Subprime Crisis in Financial Market

Subprime Crisis in Financial Market

Abstract

This paper analyzes the reasons of the subprime crisis in mortgage financing occurred in 2007 and the impacts of the crisis on the overall financial system. The subprime crisis in US is caused by excessive amounts of loans made to people who could not afford them, and also the investors who were very eager for high return put excessive amounts of money into the mortgage. There are a number of factors in generating crisis, such as legislations like Community Reinvestment Act, low rate of interest, mortgage brokers and lenders, rating agencies, etc. Subprime crisis relates to three important dimensions, which are poor regulation of investment banks, relaxation in lending standards led by greedy unbridled competition and failure of the asset market to realize the dues from the defaulter. When subprime crisis occurred, consumer spending is down, the housing market has plummeted, foreclosure numbers continue to rise and the stock market has been shaken, which drag not only the United State but also the global economy into a recession.

The Impacts of Subprime Crisis in Financial Market

Subprime crisis in 2007 in the United States is a hot topic of discussion around the globe. It started as a financial crisis and quickly assumed the form of general economic crisis. It is the result from multiple factors and it has serious implications to the global economy. In this paper, the writer will introduce the causes and impacts of the subprime crisis.

Causes of the subprime crisis

The first cause of the subprime crisis is the mortgage lending process in the United States. In the U.S. the residential mortgage process is that a person who wants to purchase a house, with help from a real estate broker, selects a mortgage lender who gives the loan after checking his or her credit score, and then the property that he or she is going to purchase will serve as collateral for the loan. After the loan is disbursed, most mortgage lenders resell these loans to investors or Wall Street firms, often through multiple intermediaries. Wall Street firms in turn bundle thousands of mortgage loans from different lenders into mortgage-backed securities (MBS).These institutions then slice these mortgages into residential mortgages backed securities(RMBS), or in other words, securities that are backed by collateral; the collateral here being the mortgages held by subprime borrowers. These mortgage-backed securities are, in turn, often sliced and diced into different structures, for example, a Collateralized Debt Obligation (CDO). Thus CDOs are pools of bond securities that are grouped together to help diversify risk. The different tranches of these structures are assigned a risk rating by the rating agencies such as Moody's, Standard & Poor's, and Fitch based on various parameters. They are subsequently sold by Wall Street firms to institutional investors worldwide - mutual funds, banks, hedge funds, central banks and pension funds. The information provided above lists the agents involved the US housing mortgage market, and it will help to identify who were hit by the crisis. There are house purchasers, real estate agents, mortgage lenders, wall-street firms, rating agencies, and investors.

The second cause of the

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