Sub Prime Crisis

and its rippling effects on the global

economy

Story Of Two Americans

American A

American B

Prime Customer

Sub-Prime Customer

High Income

Low Income

Good Credit Rating

Poor Credit Rating

Stable Employment

Unstable Employment

Both Dream to Have big homes

But American B cannot fulfill his dreams due to banks strict rules
And American A can fulfill his dreams

American A
HAPPY!!!

American B
SAD.

What are Prime and Sub-Prime

Lending ?
Typically, those who qualify for the most ideal

mortgage loan with the best interest rates are

those with good credit scores and minimal
debt.
A subprime mortgage is a type of loan granted

to individuals with poor credit histories

(typically below 600), who would not be able to
qualify for conventional mortgages.
Subprime mortgages charge interest rates that

are above the typical interest rate because of

the risk that is involved on the part of the
lender.

About the crisis

Post 2001, the US government had encouraged US

banks to lend money to people, to encourage

spending & investing mainly for the purpose of
buying houses
These

banks granted loans to large number of

borrowers despite having lower income levels, unsure
employment status, unscrupulous credit history, etc.

Huge number of borrowers availed of bank credit

without evaluating their repayment capacities. The

economy was flush with liquidity & stock markets
were booming

The bubble burst

A silent storm brewed in international financial

markets with origins in the US housing market,

which witnessed an unprecedented boom since
2001
The boom was led by rising housing prices, low

interest rates & aggravated by

innovation viz. MBS, CDO and CDS

financial

Housing prices in USA began to drop in 2006.

Rising interest rates & falling housing prices

led
to
rise
in
sub
prime
mortgage
delinquencies & resultant foreclosure

Sequence of Events...

Impact of Sub Prime Crisis in USA

The chart above brings out the irony and shows that underlying
sub prime houses are only a small percentage of the total housing
market and it was the bubble formed due to financial instruments
viz. MBS, CDO and CDS, that caused the real problem

Domino Effect in India

$ FII investments increased in most of
2007 in a booming Indian economy,
as the Sensex was on its way to a
historic peak of over 20,000 points
$ Since the inflow of dollars in the
Indian economy increased, the
dollar exchange rate decreased
$ In 2008, however, due to the effect
of the sub prime crisis, FIIs
liquidated their equity investments
in a big way leading to a crash in
the stock markets
$ Simultaneously commodity prices,
including oil prices, were on a rise
due increasing demand for these
commodities
$ The combined effect resulted in an
increase in the dollar exchange rate

Mortgage Backed Securities

A mortgage-backed security (MBS)is a type of a bond that

is secured by a mortgage or collection of mortgages.

When you invest in a mortgage-backed security you are
essentially lending money to a home buyer or business.
This type of security is also commonly used to redirect the
interest and principal payments from the pool of
mortgages to the holder of MBS.
These payments can be further broken down into different
classes of securities, depending on the riskiness of
different mortgages as they are classified under the MBS.

Features of MBS
The amount of the principal payment

increases as time passes.

The amount of interest decreases as time
passes.
The servicing fee also declines as time
passes.
The ability of the borrower to repay results
in prepayment risk. Prepayments and
curtailments reduce the amount of interest
the lender receives over the life of the
mortgage and cause the principal to be
repaid sooner.