The US Housing Market and the Subprime Mortgage Crisis (A)

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Case Details:

Case Code : BENV014
Case Length : 21 Pages
Period : 2001-2007
Pub Date : 2008
Teaching Note :Not Available
Organization : -
Industry : Financial Services
Countries : USA

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This case study was compiled from published sources, and is intended to be used as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of a management situation. Nor is it a primary information source.

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Introduction Contd...

From 2006, the real estate markets in several regions in the US saw price declines, after witnessing double-digit growth rates between 2000 and 2005. This decline in house prices, together with rising interest rates, seriously affected the subprime mortgage borrowers – a class of borrowers who on account of their poor credit histories were not eligible for prime loans - with several of them failing to make payments on their mortgage loans. Given that the subprime mortgage market9 had surged from $120 billion in 2001 to $600 billion in 2006 and accounted for a significant share of the mortgage market, the high rate of defaults in subprime loans was seen as an indicator of the worsening situation in the housing market and the US economy as a whole.

In early 2000, with declining interest rates, buying a house became affordable for both prime and subprime borrowers.

However, from mid 2004, with increasing interest rates there was a decline in house sales, and home owners with flexible rate subprime mortgage loans were not able to pay the higher interest charges.

With increasing interest rates and falling house prices, they also could not refinance their existing mortgages10.

As a result, there were a large numbers of foreclosures11 which led to an increase in the supply of houses resulting in a further decline in house prices. The increasing number of foreclosures led to a tightening of credit in the real estate market by end 2007.

 Excerpts >>

9] Mortgage market refers to the residential mortgage market in this case study.

10] Refinancing an existing mortgage may mean altering the conditions on the mortgage (lower interest rates or longer payment period) or replacing it with a new one.

11] Foreclosure refers to the legal process where a bank or a secured creditor sells or repossesses a parcel of immovable property after the owner defaults on making payments on his mortgage. The proceeds from the sale of the property are used to pay off the mortgage and legal costs, if any.


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