The Sub Prime Mortgage Crisis

The Sub-Prime Mortgage Crisis Introduction The United States Federal Deposit Insurance Corp. defines the term Sub-Prime as the credit characteristics of the personal borrowers. Subprime borrowers were the delinquent borrowers who caused charge-offs, judgments and bankruptcies, all because of their payment delinquencies.

In addition to that, it had also been noticed that the majority of the borrowers who had taken loans against property mortgages did not have the repayment capacity. In fact, subprime borrowers are these types of borrowers. These loans, hence, had a higher risk of default.

Overview of the Sub-prime crisis After the Vietnam War, for over a decade, there was a massive influx of money from people that were moving into America. The money that was injected into the economy caused the banks and other institutions to give out loans on cheap rates. This resulted in many people purchasing property against mortgage. Many loans were accepted in this time under easy credit terms. At times the credit worthiness of the borrowers was not even checked before they were given loans. People were of the view that the property values will increase, and therefore much house building and construction took place. Because the loans were still available, the supply exceeded the demand therefore causing the prices to fall.

Meanwhile, these home loans were combined to form new financial instruments which were called, Mortgage Backed Securities (MBS). The agencies that had created these instruments had them rated from credit-rating agencies from Wall Street, which were willing to give them a good grade if good money was paid. This resulted in investments in MBS from all over the world. The prices of the MBS therefore went higher. Two of the top sellers of the MBS were Freddie Mac and Fannie Mae, who believed that the government guaranteed these securities and therefore they put in all their investments to get more out of these securities, which further fueled the prices.

When the home owners defaulted on the mortgage, the banks had to take back their houses and sell them. The houses were sold for lesser amounts than they were bought for, because of the falling property market. The mortgage backed securities had been traded all over America and even among the banks that had created the MBS in the first place. These banks started to suffer losses, as a result of which, the other banks and agencies that owned or traded the MBS started to suffer losses as well. There were many personal investments in the MBS as well, due to which people lost a lot of money on a personal basis.

Source: http://www.researchomatic.com/Mortgage-SubPrime-Crisis-10055.html