{"id":9171,"date":"2018-09-21T12:56:39","date_gmt":"2018-09-21T07:26:39","guid":{"rendered":"https:\/\/trial.indiaeconomyandbusiness.com\/?p=9171"},"modified":"2024-01-31T03:24:32","modified_gmt":"2024-01-30T21:54:32","slug":"subprime-crisis-part-ii","status":"publish","type":"post","link":"https:\/\/www.indiaeconomyandbusiness.com\/is\/subprime-crisis-part-ii\/","title":{"rendered":"Subprime Crisis – Part II"},"content":{"rendered":"

The sign of the busting of bubble started to show from the middle of 2006 with the transition of loan from \u2018interest only\u2019 and \u2018teaser rates\u2019 to regular payments. This coupled with increase in market interest rate led to doubling or even tripling of\u00a0monthly repayments. Unable to pay the increased monthly repayments, borrowers began defaulting and surrendering their houses adding to the pile of inventory of unsold houses. Unsold inventory was up nearly 40% in sept\u201906, around the time\u00a0\u00a0 when prices began to decline.<\/p>\n

This put pressure on the other set of borrowers who had taken loan only because they believed that the prices would keep increasing and they would refinance their loan after the grace period of 12-24 months is over. However, the declining prices made it difficult for them to switch over and they surrendered their house to the banks. The vicious cycle of falling prices and rising defaults was gaining momentum. Number of defaults increased by as much as 80% in 2007 over previous year.<\/p>\n

The cookie crumbled when\u00a0the\u00a0value of loan on the house became more than its market price. As per estimates, nearly 10% of houses were having negative equity in March\u201908 which stayed above 20% as late as Sept\u201910.<\/p>\n

The impact had spread beyond the borrower and the lender by then. The increasing default meant the drying of cash flow to MBS owned by investors like hedge funds, investment banks and traditional banks. Most of these MBS were protected by CDS (Credit Default Swaps), a kind of insurance, implying that the issuer of CDS would pay up in case the mortgages pooled together in MBS defaulted. However, the wave of default was so huge that even insurers like AIG who had issued the CDS, without having adequate coverage, failed to honor their commitment. (Read more at \u2013 https:\/\/trial.indiaeconomyandbusiness.com\/subprime-crisis-ten-years\/<\/a>).<\/p>\n

For the banking sector, this meant additional trouble since their equity erosion reduced their ability to lend to the rest of the economy. This marked the spread of contagion beyond the housing market.\u00a0Worse, these MBS were owned by investors across the globe leading to spread of the crisis beyond US. The estimate of loss from the crisis stands at about $ 15 trillion of lost output. Value of listed stocks in U.S.\u00a0declined from $20 trillion to $12 trillion between Jan-Oct\u201908 alone.<\/p>\n

At the end, it was all manmade \u2013 at least an implicit, if not outright fraud. Goldman Sachs, one among many, paying a record fine of $550 million for providing incomplete information is a testimony to that. Rating agencies were another cog in the wheel who had rated most of these securities as triple A.\u00a0James Grant wrote in Oct\u20192006 how \u201cWall street transforms BBB minus rated mortgages into AAA rates tranches\u201d by creating CDOs (quoted by Financial Crisis Inquiry Commission).<\/p>\n

And this was aided and abetted by those who championed deregulation of financial market. If Warren Buffett says derivatives are \u201cweapons of mass destruction\u201d, probably Alan Greespan, the Fed chairman till 2006, helped drop that bomb on the US economy..!<\/p>\n","protected":false},"excerpt":{"rendered":"

The sign of the busting of bubble started to show from the middle of 2006 with the transition of loan from \u2018interest only\u2019 and \u2018teaser rates\u2019 to regular payments. This coupled with increase in market interest rate led to doubling or even tripling of\u00a0monthly repayments. Unable to pay the increased monthly repayments, borrowers began defaulting […]<\/p>\n","protected":false},"author":8,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[859],"tags":[],"class_list":["post-9171","post","type-post","status-publish","format-standard","hentry","category-international","membership-content","access-restricted"],"yoast_head":"\nSubprime Crisis - Part II - Indian Economy & Business Analysis<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.indiaeconomyandbusiness.com\/is\/subprime-crisis-part-ii\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Subprime Crisis - Part II - Indian Economy & Business Analysis\" \/>\n<meta property=\"og:description\" content=\"The sign of the busting of bubble started to show from the middle of 2006 with the transition of loan from \u2018interest only\u2019 and \u2018teaser rates\u2019 to regular payments. This coupled with increase in market interest rate led to doubling or even tripling of\u00a0monthly repayments. 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