" Subprime mortgage crisis " : why too much shouting about it???

[Prabhat Gupta]

Hi All,
I don't know whether it is suitable or not to ask this question here.
Well i am very much curious about this term Subprime mortgage crisis.whenever i read any article about US market slowdown ,i come across this word very frequently .Although tried to search in wikipedia but not able to understand exactly what type of GHOST it is .

Can you tell me what exactly it is? And in what sense it affects the financial market?


With thanks in advance,

Prabhat

[David O'Meara]

People that were having problems getting loans (subprime borrowers) were borrowing against higher risk lenders in the hope the housing market would be strong and they would be able to refinance later.

Instead the market collapsed, and large numbers (hundreds of thousands?) are losing their homes, but their failure to repay loans is also causing the collapse of other financial organisations. Since smaller organisations are backed by larger organisations, it is causing a major melt-down that will impact all areas of the US economy.

More or less.

[David O'Meara]

Not hundreds of thousands, over a million in 2007 alone.

http://en.wikipedia.org/wiki/Image:Foreclosure_Trend_-_2007.png
[ April 24, 2008: Message edited by: David O'Meara ]

[Prabhat Gupta]

Instead the market collapsed, and large numbers (hundreds of thousands?) are losing their homes

Can i interpret this as in recent times the house prices or house-rent in US has become cheaper that's why market collapsed (As people were expecting a huge return back from their house).
Here in india,the market of real-estate is damn booming ,also house rents are now sky-touching.

[Tim Holloway]

While it's not technically job-related, anything that can trash the economy ultimately is going to affect the job market.

Normally, residential real estate is one of the safer and more stable investments. That's because, unlike stocks, you can't dump them in a day, and even if you could, you don't live in your stocks - selling a home has consequence beyond the financial.

However, at the end of the frenzy, the bulk of homes purchased weren't for primary residences. Houses were being built and sold for vacation residences, rental properties (except that buying was better!), and to "flip".

That broke all the usual rules. There was no strong stake in these properties, so when the collapse began, people just walked away from them. Their loss, except that now the mortgage holders are stuck with lots of properties that have to be maintained and resold, since banks aren't in the housing business.

Compounding the problem is that the lenders were not only ignoring failure potential, they had lobbied for, and received, release from some of the Depression-legacy restrictions on financial activities. Or in other words, because "This time, it's different", they'd discarded their safety valves in favor of more profit potential.

An additional factor was probably the knowledge that, while in Modern Day America, an ordinary individual can be tossed on the street for fiscal irresponsibility, if you're big enough, you can screw up royally and actually get rewarded for doing so.

That annoys a lot of people, from the Libertarians who think that failure should carry consequences to the Marxists who think that proper regulations should have prevented it from ever happening, but the reality is the same cold hard fact that keeps me from being allowed under the 2nd Amendment to keep and bear thermonuclear weapons: When you screw up and it affects only you, tough. When you screw up and it affects millions of other people, someone has to do something.

The problem is that so far, no one has come up with an idea that doesn't involve the rest of us paying for the misdeeds of the few. And. insofar as that diverts money from the mainstream economy, it reduces the demand for goods and services that keeps the rest of us employed.

[Henry Wong]

Another issue with the subprime mess is that real money is being lost -- in the order of billions of dollars.

Basically, once forclosures increased, the risk increased. Banks are now holding high risk items on the books. To lower the risk they sold. This effectively shutdown the trading of subprime collateral and their derivatives. Banks are now holding the items on the books that they can't rid of... you can't have a market of all sellers and no buyers.

And then, everyone realize that it was worse than expected. Many people who couldn't afford basic necessities took out subprime mortgages, with no money down, knowing that they can flip the property in a few months for profit.

So now, we have some large banks writing off billions of dollars, due to the flippers. Large number of legitimate borrowers who got over extended, and can't make the payments on the newer higher rates -- which if can't be saved, will cause even more write offs.

Builders going out business. Some banks going out of business. Tons of people losing homes. Flippers losing tons of money. (Quite frankly, I couldn't care less about the last one)


And of course, all of this chain reacts to the securities markets going into recession, the fed stepping in to lower interest rates, the market reacting by lowering value of the dollar, causing the price of fuel to increase (amoung many other reasons), the price of food, airlines, fuel, etc. going up and BAM !!! .... All hell breaks loose.

Henry
[ April 24, 2008: Message edited by: Henry Wong ]

[Rambo Prasad]

We saw the effect of subprime mess recently..Bear stearns went bust recently..In fact lot of financial Cos like Merill Lynch,Citigroup,UBS and many more companies have writen off billions of dollars...

The problem started with the real estate boom...Financial companies wanted to enter the attractive mortgage market and loosened their lending standards and extended credit to people with weaker financial backgrounds .But they didn't have any risk mitigation measures and did not anticipate a slowdown in housing..So when the slowdown happened subprime homeowners found they could no longer afford their monthly payments, leading to a spike in defaults. Investors panicked because they could no longer value the securities backed by these mortgages.At first, some thought the problem would be contained within the mortgage industry. But within a few months, it spread like wildfire through the debt market..

Now financial firms are also shying away from extending credit to one another..This has also made the situation worse

The weakening dollar is adding to the woes. The dollar's fall against other currencies has made it less attractive for foreign investors to put their money in dollar-denominated U.S. securities.

This could have a cascading effect on other sectors as well...Now people are speaking about V,U,W and L shaped recession in US

[Rambo Prasad]

Here in india,the market of real-estate is damn booming ,also house rents are now sky-touching.

I think soon an indian subprime will happen..Just think, a 500 sq feet shop sell for over Rs 2 to 4 crores(Rs 1 crore is approximately 249,812 US Dollars) in Bombay.

What returns would you need to sustain an investment of such magnitude for so small an office space? What type of business could have margins that would justify investment into Reality this expensive and which are the guys who are forking out money to buy them?

[Jeanne Boyarsky]

Originally posted by Prabhat Gupta:
Can i interpret this as in recent times the house prices or house-rent in US has become cheaper that's why market collapsed

Not entirely. Rent has been constant (or gone up a little as it always does) because people losing their homes due to foreclosure need to rent. This means demand for rentals has gone up rather than down.

House prices SHOULD be going down. Different parts of the US deal with this differently. (This hasn't happened in NYC because overseas investors are buying up real estate.) If someone really needs to sell, they could do so for less money. A bigger problem is that people can't sell at all. If they still have a big mortgage, they owe more on the mortgage than they can sell for. This essentially creates a situation where people cannot move at all.

[Prabhat Gupta]

Thanks all for yours valuable replies.
Now i am concluding that subprime mortgage crisis has spread out due to money-lenders(banks) negligence during lending money to people. They should have checked whether borrowers have enough mortgage or not so that their(lenders) money would have been safe. Moreover it is also due to greed of people to make money in real estate.

Okies ,now what are the ways (if possible)to overcome this much talked problem "subprime mortgage crisis " ?

[Henry Wong]

Now i am concluding that subprime mortgage crisis has spread out due to money-lenders(banks) negligence during lending money to people. They should have checked whether borrowers have enough mortgage or not so that their(lenders) money would have been safe.

Sure, it's easy, blame the banks....

Keep in mind, that banks that didn't provide easy, "no money down", sub prime loans, lost potential customers. And lost potential profit. Sub-prime mortgages may be an "obvious" disaster -- but banks made tons of money off of them for many years.

You can also make the case that the dot-com bubble burst was obvious too, but tons of people made tons of money before the burst.

Henry

[Luke Kolin]

Originally posted by Henry Wong:
Keep in mind, that banks that didn't provide easy, "no money down", sub prime loans, lost potential customers. And lost potential profit. Sub-prime mortgages may be an "obvious" disaster -- but banks made tons of money off of them for many years.

One could also argue that part of the problem was based on the fact that banks don't actually do very much business in mortgage loans anymore. Most is originated by specialized mortgage companies who then securitize the loan and resell it.

Unlike a traditional bank, they don't hold the loan on their books and therefore have little incentive to care if the borrower defaults several years down the road.

Cheers!

Luke

[Rambo Prasad]

Here in india,the market of real-estate is damn booming ,also house rents are now sky-touching.

Looks like something similar to subprime but at a lesser magnitude has started to happen in India...

Check out this article
http://timesofindia.indiatimes.com/Cities/Mumbai_Top_builders_in_dire_straits/rssarticleshow/3128002.cms
[ June 16, 2008: Message edited by: Rambo Prasad ]

[Arvind Mahendra]

Ultimately aren't people in general responsible for it. These banks were just trying to maximize shareholder's returns. If they could do it successfully without causing this meltdown people would've applauded the management for its great efforts.

[Henry Wong]

The crisis is caused by a bit more than just "bad loans".

First, many of these loans were of the "no money down" variety. In some cases, the borrowers actually walked out of the signing with a check -- i.e. paid to by a home.

Second, many of these loans were of the low interest for 6 months (or first year) type. So, in six months, there was no chance that the borrower would be able to handle the new interest. The idea was either (1) sell the house after six months for a profit, or (2) refinance with another sub-prime loan.

So, what happens when the housing market goes down? The loan can't be refinanced because the house is not valuable enough. The house can't be sold for a profit. And since the owner never put any of his money on the home, he simply walkes away -- to let the bank sell the home for a loss.


Now, why is this a crisis? If it was just the loans, then it would be just a market loss. The banks will loss money but they should get some of it back one the home is sold -- eventually.

The problems are the deriatives. These are all the paper funny money type of transactions used by banks to hedge the loans. These are also short term so they can't wait "eventually". So, when the market stopped. The deriatives value dropped drastically (all sellers, no buyers). The risk also skyrocketed, because the loans couldn't be hedged anymore. And again, all sellers, no buyers.

Some banks, were holding so many loses, that they actually encountered a "run on the bank".

Henry

[fred rosenberger]

houses were also being 'overvalued'. person A would buy a house today for $100k. person B would buy it six months later for $120k, then person C six months later for $150k. Note that person A, B, and C might just be the same person re-financing the loan on their own home, effectively getting free money.

Eventually, somebody realizes the home is only worth $105k, but they owe $150. This is called being 'upside down' on the mortgage - you owe more than the hosue is worth. People would simply walk away, defaulting on their loan, and let the bank take the house.

Further, some banks were so eager to make loans, they 'looked the other way' on a lot of things. I heard a story where after the rate adjusted, a woman owed more per month on her house than her GROSS income for the month. The bank KNEW this would happen when they offered and approved the loan - they even told her some tips for making it look like she had more money than she did, such as moving large sums of money from a checking to a savings account every two weeks, effectivly making it appear she had twice as much cash as she did.