Principle of Banking and Finance
In a nut shell, the sub-prime crisis is a financial crisis, which started as early as 2001, and it finally took its stage in 2008 to 2009. It started with rising in the mortgage market, which saw the rising of the demand in housing “bubble”, to the bursting of the housing “bubble”, to the introduction of Collateralized Debt Obligations which led to the robust of the economy in the U.S till 2007. The Sub-prime crisis came in a combination of a number of events, conditions and factors, in which sub-prime lending played a major part in. There were many causes of this crisis and as we factor in, government housing policies, regulators, financial institutions, banks, credit rating agencies, as well as the consumers, which were mainly some the parties involved. In addition, the effect of this financial crisis in 2008-2009 saw an increase in mortgage foreclosures that led to the collapse of numerous of banks, financial institutions and mortgage lenders which affected many hedge funds, mutual funds, corporate assets and pension funds. From those who were involved to those who were victims were all held responsible for their own actions, whether the partly or fully, to pay the price of greed, negligence and ignorance. Thus, the outcome of these actions sent the U.S. spiralled into a sub-prime meltdown, otherwise known as sub-prime crisis, and then to the extent of the turmoil around the world – a recession.
As early as 2001, the government wanted to stimulate economies in the U.s to make loans n banks more profitable, they allowed the Central banks to issue lowered interest rates. As a result, housing market increased rapidly due to lower interest rate being issued to borrowers of high credit score, known as prime borrowers. Prime borrowers are people with a proper job, a credit score achieved via their credit cards and they had the ability to at least own an apartment on their own. With the lower interest rates in place, it tempted even more people to borrow money which comes with a lower monthly payment. It was a win-win situation for both the prime borrowers and the banks and financial institutions. However, with such easy access and availability to money and credit and the rise in the demand for housing, whether it is for speculation, investments or living purposes, it created a housing “bubble” within the mortgage market. Financial institutions, banks and investors view this as money making opportunity and started to exploit it. Derivatives were derived out from the housing mortgages to be sold to investors all over the world. As to how is it being done, the banks and financial institutions would take such housing loans and sent them to be rated by the credit rating agencies and then sold them as mortgage-backed securities (MBS), which is a type of collateralized debt obligations (CDO), a derivative. After being given a good rating, AAA or AA, by the credit rating agencies, these mortgage-backed securities