutions holding the bonds to lower their valuation or to sell them, as some entities (such as pension funds) are only allowed to hold the highest-grade bonds. The impact of such devaluation on institutional investors and corporations holding the bonds (including major banks) has been estimated as high as $200 billion. Regulators are taking action to
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encourage banks to lend the required capital to certain monoline insurers, to avoid such an impact.
3.6 Impact on 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 peak. However, there was significant variation in price changes across U.S. markets, with many appreciating and others depreciating. 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. By January 2008, the inventory of unsold new homes stood at 9.8 months based on December 2007 sales volume, the highest level since 1981. Housing prices are expected to continue declining until this inventory of surplus homes (excess supply) is reduced to more typical levels. As MBS and CDO valuation is related to the value of the underlying housing collateral, MBS and CDO losses will continue until housing prices stabilize. As home prices have declined following the rise of home prices caused by speculation and as re-financing standards have tightened, a number of homes have been foreclosed and sit vacant. These vacant homes are often poorly maintained and sometimes attract squatters and/or criminal activity with the result that increasing foreclosures in a neighborhood often serve to further accelerate home price declines in the area. Rents have not fallen as much as home prices with the result that in some affluent neighborhoods homes that were formerly owner occupied are now occupied by renters. In select areas falling home prices along with a decline in the U.S. dollar have encouraged foreigners to buy homes for either occasional use and/or long term investments. Additional problems are anticipated in the future from the impending retirement of the baby boomer generation. It is believed that a significant proportion of baby boomers are not saving adequately for retirement and were planning on using their Page 41
increased property value as a "piggy bank" or replacement for a retirementsavings account. This is a departure from the traditional American approach to homes where "people worked toward paying off the family house so they could hand it down to their children"
3.7 Impact on minorities

There is a disproportionate level of foreclosures in some minority neighborhoods. About 46% of Hispanics and 55% of blacks who obtained mortgages in 2005 got higher-cost loans compared with about 17% of whites and Asians, according to Federal Reserve data. Other studies indicate they would have qualified for lowerrate loans.
3.8 Specific Impacts by Firm or Sector

Wall Street investment banks and other financial institutions around the world have also been affected. On June 20, 2007, Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds that were involved in securities backed by subprime loans. The two funds are now essentially worthless American Home Mortgage Investment Corporation (AHMI, Melville, New York) filed Chapter 11 bankruptcy on August 6, 2007, after a layoff of its employees the week before. Accredited Home Lenders reported on August 10 that the company expected to see up to a $60 million loss for the first quarter 2007 On 8 August 2007, Mortgage Guaranty Insurance Corporation (MGIC, Milwaukee, Wisconsin) announced it would discontinue its purchase of Radian Group (Philadelphia, Pennsylvania) after suffering a billion-dollar loss of its investment in Credit-Based Asset Servicing and Securitization (C-BASS, New
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York City). C-BASS is seeking to restructure its financing. The MGIC-Radian transaction would have been a $4.9 billion deal. Later, on August 9, French bank BNP Paribas stopped valuing three of its funds and suspended all withdrawals by investors after United States subprime mortgage woes had caused "a complete evaporation of liquidity". Goldman Sachs' $8 billion Global Alpha hedge fund, its largest, reportedly lost 26% in 2007. Later, on August 13, the company announced that a group of investors invested more in its Global Equity Opportunities fund by infusing $3 billion after it lost 28% of its total value in one week. Also, Citigroup has reported taking $700 million in losses in its credit business in July and August 2007. On August 14, several media outlets reported that another fund, Sentinel Management Group, suspended redemptions for investors and sold off $312 million worth of assets. Three days later, Sentinel filed for Chapter 11 bankruptcy protection amid ongoing legal action with respect to this move.US and European stock indices continued to fall. Later that same day Thornburg Mortgage, a jumbo mortgage lender, announced they were delaying their dividend after facing margin calls and disruptions in funding mortgages in the commercial paper and asset-backed securities markets. Thornburg shares fell over 46% in trading on the NYSE. On August 15, the stock of Countrywide Financial, which is the largest mortgage lender in the United States, fell around 13% on the New York Stock Exchange, its largest one-day decline since the 1987 stock market crash, on fears that the company could face bankruptcy. This comes a day after Countrywide said foreclosures and mortgage delinquencies had risen to their highest levels since early 2002. Concerned customers of Northern Rock queuing to withdraw savings from the bank due to fallout from the subprime crisis Page 43
Rams Home Loans Group, an Australian lender, announced on August 16 that the company was unable to refinance short-term debt as buyers stayed away from the credit markets. The company said they were unable to sell AUD$ 6.17 billion of extendable commercial paper, which is the company's largest source of funding for loans. Rams shares fell as much as 41% on the Australian Stock Exchange. A AUD$ 140 million private sector bailout by Westpac was announced on October 2 due to the lender's inability to refinance its loans. The deal valued Rams at AUD$0.40 per share. On August 29 the Australian Hedge Fund, Basis Capital's "Basis Yield Alpha Fund" applied for bankruptcy protection. Investors in the fund are unlikely to get any of their money back as the fund falls under the weight of its exposure to subprime credit in the US. United States, Asian, and European stock markets also continued to struggle with the turmoil in the credit markets into early September. A report on existing home sales released on September 5 said that the number of Americans buying existing homes had dropped by its largest amount since 2001, when the report first came into existence. Earnings estimates from investment banks such as Lehman Brothers and Morgan Stanley were cut significantly. Homebuilding stocks, such as Lennar and D.R. Horton, continued to decline. On September 7, a report by the US Labor Department announced that non-farm payrolls fell by 4,000 in August 2007, the first month of negative job growth since August 2003. The number fell well short of expectations, as analysts were expecting payrolls to grow by 110,000. The Dow Jones Industrials fell by as much as 180 points on the news. Cited as a reason for the unexpected weakness in the job market are the problems in the housing and credit markets. On September 13, British bank Northern Rock applied to the Bank of England for emergency funds caused by liquidity problems. Concerned customers produced "an estimated 2bn withdrawn in just three days". Page 44
On October 5, Merrill Lynch announced a US$5.5 billion loss as a consequence of the subprime crisis, which was revised to $8.4 billion on October 24, a sum that credit rating firm Standard & Poor's called "startling".
ACTIONS TO MANAGE THE CRISIS
Lenders and homeowners both may benefit from avoiding foreclosure, which is a costly and lengthy process. Some lenders have taken action to reach out to homeowners to provide more favorable mortgage terms (i.e., loan modification or refinancing). Homeowners have also been encouraged to contact their lenders to discuss alternatives. Corporations, trade groups, and consumer advocates have begun to cite statistics on the numbers and types of homeowners assisted by loan modification programs. There is some dispute regarding the appropriate measures, sources of data, and adequacy of progress. A report issued in January 2008 showed that mortgage lenders modified 54,000 loans and established 183,000 repayment plans in the third quarter of 2007, a period in which there were 384,000 new foreclosures. Consumer groups claimed the modifications affected less than 1 percent of the 3 million subprime loans with adjustable rates that were outstanding in the third quarter. Page 45
Credit rating agencies help evaluate and report on the risk involved with various investment alternatives. The rating processes can be re-examined and improved to encourage greater transparency to the risks involved with complex mortgage-backed securities and the entities that provide them. Rating agencies have recently begun to aggressively downgrade large amounts of mortgage-backed debt.
Regulators and legislators can take action regarding lending practices, bankruptcy protection, tax policies, affordable housing, credit counseling, education, and the licensing and qualifications of lenders. Regulations or guidelines can also influence the nature, transparency and regulatory reporting required for the complex legal entities and securities involved in these transactions. Congress also is conducting hearings help identify solutions and apply pressure to the various parties involved.
The media can help educate the public and parties involved. It can also ensure the top subject material experts are engaged and have a voice to ensure a reasoned debate about the pros and cons of various solutions.
Banks have sought and received additional capital (i.e., cash investments) from sovereign wealth funds, which are entities that control the surplus savings of developing countries. An estimated U.S. $69 billion has been invested by these entities in large financial institutions over the past year. On January 15, 2008, sovereign wealth funds provided a total of $21 billion to two major U.S. financial institutions. Such capital is used to help banks maintain required capital ratios (an important measure of financial health), which have declined significantly due to subprime loan or CDO losses. Sovereign wealth funds are estimated to control nearly $2.9 trillion. Much of this wealth is oil and gas related. As they represent the surplus funds of governments, these entities carry at least the perception that their investments have underlying political motives. Page 46
Litigation related to the subprime crisis is underway. A study released in February 2008 indicated that 278 civil lawsuits were filed in federal courts during 2007 related to the subprime crisis. The number of filings in state courts were not quantified by are also believed to be significant. The study found that 43 percent of the cases were class actions brought by borrowers, such as those that contended they were victims of discriminatory lending practices. Other cases include securities lawsuits filed by investors, commercial contract disputes, employment class actions, and bankruptcy-related cases. Defendants included mortgage bankers, brokers, lenders, appraisers, title companies, home builders, servicers, issuers, underwriters, bond insurers, money managers, public accounting firms, and company boards and officers.
Economic Stimulus Act of 2008 : President Bush also signed into law on February 13, 2008 an economic stimulus package of $168 billion, mainly in the form of income tax rebates, to help stimulate economic growth.
Bush Administration plan

President George W. Bush announced a plan to voluntarily and temporarily freeze the mortgages of a limited number of mortgage debtors holding ARMs, declaring "I have a message for every homeowner worried about rising mortgage payments: The best you can do for your family is to call 1-800995-HOPE (sic)" The correct number is 1-888-995-HOPE. A refinancing facility called FHA-Secure was also created. This is part of an ongoing collaborative effort between the US Government and private industry to help some sub-prime borrowers called the Hope Now Alliance. The Hope Now Alliance released a report in February, 2008 indicating it helped 545,000 subprime borrowers with shaky credit in the second half of 2007, or 7.7 percent of 7.1 million subprime loans outstanding in September 2007. A spokesperson acknowledged that much more must be done.
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During February 2008, a program called "Project Lifeline" was announced. Six of the largest U.S. lenders, in partnership with the Hope Now Alliance, agreed to defer foreclosure actions for 30 days for homeowners 90 or more days delinquent on payments. The intent of the program was to encourage more loan adjustments, to avoid foreclosures. The U.S. Treasury Department is working directly with major banks to develop a systematic means of modifying loans for a significant portion of borrowers facing ARM increases, rather than working through loans on a caseby-case basis. President Bush also signed into law on February 13, 2008 an economic stimulus package of $168 billion, mainly in the form of income tax rebates, to help stimulate economic growth.
The Federal Reserve

Within the Federal Reserve, Chairman Ben Bernanke signals towards making interest rate cuts. In early 2008, Ben Bernanke said: "Broadly, the Federal Reserves response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy." Tougher regulatory standards are proposed. Additionally, a freeze of interest payments on certain sub-prime loans is announced. On January 22, 2008, the Fed also slashed a key interest rate (the federal funds rate) by 75 basis points to 3.5%, the biggest cut since 1984, followed by another cut of 50 basis points on January 30th. Central banks have conducted open market operations to ensure member banks have access to funds (i.e., liquidity). These are effectively short-term loans to member banks collateralized by government securities. Central banks have also lowered the interest rates charged to member banks (called the discount rate in the U.S.) for short-term loans. Both measures effectively lubricate the Page 48
financial system, in two key ways. First, they help provide access to funds for those entities with illiquid mortgage-backed assets. This helps lenders, SPE, and SIV avoid selling mortgage-backed assets at a steep loss. Second, the available funds stimulate the commercial paper market and general economic activity. Specific responses by central banks are included in the subprime crisis impact timeline.
Expectations and forecasts

As early as the 2003 Annual Report issued by Fairfax Financial Holdings Limited, Prem Watsa was raising concerns about securitized products: "We have been concerned for some time about the risks in asset-backed bonds, particularly bonds that are backed by home equity loans, automobile loans or credit card debt (we own no asset-backed bonds). It seems to us that securitization (or the creation of these asset-backed bonds) eliminates the incentive for the originator of the loan to be credit sensitive. Take the case of an automobile dealer. Prior to securitization, the dealer would be very concerned about who was given credit to buy an automobile. With securitization, the dealer (almost) does not care as these loans can be laid off through securitization. Thus, the loss experienced on these loans after securitization will no longer be comparable to that experienced prior to securitization (called a moral hazard)... This is not a small problem. There is $1.0 trillion in asset-backed bonds outstanding as of December 31, 2003 in the U.S.... Who is buying these bonds? Insurance companies, money managers and banks in the main all reaching for yield given the excellent ratings for these bonds. What happens if we hit an air pocket? Unlike..."
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The legacy of Alan Greenspan has been cast into doubt with Senator Chris Dodd claiming he created the "perfect storm" Alan Greenspan has remarked that there is a one-in-three chance of recession from the fallout. Nouriel Roubini, a professor at New York University and head of Roubini Global Economics, has said that if the economy slips into recession "then you have a systemic banking crisis like we haven't had since the 1930s" On September 7, 2007, the Wall Street Journal reported that Alan Greenspan has said that the current turmoil in the financial markets is in many ways "identical" to the problems in 1987 and 1998. The Associated Press described the current climate of the market on August 13, 2007, as one where investors were waiting for "the next shoe to drop" as problems from "an overheated housing market and an overextended consumer" are "just beginning to emerge."Market Watch has cited several economic analysts with Stifel Nicolaus claiming that the problem mortgages are not limited to the subprime niche saying "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", calling it a "vicious cycle" and adding that they "continue to believe conditions will get worse" As of November 22, 2007, analysts at a leading investment bank estimated losses on subprime CDO would be approximately U.S. $148 billion. As of December 22, 2007, a leading business periodical estimated subprime defaults between U.S. $200-300 billion. Alan Greenspan, the former Chairman of the Federal Reserve, stated: "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 Page 50
for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business." On March 20, 2008 the Organization for Economic Cooperation and Development downgraded its economic forecasts for the United States, the Eurozone and Japan for the first half of 2008.
SOME IMPORTANT TIME LINES 5.1 Subprime crisis impact timeline

The subprime crisis impact timeline begins with a context that includes the Dot-com bubble, Early 2000s recession, United States housing bubble, and the bubble burst (market correction) in 2005 which resulted in the subprime crisis itself in 2007 and its consequences.
Context and summary

20012005: United States housing bubble (part of the world housing bubble) 2001: US Federal Reserve lowers Federal funds rate 11 times, from 6.5% (May 2000) to 1.75% (December 2001). 2002: Annual home price appreciation of 10% or more in California, Florida, and most Northeastern states. 2004-2005: Arizona, California, Florida, Hawaii, and Nevada record price increases in excess of 25% per year. 2005ongoing: Market correction ("bubble bursting") 2005: Boom ended August 2005. The booming housing market halted abruptly for many parts of the U.S. in late summer of 2005. Page 51
2006: Continued market slowdown. Prices are flat, home sales fall, resulting in inventory buildup. U.S. Home Construction Index is down over 40% as of mid-August 2006 compared to a year earlier.
2007: Home sales continue to fall. The plunge in existing-home sales is the steepest since 1989. In Q1/2007, S&P/Case-Shiller house price index records first year-over-year decline in nationwide house prices since 1991. The subprime mortgage industry collapses, and a surge of foreclosure activity (twice as bad as 2006) and rising interest rates threaten to depress prices further as problems in the subprime markets spread to the near-prime and prime mortgage markets. The U.S. Treasury secretary calls the bursting housing bubble "the most significant risk to our economy."
FebruaryMarch: Subprime industry collapse; more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale.
April 2: New Century Financial, largest U.S. subprime lender, files for chapter 11 bankruptcy. July 19: Dow-Jones closes above 14,000 for the first time in its history. August: worldwide "credit crunch" as subprime mortgage backed securities are discovered in portfolios of banks and hedge funds around the world, from BNP Paribas to Bank of China. Many lenders stop offering home equity loans and "stated income" loans. Federal Reserve injects about $100B into the money supply for banks to borrow at a low rate.
August 6: American Home Mortgage files for chapter 11 bankruptcy. August 7: Democratic presidential front-runner Hillary Clinton proposes a $1 billion bailout fund to help homeowners at risk for foreclosure August 16: Countrywide Financial Corporation, the biggest U.S. mortgage lender, narrowly avoids bankruptcy by taking out an emergency loan of $11 billion from a group of banks.
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August 17: Federal Reserve lowers the discount rate by 50 basis points to 5.75% from 6.25%. August 31: President Bush announces a limited bailout of U.S. homeowners unable to pay the rising costs of their debts. Ameriquest, once the largest subprime lender in the U.S., goes out of business;
September 13: Fed Economic Symposium in Jackson Hole, WY addressed the housing recession that jeopardizes U.S. growth. Several critics argued that the Fed should use regulation and interest rates to prevent asset-price bubbles, blamed former Fed-chairman Alan Greenspan's low interest rate policies for stoking the U.S. housing boom and subsequent bust, and Yale University economist Robert Shiller warned of possible home price declines of fifty percent.
September 14: A run on the bank forms at the United Kingdom's Northern Rock bank precipitated by liquidity problems related to the subprime crisis. September 17: Former Fed Chairman Alan Greenspan said "we had a bubble in housing" and warns of "large double digit declines" in home values "larger than most people expect."
September 18: The Fed lowers interest rates by half a point (0.5%) in an attempt to limit damage to the economy from the housing and credit crises.
September 28: Television finance personality Jim Cramer warns Americans on The Today Show, "don't you dare buy a homeyou'll lose money," causing a furor among realtors.
September 30: Affected by the spiraling mortgage and credit crises, Internet banking pioneer Net Bank goes bankrupt, and the Swiss bank UBS announced that it lost US$690 million in the third quarter.
October 10: Hope Now Alliance was created by the US Government and private industry to help some sub-prime borrowers. October 1517: A consortium of U.S. banks backed by the U.S. government announced a "super fund" of $100 billion to purchase Page 53
mortgage backed securities whose mark-to-market value plummeted in the subprime collapse.[19] Both Fed chairman Ben Bernanke and Treasury Secretary Hank Paulson expressed alarm about the dangers posed by the bursting housing bubble; Paulson said "the housing decline is still unfolding and I view it as the most significant risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth." October 31: Federal Reserve lowers the federal funds rate by 25 basis points to 4.5%. November 1: Federal Reserve injects $41B into the money supply for banks to borrow at a low rate. The largest single expansion by the Fed since $50.35B on September 19, 2001. December 6:President Bush announced a plan to voluntarily and temporarily freeze the mortgages of a limited number of mortgage debtors holding adjustable rate mortgages (ARM). He also ask Members Of Congress to: 1. pass legislation to modernize the FHA. 2. temporarily reform the tax code to help homeowners refinance during this time of housing market stress. 3. pass funding to support mortgage counseling. 4. pass legislation to reform Government Sponsored Enterprises (GSEs) like Freddie Mac and Fannie Mae.
5.2 Central Bank Response Timeline

Central banks around the world have begun coordinated efforts of their own to increase liquidity in their own currencies to stabilize foreign exchange rates (thus stemming a further fall in the American dollar and diminishing any incentive to sell them off) and prevent the probable significant global consequences a run on the American dollar would cause. It marks the first time the American, European, and Japanese central banks have taken such actions together since the aftermath of the September 11, 2001 terrorist attacks.
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As of August 10, 2007, the United States Federal Reserve (Fed) has injected a combined 43 billion USD, the European Central Bank (ECB) 156 billion euros (214.6 billion USD), and the Bank of Japan 1 trillion Yen (8.4 billion USD). Smaller amounts have come from the central banks of Australia, and Canada. Fed injected $30 billion to ensure the effective Federal funds rate trades at the target rate (it had begun to trade significantly above target). It later injected $38 billion to lower the effective federal funds rate and continued to inject various amounts thereafter. The European Central Bank (ECB) injected 61 billion, and the Federal Reserve injected $68 billion into their respective banking systems on Friday, 10 August 2007 in order to calm their markets, on top of the 95 billion the ECB had injected on Thursday, 9 August 2007. The Federal Reserve further injected $24 billion into the US financial system that day. On 13 August, the ECB injected another 47.67 billion into the banking system and noted that credit conditions were "normalizing" while the Bank of Japan injected another 600 billion. On August 17, the Federal Reserve cut the discount rate by half a percent to 5.75% from 6.25% while leaving the federal funds rate unchanged in an attempt to stabilize financial markets. A September 5 report by Barclays Capital stated that since the Federal Reserve and European Central Bank had injected funds into their respective financial systems, conditions in the credit market have gotten even worse, not better. The LIBOR rate, the interest rate that banks charge each other rose to 5.72%, the highest it had been in seven years. However, the Beige Book, a survey compiled by the Federal Reserve about business conditions in different parts of the United States, concluded that the credit crunch has had a "limited" impact so far on the rest of the economy
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On September 6, after having already injected billions of dollars over the past weeks, "the Federal Reserve added $31.25 billion in temporary reserves to the US money markets..the latest move to keep credit markets from drying up." These reserves are temporary loans to banks, using securities as collateral. The loans must be repaid within two weeks. December 11th, Fed sets up TAF as an added tool to alleviate financial strain.
LIST
OF ENTITIES INVOLVED IN
2007
FINANCE CRISES
A list of companies, non profits organization, governmental and quasigovernmental agencies involved in the various economic and financial crises of 2007. This is categorized by sector with the entity's largest interest.
United States
National Builders
1. 2. 3. 4. 5. 6. 7.
Beazer Homes USA Hovnanian Enterprises Lennar Corporation KB Home NVR Pulte Homes Toll Brothers
Real estate and appraisal

1. 2.
Coldwell Banker Prudential Real Estate Page 56
Associations
1. 2. 3. 4. 5. 6.
American Society of Appraisers Appraisal Institute National Association of Home Builders National Association of Realtors Real Estate Counseling Group of America Urban Land Institute
Subprime lenders
1. 2. 3. 4. 5. 6. 7. 8. 9.
New Century Financial Corporation American Home Mortgage Investment Corporation Accredited Home Lenders Countrywide Financial Northern Rock (UK) Ameriquest E*TRADE Option One American Freedom Mortgage, Inc.
Other lenders
1. 2. 3. 4. 5. 6. 7. 8.
Washington Mutual Suntrust Luminent Mortgage Capital Aegis Wholesale 1st National Bank of Arizona GreenPoint Mortgage Velocity Commercial Lender Fremont Investment & Loan Page 57
9.
ResMAE Mortgage Corp
Insurers
1.
Mortgage Guaranty Insurance Corporation
Banks
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
BNP Paribas, , France JPMorgan Chase, USA Citigroup, USA Credit Suisse, Switzerland Deutsche Bank, Germany IKB Industriekredit-Bank, Germany Bear Stearns Schsische Landesbank, Germany Goldman Sachs Lehman Brothers Netbank, USA Banca March, Spain UBS, Switzerland Northern Rock, UK HSBC, UK Merrill Lynch . USA
Credit rating agencies

1.
Moody's Page 58
2. 3.
Standard & Poor's Fitch Ratings
Governmental and quasi-governmental

Central Banks
1.
Federal Reserve Bank

o
Federal Reserve Bank of New York
2. 3.
European Central Bank Bank of Japan
BIBLIOGRAPHY:

www.economist.com http://news.bbc.co.uk http://wikipedia.org www.livemint.com
www.investopedia.com

www.federalreserve.gov www.marketwatch.com www.bloomberg.com www.securitisation.co.in
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