Lending Crisis Power Point Subprime

T he Le ndi ng Cri si s: Cau se an d Ef fect

Be fore t he d own turn : Th e Ho usi ng Bo om  The introduction of exotic loans, adjustable rate mortgages, and relaxed standards allows for an increase in subprime mortgage lending.  Low interest rates encourage Wall Street investors to back subprime loans in greater quantities.  Hedge funds worldwide borrow money to invest heavily in subprime mortgages.

Th e downturn b egin s:  Interest rates rise and housing prices fall. Monthly mortgage rates for subprime borrowers skyrocket, but the post-2005 housing slump means they do not have enough equity to refinance or sell.  Lenders, rating agencies, and investors underestimated the number of loans that would default. Relaxed standards lured borrowers into taking out loans they couldn’t afford once initial interest rates expired.  This leads to a 113% increase in foreclosures from July 2006 to July 2007.

Th e downturn contin  Delinquenciesues: and foreclosures on subprime

mortgages force dozens of mortgage lenders to go out of business, contract, or declare bankruptcy. Many have stopped issuing subprime loans altogether. Even borrowers with good credit history are forced to pay higher interest rates.  By the end of July/early August 2007, both National City and Wells Fargo have stopped approving home-equity loans through brokers, as well a subprime mortgage loans.  Thursday, August 16th, 2007 Countrywide Financial, the nation’s largest mortgage lender, borrows $11.5 billion so that it can continue making loans.  By August 21st, 2007, Countrywide Financial has laid off nearly 500 employees in the subprime mortgage lending unit.

He dge f unds a re h it hard:

 Global Hedge funds that borrowed money to invest in subprime mortgages are forced to sell their mortgages at extremely low prices to pay off lenders and investors who want out.  To raise cash quickly, many hedge funds dumped stock, causing stock market prices to plunge worldwide.

Ba nks pull back:

 Banks re-evaluate highrisk loans in the face of potential losses on loans to hedge funds.  As a result, credit is tightened for borrowers across the board, affecting commercial real estate, leveraged buyouts, venture capital lending, mergers and acquisitions, etc.

Go vern me nt Ac tio n:

 To avoid complete market failure and to allow banks to borrow money cheaply, the Federal Reserve, European Central Bank, and their counterparts flood the market with billions of dollars, euros, and yen in August 2007.  The injected government funds are designed to encourage banks to continue making loans rather than conserving cash and making the credit crunch worse.  Analysts are concerned that rather than calming the markets and biding time for the crisis to pass, government action will lead to inflation and an international credit crunch that would slow economic growth worldwide.

Who is t o Bla me?  Lenders: for their predatory lending practices focused on subprime mortgage candidates  Mortgage brokers: for steering borrowers to unaffordable loans  Appraisers: for inflating housing values  Wall Street investors: for backing subprime mortgage loans without first verifying the security of the portfolio  Borrowers: for overstating income levels on loan applications and entering into loan agreements they could not afford  Government: for lack of oversight

On goin g Effe cts :  Subprime mortgage industry collapses, thousands of jobs are lost  Surge of foreclosure activity  Housing prices and sales are both down  Interest rates rise across the board as the effects of the collapse of the subprime mortgage industry seep into the near-prime and prime mortgage markets  Investors lost billions of dollars in securities tied to the subprime mortgage industry, resulting in upheavals throughout the global financial market