Subprime mortgage crisis

1. Subprime mortgage crisis GROUP 18 138667 ANG GAIK KEE 138457 TANG CHENG THING 138563 YIK SOOK MEI 138631 ANG MIEN HUA

2. INTRODUCTION

3. Introduction • Ongoing financial crisis triggered by dramatic rise in mortgage delinquencies & foreclosures in U.S. • major consequences for banks & financial markets around the globe. • has its roots in closing years of 20th century, become apparent in 2007. • exposed weakness in financial industrial regulation & global system.

4. Subprime Mortgage Crisis • A housing bull market was created following the Fed reserve stimulating econ by cutting i/r to historical low levels. • Mortgage delinquencies soared when U.S house prices began to decline in 2006-07. • Many mortgages issued were made to subprime borrowers (high risk borrowers)- those with lesser ability to repay the loan. - initially monthly payment consumed an ever greater percentage of income and with little or no equity in the home. • Eventually, i/r climbed back up and many subprime borrowers defaulted when their mortgage were reset to much higher monthly payments.

5. • This left mortgage lenders with property that was worth less than loan value due to a weakening housing market. • Default increased, several lenders went bankrupt. • Investors & hedge funds also suffered because lenders sold mortgages they originated into secondary market. • Mortgages were bundled together & sold to investors as collateralized debt obligations (CDOs) & other mortgages-backed securities (MBSs). • A large decline in capital of many banks & USA government tightening credit around the world.

6. • The financial institution that have been affected by crisis have either been: a) taken over or merged with another financial institution b) nationalised by a government or central bank c) declared insolvent or liquidated

7. List of Company Writedowns due to Subprime Crisis

8. investment banking giants- Merrill Lynch and • Lehman Brothers • made so much money lending, servicing and • selling subprime loans and securities derived • from those loans that they took outrageous risks • They borrowed billions of dollars to expand their • subprime business • When the subprime market collapsed, these • institutions lost their cash flow and their credit • ratings • Lehman Brothers went out of business • Merrill Lynch had to sell itself to Bank of • America at a fraction of its former value. Jonathan Ginsberg February 25, 2009

9. 12 Mar 2009, Subhasish Roy, • The present global financial crisis has been attributed to the subprime mortgages which originated in the US housing mortgage sector few years back. • During the booming housing market, when low interest rates were prevailing and the housing prices were continuously increasing, • offering financial assistance to subprime borrowers was considered a lucrative proposition by some banks/financial institutions • ignoring the inherent risk involved in such activities

10. RHB sees slower loan growth in 2009 (11.11.2008) • RHB Capital, Malaysia's fourth-largest lender, expects slower loan growth and corporate defaults to creep up next year as the local economy slows sharply. • Malaysia's banking system has not been directly affected by the US subprime mortgage crisis • Southeast Asian country will not escape the impact of a marked slowdown in the global economy given its heavy reliance on exports.

11. CAUSES

12. Causes • There are a few causes which lead to subprime mortgage crisis. They are as following: 1)Boom and bust in the housing market - Low interest rates and large inflows of foreign funds. - created easy credit conditions for a number of years prior to the crisis - It fuels a housing market boom and encourages debt-financed consumption. - The USA home ownership rate increased from 64% in 1994 (about where it had been since 1980) to an all-time high of 69.2% in 2004

13. High-risk mortgage loans and lending/borrowing practices - Lenders began to offer more and more loans to higher-risk borrowers, including illegal immigrants. - Lenders have offered increasingly risky loan options and borrowing incentives. - One high-risk option was the "No Income, No Job and no Assets" loans, sometimes referred to as Ninja loans.

14. 3) Securitization practices - Securitization, a form of structured finance, involves the pooling of financial assets. - It simply means that mortgages with a high risk of default could be sold easily to "warehousers," with the risk shifted from the mortgage originator to investors. - Securitization allows issuers to easily generate capital for new loans.

15. 4) Inaccurate credit ratings - High ratings encouraged investors to buy securities backed by subprime mortgages, helping finance the housing boom. - The reliance on agency ratings and the way ratings were used to justify investments led many investors to treat securitized products — some based on subprime mortgages — as equivalent to higher quality securities.

16. 5) Government policies - Increasing home ownership was a goal of the Clinton and Bush administrations. - There is evidence that the Federal government leaned on the mortgage industry, including Fannie Mae and Freddie Mac (the GSE), to lower lending standards. - Also, the U.S. Department of Housing and Urban Development's (HUD) mortgage policies fueled the trend towards issuing risky loans.

17. 6) Policies of central banks - Central banks manage monetary policy and may target the rate of inflation. - They are less concerned with avoiding asset price bubbles, such as the housing bubble and dot-com bubble. - Central banks have generally chosen to react after such bubbles burst so as to minimize collateral damage to the economy, rather than trying to prevent or stop the bubble itself.

18. Financial institution debt levels and incentives - Many financial institutions, investment banks invested the proceeds in mortgage-backed securities (MBS), betting that house prices would continue to rise, and that households would continue to make their mortgage payments. - This strategy proved profitable during the housing boom, but resulted in large losses when house prices began to decline and mortgages began to default.

19. 8) Credit default swaps - Credit defaults swaps (CDS) are financial instruments used as a hedge and protection for debtholders, from the risk of default. - As the net worth of banks and other financial institutions deteriorated, the likelihood increased that those providing the insurance would have to pay their counterparties. - This created uncertainty across the system, as investors wondered which companies would be required to pay to cover mortgage defaults.

20. IMPACT

21. Impact Impact in the U.S 2. Financial Market Impact 2007 3. Financial Market Impact 2008 4. Securitization Market Impact 5. Indirect Economic Effect

22. Impact in the U.S Between June 2007 and November 2008, Americans lost more than a quarter of their net worth. a broad U.S. stock index was down 45 percent from its 2007 high. housing prices had dropped 20% from their 2006 peak futures markets signaling a 30-35% potential drop.

23. Total home equity in the United States was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total retirement assets, from $10.3 trillion in 2006 to $8 trillion in mid-2008. savings and investment assets lost $1.2 trillion and pension assets lost $1.3 trillion. Total lost is $8.3 trillion.

24. Financial Market Impact 2007 began to affect the financial sector in February 2007, when HSBC (world's largest bank -2008) wrote down its holdings of subprime-related MBS by $10.5 billion at least 100 mortgage companies either shut down, suspended operations or were sold As the crisis deepened, more and more financial firms either merged, or announced that they were negotiating seeking merger partners

25. panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value". collapse of the financial derivatives markets has contributed to the world food price crisis and oil price increases due to a "commodities super-cycle In all of 2007, insured depository institutions earned approximately $100 billion, down 31% from a record profit of $145 billion in 2006.

26. Financial Market Impact 2008 As of August 2008, financial firms around the globe have written down their holdings of subprime related securities by US$501 billion When Lehman Brothers and other important financial institutions failed in September 2008, the crisis hit a key point. last quarter of 2008, central banks purchased US$2.5 trillion of government debt and troubled private assets from banks

27. largest liquidity injection into the credit market, and the largest monetary policy action The governments of European nations and the USA also raised the capital of their national banking systems by $1.5 trillion, by purchasing newly issued preferred stock in their major banks.

28. Securitization Market Impact Before the crisis, banks would lend to customers for mortgages, credit cards or auto loans, then sell the related assets to investors via the securitization markets. The allowed banks to replenish their cash so they could lend again, generating fees with each transaction. The securitization markets started to close down in the spring of 2007 and nearly shut-down in the fall of 2008.

29. In February 2009, Ben Bernanke stated that securitization markets remained effectively shut, with the exception of conforming mortgages, which could be sold to Fannie Mae and Freddie Mac.

30. Indirect Economic Effect U.S. GDP contracted at a 6.2% annual rate during Q4 2008 In the 12 month period ending in February 2009, the number of unemployed persons in the U.S. increased by approximately five million The U.S. unemployment rate climbed to 8.1% in February 2009 Declining house prices have reduced household wealth and the collateral for home equity loans

31. The tightening of credit has caused a major decline in the sale of motor vehicles • General Motors sales were down 15.6%, and Toyota sales had declined 32.3%. • Cause global automobile industry crisis, and calls for some form of government intervention • Nationwide, up to 40% of all people at risk of eviction due to foreclosure are renters, according to the National Low Income Housing Coalition.

32. RESPONSES

33. Response • Federal Reserve and central banks • Regulation • Economic stimulus • Bank capital replenishment • Homeowner assistance • Litigation • Law enforcement • Ethics investigation • Executive compensation reform

34. Federal Reserve and central banks • Lowered the target for the Federal funds rate from 5.25% to 2%, and the discount rate from 5.75% to 2.25%. • open market operations to ensure member banks remain liquid. These are effectively short-term loans to member banks collateralized by government securities. Central banks have also lowered the interest rates they charge member banks for short-term loans; • Used the Term Auction Facility (TAF) to provide short-term loans (liquidity) to banks. A total of $1.6 trillion in loans to banks were made for various types of collateral by November 2008.

35. Regulation • Regulators and legislators have contemplated taking action with respect to lending practices, bankruptcy protection, tax policies, affordable housing, credit counseling, education, and the licensing and qualifications of lenders. Regulations or guidelines can influence the transparency and reporting required of lenders and the types of loans they choose to issue. Congressional committees are also conducting hearings to help identify solutions and apply pressure to the various parties involved.

36. Economic stimulus • On 13 February 2008, a $168 billion economic stimulus package, mainly taking the form of income tax rebate checks mailed directly to taxpayers. Checks were mailed starting the week of 28 April 2008. However, this rebate coincided with an unexpected jump in gasoline and food prices. This coincidence led some to wonder whether the stimulus package would have the intended effect, or whether consumers would simply spend their rebates to cover higher food and fuel prices. • On 17 February 2009, U.S. President Barack Obama signed the American Recovery and Reinvestment Act of 2009, an $800 billion stimulus package with a broad spectrum of spending and tax cuts

37. Bank capital replenishment • Losses on mortgage-backed securities and other assets purchased with borrowed money have dramatically reduced the capital base of financial institutions, rendering many either insolvent or less capable of lending. Banks have taken significant steps to acquire additional capital from private sources and governments have also injected capital into selected banks.

38. Homeowner assistance • There are four primary variables that can be adjusted to lower monthly payments and help homeowners: • 1) Reduce the interest rate; • 2) Reduce the loan principal amount; • 3) Extend the mortgage term, such as from 30 to 40 years; and • 4) Convert variable-rate ARM mortgages to fixed-rate.

39. Litigation • Litigation related to the subprime crisis is underway. A study released in February 2008 indicated that 278 civil lawsuits were filed in federal courts during 2007 related to the subprime crisis.

40. Law enforcement • The number of Federal Bureau of Investigation (FBI) agents assigned to mortgage-related crimes increased by 50% between 2007 and 2008

41. Ethics investigation • On 18 June 2008, a Congressional ethics panel started examining allegations that Democrat Senators Christopher Dodd of Connecticut (the sponsor of a major $300 billion housing rescue bill) and Kent Conrad of North Dakota received preferential loans by troubled mortgage lender Countrywide Financial Corp

42. Executive compensation reform • Banks and executives are under pressure to reduce bonuses, as much of the profits recognized by major banks were wiped out by subsequent losses during the crisis. The extent of risk taken was not properly factored into bonus computations.

43. CONCLUSION

44. Conclusion Subprime mortgages are a small part of the United States residential mortgage lending market. Most home mortgages in the United States are securitized, creating bond called Mortgage Bond Security (MBS). The U.S residential MBS market is larger than any other fixed income sector, including treasury, corporate, or agency securities.

45. From 2000 to 2006, housing bubbles is pushed much higher than the GDP growth. • This is due to the low mortgage rate and hence the housing price kept going up. • Subprime borrowing was a major contributor to an increase in home ownership rates and the demand for housing. • The growth of the subprime mortgage results in homeowners’ mortgage is greater than their equity.

46. Unfortunately, we still have a long way to go before this crisis is over. • At the peak of the subprime loan originations, approximately 80% of these mortgages featured artificially low teaser interest rates. • Now, with home prices falling and interest rate resets coming, there very easily could be an increase in the default rate among subprime mortgages.

47. The financial institutions that have purchased the MBS backed by subprime mortgages may face additional write-downs on these loans. This will pressurize their earnings and stock prices. This could lead to continued liquidity issues in the credit markets and tightening of the lending standards going forward. The effects of the unwinding of these mortgages have yet to be seen fully in the financial market.