US Financial Crisis: The Role of Subprime Mortgages
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Code : ECC0017
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Region : US |
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US Subprime History US economy flourished with healthy performance through the 1990s with the economy expanding at a fairly healthy rate. Technological breakthroughs brought a wide range of sophisticated new products. Innovations in telecommunications and automation spawned a vast computer hardware and software industry that revolutionised the way many industries operate. The growth of information technology enabled the matured industries to expand the scope of operations in amore profitable way. During this period, US consumer creditmarkets have shifted dramatically and moved away from credit rationing to risk-based pricing. Mortgage Bond Market and its Intricacies Traditionally, banks have financed their mortgage lending through the deposits they received from their customers. But during 1990s, they entered into a new model where they sell the mortgages to mortgage bond market to raise capital. Home loan companies created MBS to leverage their asset base, on the same level of capital from their existing portfolio. For instance, a home loan company, may bundle loan assets with residual maturity of 10 years and sell these assets as securities to investors. |
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Delinquencies Leading to Credit Crisis With delinquencies and foreclosures in subprime market increasing, the financial turmoil began in summer of 2007. Prof. Charles W. Calomiris noted, "The turmoil has many dimensions in addition to the obvious statistics of falling asset prices, increased foreclosures, and widening default spreads – the 'financial revulsion" – marks the end of a boom in housing prices, the collapse of the young subprime mortgage market, and the demise of a recent wave of complex securitisation structures engineered by Wall Street to share risk and conserve on financial intermediaries' capital. The collapse of subprime markets sets an end of the longest periods of high profitability, high equity capital and abundant flow of credit supply in US Banking history (1993–2006)".
