Sub Prime Crisis

Sub Prime Crisis...

My Supply of information on Sameer's demand:

Markets are driven by Supply and Demand.If there is demand of anything,supply for it will automatically come.
So what is the demand in this case?Borrowers with less Credit worthiness-either defaulters on their previous loans,higher risk with lower income or poor credit history.
They need money rite?Even if they haven't paid on their old or have bad reputation on previous debts.They are not getting from anywhere else.
Hence a market is created for such lendings.

Here comes into picture the Lenders who lend/loan money to these people.
Whats the catch???
Of course there is risk involved.But you charge them high interest rates.So you will make money.

Sub prime name---not Prime i.e. not lending to Primary Borrower.

Now the situation has various angles:

There's packaging of loans in good incentives when you are attracting people to take loans from you.
You are required to pay only the interest.
Theres a term ARMs(Adjustable Rate Mortgages)...Initially there's a low interest rate which gradually rises or get adjusted.

Now we have borrowers with poor credit history, lenders who are giving them loans in better packaging schemes.

In financial markets,risker the scheme,more returns it may return.
Same concept here.
So now if my borrower is defaulting again on his loan,only a few lenders/financial institutions who give Sub Prime Lending should suffer/be in losses.But as we all know,its a global crisis.How???

MBS (Mortgage Backed Securities)...In market,you can sell anything...ANYTHING.
So what these Sub prime lenders do?They spread the risky portfolio.
Again good packaging,SIV(Special Investment Vehicles) are created and these mortgages are sold to banks,Hedge Funds,financial institutions.:)
Now you are beginning to understand all this.Rite?

Big Financial Institutions,Investment Banks,Banks,Private Equity Firms all buy such things as Insurance Policies,Mortgages,Loans,etc so that they get to have benefits.(Its a profitable investment business...think about it)...

The problem...

High interest rates led to bursting of US Housing Bubble.
Defaulters on loan again.Though sub prime lendings form only 6.8% of total housing lendings,the foreclosures were > 40% for this.
Falling Housing Prices also added Ghee to the Fire.You cannot actually refinance on a depriciating asset.(Or can you?)
Panic.Of course...

Many Sub Prime Lenders file for bankruptcy.And the effect was cascaded.Where ?To all the banks,hedge funds,investment vehicles...and eventually Stock Markets.
Banks started selling these mortgages at throw away prices.
Around $80 billion losses so far have been recorded.
N its just the begining.Remember I mentioned ARMs....Now the rates are going to be adjusted to higher levels...

Don't you people worry.
The situation is dreary.But the Govts are also awaken up to this Crisis.
New bailing out options have been there....

But the times are to be cautious...And big no to Sub Prime Lending at least for the present time...


~Rajan












Disclaimer:I have tried to be as simple as possible for non finance back ground.
If you want to know more about it,ping me and I may respond back.:)