conduct shocksout of the blue?Subprime mortgage crisisFrom Wikipedia, the free encyclopedia (Redirected from 2007 subprime mortgage financial crisis)  The image above is proposed for deletion. See images and media for deletion to help reach a consensus on what to do.  The image above is proposed for deletion. See images and media for deletion to help reach a consensus on what to do.  The subprime mortgage crisis is a current economic problem characterized by contracted liquidity in the global credit markets and banking system. An undervaluation of real risk in the subprime market ultimately resulted in cascades and ripple effects affecting the world economy generally. The crisis began with the bursting of the US housing bubble[3][4] and high default rates on "subprime" and adjustable rate mortgages (ARM). Loan incentives, such as easy initial terms, in conjunction with an acceleration in rising housing prices encouraged borrowers to assume difficult mortgages on the belief they would be able to quickly refinance at more favorable terms. 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 easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in the United States in late 2006 and triggered a global financial crisis through 2007 and 2008. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from 2006.[5] 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. $435 billion as of July 17, 2008.[6][7] Owing 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) 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 effect on financial institutions caused reduced lending activity and increased spreads on higher interest rates. Similarly, the ability of corporations to obtain funds through the issuance of commercial paper was affected. 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 lending to worthy borrowers and to restore faith in the commercial paper markets. The subprime crisis has adversely affected several inputs in the economy, resulting in downward pressure on economic growth. Fewer and more expensive loans tend to result in decreased business investment and consumer spending. The initial leveling off in the housing market has become a downturn in many areas due to a surplus inventory of homes. The reduction and shift in demand versus supply has resulted in a significant decline in new home construction.[8] With interest rates on a large number of subprime and other ARM due to adjust upward during the 2008 period, U.S. legislators, the U.S. Treasury Department, and financial institutions are taking action. A systematic program to limit or defer interest rate adjustments was implemented to reduce the effect. In addition, lenders and borrowers facing defaults have been encouraged to cooperate to enable borrowers to stay in their homes. Banks have sought and received over $250 billion in additional funds from investors to offset losses.[9] The risks to the broader economy created by the financial market crisis and housing market downturn were primary factors in several decisions by the U.S. Federal reserve to cut interest rates and the economic stimulus package passed by Congress and signed by President George W. Bush on February 13, 2008.[10][11][12] Both actions are designed to stimulate economic growth and inspire confidence in the financial markets. [edit] Background informationThe term subprime lending refers to the practice of making loans to borrowers who do not qualify for market interest rates owing to various risk factors, such as income level, size of the down payment made, credit history, and employment status. The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007,[13] with over 7.5 million first-lien subprime mortgages outstanding.[14]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.[15] By January 2008, the delinquency rate had risen to 21%[16] and by May 2008 it was 25%.[17]  Subprime ARMs only represent 6.8% of the loans outstanding in the US, yet they represent 43.0% of the foreclosures started during the third quarter of 2007.[18] During 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.[19] More homeowners continue to receive foreclosure notices, with one in every 519 households receiving a foreclosure filing in April, 2008.[20] 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.[21] An average of 450,000 subprime ARM are scheduled to undergo their first rate increase each quarter in 2008.[22] [edit] Understanding the causes and risks of the subprime crisisThe reasons for this crisis are varied and complex.[23] Understanding and managing the ripple effect through the world-wide economy poses a critical challenge for governments, businesses, and investors. The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments; poor judgment by the borrower and/or the lender; and mortgage incentives such as "teaser" interest rates that later rise significantly. Further, declining home prices have made re-financing more difficult. As a result of innovations in securitization, risks related to the inability of homeowners to meet mortgage payments have been distributed broadly, with a series of consequential impacts. There are four primary categories of risk involved:
[edit] Understanding the effect on corporations and investorsAverage investors and corporations face a variety of risks owing to the inability of mortgage holders to pay. These vary by legal entity. Some general exposures by entity type include:
[edit] Causes of the crisis[edit] 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.[31] This demand helped fuel housing price increases and consumer spending. Between 1997 and 2006, American home prices increased by 124%.[32] 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.[33] 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 by the current President, George W. Bush, to spend their way out of economic decline and "Get down to Disney World in Florida."[34] This call linking patriotism to shopping echoed the urging of former President Bill Clinton to "get out and shop"[35], and corporations like General Motors produced commercials with the same theme.  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 December 2007 sales volume, the highest level since 1981.[36] Further, a record of nearly four million unsold existing homes were for sale,[37]including nearly 2.9 million that were vacant.[38] 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 price index, by November 2007, average U.S. housing prices had fallen approximately 8% from their Q2 2006 peak[33] and by May 2008 they had fallen 18.4%.[39] However, there was significant variation in price changes across U.S. markets, with many appreciating and others depreciating.[40] The price decline in December 2007 versus the year-ago period was 10.4% and for May 2008 it was 15.8%.[41]Housing prices are expected to continue declining until this inventory of surplus homes (excess supply) is reduced to more typical levels. [edit] Role of borrowersA 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.[16] 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.[42] 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."[44] US Department of the Treasury suspicious activity report of mortgage fraud increased by 1,411 percent between 1997 and 2005. [43] There remains an important, unresolved question about the role of borrowers. Judge Leslie Tchaikovsky of the U.S. Bankruptcy Court for the Northern District of California, found on May 25, 2008 that even though a pair of borrowers had, indeed, misrepresented their incomes on a "stated income" home equity loan, National City Bank's "reliance" on these statements of income "was not reasonable based on an objective standard"[45]. Moreover, the Center for Responsible Lending, in its report on Indymac, related testimony that the bank made actually made efforts to avoid having income information about some borrowers [46]. The Associated Press has reported that a federal grand jury is investigating subprime lenders Countrywide Financial Corp., New Century Financial Corp. and IndyMac Bancorp Inc. and reports also that the FBI is investigating Indymac for possible fraud. [47]. The question, then, is whether banks and other private mortgage originators of subprime and other "nonprime" loans might deliberately have profited or attempted to profit - in moneys, economic benefit or even fraudulent gain - through reducing the amount of information they collected from borrowers. [edit] Role of housing investors and speculatorsSpeculation in real estate was a contributing factor. During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%, respectively. In other words, nearly 40% of home purchases (record levels) were not primary residences. NAR's chief economist at the time, David Lereah, stated that the fall in investment buying was expected in 2006. "Speculators left the market in 2006, which caused investment sales to fall much faster than the primary market."[48] While homes had not traditionally been treated as investments like stocks, this behavior changed during the housing boom. For example, one company estimated that as many as 85% of condominium properties purchased in Miami were for investment purposes. Media widely reported the behavior of purchasing condominiums prior to completion, then "flipping" (selling) them for a profit without ever living in the home.[49]Some mortgage companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly leveraged positions in multiple properties.[50] [edit] Role of financial institutionsA variety of factors have caused lenders to offer an increasing array of higher-risk loans to higher-risk borrowers. These high risk loans included the "No Income, No Job and no Assets" loans, sometimes referred to as Ninja loans. The share of subprime mortgages to total originations was 5% ($35 billion) in 1994 [51] , 9% in 1996 [52], 13% ($160 billion) in 1999 [51] , and 20% ($600 billion) in 2006.[52][53] 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.[54] In addition to considering higher-risk borrowers, lenders have offered increasingly high-risk loan options and incentives. One example is the interest-only 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.[55] 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.[56] Critics note that the Bankruptcy Abuse Prevention and Consumer Protection Act did nothing to curtail the predatory practices of credit card companies, such as exorbitant interest rates, rising and often hidden fees, and targeting minors and the recently bankrupt for new cards. The bill's critics pointed out that these practices are themselves significant contributors to the growth of consumer bankruptcies. [57] [edit] 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.[58] 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.[59] The securitized share of subprime mortgages (i.e., those passed to third-party investors) increased from 54% in 2001, to 75% in 2006.[54] 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. [60] [edit] Role of mortgage brokersMortgage brokers do not lend their own money. There is not a direct correlation between loan performance and income. They have a financial incentive for selling complex, adjustable rate mortgages (ARMs), since they earn significantly higher commissions. [61] 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. [62] 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. [63] [edit] Role of mortgage underwritersUnderwriters 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 C’s of underwriting: credit, capacity and collateral. See mortgage underwriting. In 2007, 40 percent of all subprime loans were generated by automated underwriting. [64] 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."[65] 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 subp |
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