Sub-Prime Mortgage Crisis May, 2014 May, 2014 | Page 2

The Sub-Prime Mortgage Crisis
Introduction
The United States Federal Deposit Insurance Corp. defines the term Sub-Prime as the credit
characteristics of the personal borrowers. Subprime borrowers were the delinquent borrowers
who caused charge-offs, judgments and bankruptcies, all because of their payment
delinquencies.
In addition to that, it had also been noticed that the majority of the borrowers who had taken
loans against property mortgages did not have the repayment capacity. In fact, subprime
borrowers are these types of borrowers. These loans, hence, had a higher risk of default.

Overview of the Sub-prime crisis
After the Vietnam War, for over a decade, there was a massive influx of money from people
that were moving into America. The money that was injected into the economy caused the
banks and other institutions to give out loans on cheap rates. This resulted in many people
purchasing property against mortgage. Many loans were accepted in this time under easy credit
terms. At times the credit worthiness of the borrowers was not even checked before they were
given loans. People were of the view that the property values will increase, and therefore
much house building and construction took place. Because the loans were still available, the
supply exceeded the demand therefore causing the prices to fall.
Meanwhile, these home loans were combined to form new financial instruments which were
called, Mortgage Backed Securities (MBS). The agencies that had created these instruments had
them rated from credit-rating agencies from Wall Street, which were willing to give them a
good grade if good money was paid. This resulted in investments in MBS from all over the
world. The prices of the MBS therefore went higher. Two of the top sellers of the MBS were
Freddie Mac and Fannie Mae, who believed that the government guaranteed these securities
and therefore they put in all their investments to get more out of these securities, which
further fueled the prices.
When the home owners defaulted on the mortgage, the banks had to take back their houses
and sell them. The houses were sold for lesser amounts than they were bought for, because of
the falling property market. The mortgage backed securities had been traded all over America
and even among the banks that had created the MBS in the first place. These banks started to
suffer losses, as a result of which, the other banks and agencies that owned or traded the MBS
started to suffer losses as well. There were many personal investments in the MBS as well, due
to which people lost a lot of money on a personal basis.

Source:
http://www.researchomatic.com/Mortgage-SubPrime-Crisis-10055.html