A Deep Understanding of US Subprime Mortgage.docx

A Deep Understanding of US Subprime Mortgage.docx

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ADeepUnderstandingofUSSubprimeMortgage

BirminghamBusinessSchool

MsCInternationalBusiness2010–2011

ModuleTitle:

IssueinManagement

BannerCode:

0722125

AssignmentNo:

1

Lecturer:

DrJohnChild

AssignmentTitle:

ADeepUnderstandingofU.S.SubprimeMortgage

WordCount:

2741

（Penaltieswillbeappliedtothosewhoexceedthestatedwordlimit）

IDnumber1115674

NOTyourname（allworkismarkedanonymously）

AdeepunderstandingofU.S.subprimemortgage

Introduction

Inthisessay,itwillpresentthemaincausesofAmericansubprimemortgagefinancialcrisis.Thisiscrisisischaracterizedbyadramaticriseinsubprimemortgagedelinquencies,whatisfollowingisthebankruptcyofsomefinancialinstitutions.Therearealargenumberofessaysthatelaboratethedirectandindirectcausesofthisfinancialcrisis.Whereasdifferentarticlesmayconcentratedifferentlyoncertaincauses.Thisessaywillmainlyfocusonthefollowingaspects.ThefirstreasonisthecollapseofthebubbleofU.S.realestatemarket.Asitisknowntoallthatthehousingbubbleplayedavitalroleinthiscrisis.Second,thelargeamountofsubprimemortgage.Numeroussubprimeborrowersgetinterest-onlyloansfrombanksandotherfinancialinstitutions.Andtheseloanswerebundledtoreselltootherinvestors,creatingalongfinancialchain.Astheseborrowerscouldnotaffordthemonthlypayment,thenallthefinancialchainbegantocollapse.Whatismore,thesefinancialinstitutionsarelackofresponsibilitiesforthemarket.Theypursuehighprofitsandneglectsomecrucialcrisis.Also,theinternationaltradeimbalancealsocontributedtothefinancialcrisis.Exportingpowers,likeChina,JapanandSaudiArabia,havingabigtradesurplus.SomeofthelargeofaccumulationofU.S.dollarsareinvestedinAmericangovernmentsecuritiesandotherfinancialinstitutionsthatarerelatedtorealestatemarket.Atlast,theeconomicpoliciesofU.S.FederalReservealsocontributedtothecrisis.Afewyearsbeforethecrisis,theFederalReservekeptthefederalfundsrateatalowlevel,whichmadeiteasyforthosesubprimeborrowerstogetmoney.Butwhenitraisedthefederalfundsratesomehomeownerscannotpayfortheadjustable-ratemortgage.ThisessaywillexplainthesereasonsaboveonebyoneandpresenttheirlinkswiththeU.S.subprimemortgagecrisis.Also,itwouldalsoproposesomesuggestionsforpreventingasimilarcrisisoccurringinthefuture.

Thecollapseofhousingbubble

SinceInternetbubbleburstin2000,AmericanshopethegrowthofrealestatecouldsavetheAmericaneconomyfromrecession.Whathappenednextistheriseinpriceofhouse.Thehousingpricekeptonrisinguntil2006,reachingthepeak.Thereisstatisticsprovesthatbetween1997and2006,thepriceoftypicalAmericanhouseincreasedby124%.Thenationalmedianhousepricerangedfrom2.9to3.1timesmedianAmericanhouseholdincome.Thisratioroseto4.0in2004,and4.6in2006.（Clifford，2009）Duetothelowinterestratesandtherisinghouseprice,asubstantialnumberofsubprimeborrowersgetcouragetobuyhouseswithmoneyfrombanksorotherfinancialinstitutions,likeFannieMaeandFreddieMac.Someofthoseborrowersdonothaveagoodcredit,tolendthemmoneyisofhighrisk.Atthattime,everyonethoughtthehousepricewouldkeeponrising,eventheycannotaffordthemonthlypayment,thehousecouldberesoldagainwithahigherprice.Accordingtothismethod,thereisnearlynoriskforlendingthemmoney.Butallofthisisbasedontherisingpriceofhouse.Therisinghousepriceencouragealargenumberofwhoactuallycannotaffordthefuturepaymenttobuyhouse.Theprosperousrealestatemarketalsocontributedtotheprosperityofhouseagents.Allofthesemadethehousingbubblebecomemoreandmorebig.Butwhenthehousingbubblecollapsed,thenightmarebegan,housingpricewentdown.Thefinancialmarketfacemanyproblemsrelatedtocapitalchain,whichledtobankruptcyofmanyfirms.

Largeamountofsubprimemortgage

First,weshouldunderstandwhatsubprimemortgageis.Itmeanslendingmoneytopeoplewhomayhavesomedifficultiesingivingthemoneybackaccordingtotherepaymentschedule.（Bellod,2009）Mostsubprimeborrowersmayhavepoorcredithistories,andwereregardingashighriskborrowerswhencomparingwithcommonborrowers.Astheriskishigh,solenderswoulddemandmorepremium.SubprimemortgageisthesourceofU.S.financialcrisis.Itbecamequitepopularinthelate1990s,butatthattime,theamountofsubprimeisnotsolargecomparingwithitof2006.Thesefinancialinstitutionsandbanksplayedavitalroleinpromotinglageramountofsubprimemortgages.Andtheyreallybenefittedalotfromsubprimemortgage.Atthesametime,thesesubprimelendingwerebondedintosecurities.Then,foreignfinancialinstitutionandinvestorswouldbuythesesecurities.Asitisobviousthatmostoftherisksweretransmittedfrombankstothosesecuritiesbuyers.Thesebankswouldbeenthusiastictolendmoremoneytothesesubprimeborrowers.What’smore,inordertolendmoremoneyformorebenefit.Bankscreatedsomeservicesformoresubprimeborrowers.AdjustableRateMortgages（ARMs）isawidelyusedtoolforbankstolendmoremoney.Itallowstheseborrowerstorepayasmallamountofmoneyinthefirstfewyears.ForsomeARMs,borrowersonlyhavetopaytheinterestsandtheinterestsinlowerthancommoninterestrates.Butwhenthefirstyearspast,theyhavetopayalargeamountofmoneyeverymonthoryear.Mostofthemcannotaffordit.Butasthehousingpricekeptonrising,peoplebelievethattheycouldbuythehouseandsellthemwhentheywhentheyhavetopaythemortgage.Thisencouragesasubstantialnumberofpeopletoborrowmoneyfrombanksandbuyhouseswhichtheycannotafford.Whentheinterestrateroseandthehousingpricewentdown,manyofthemfacedseriousproblems.Theirreturnedmoneywerethesourceofmanysecurities,whichcouldcauseddisastersforthecapitalchainwhichtightlyrelatedtothecrisis.

Thosefinancialinstitutionsarelackofresponsibilityandriskyfinancialinnovativeproducts

TheBankruptcyofLehmanBrotherswasthesymbolofthebeginningofU.S.subprimemortgagecrisis.Thereisnodoubtthatthesefinancialinstitutionsofwallstreetcontributedalottothesubprimemortgagecrisis.Somecompaniesborrowedmoneytopeoplewhowerehopingtobuyhouseswithoutevaluatingtheircredithistory.Buttheyknewthattheseloanswereofhighrisk,thentheyinvitedothercompaniestocooperatewiththem,bondingtheseloansintosecurities.Butthesesecuritieswerestrangetomanyinvestors.BothinvestorsinandoutofAmericawereafraidofrisk,especiallyforthoseSovereignwealthfunds.Inordertomakethembelievethesesecuritieswereinlowrisk.Evaluatingcompanies,likeMoody`s,joinedthisgame.Theseevaluatingcompaniesevaluatedsomeofthesesecuritieswithhighmarks,makinginvestorsbuythemwithlesshesitation.Buttherewerestillnotenoughbuyersforthosesecurities,then,insurancecompaniesjoinedthisgametoo.Someofthosesecuritieswereguaranteedbythem.Allthosefinancialinstitutionsworkedtogethertoselltheseloanstoinvestorsandusedtheirmoneytomakemoreloansandsecurities.Becauseofwhattheydid,theU.S.housingmarketseemedtobefluorescent.ButwhattheywereactuallydoingwascontributingtothehousingbubblewhichwasthefoundationoftheU.S.subprimemortgagecrisis.

Theinternationaltradeimbalance

Inrecentyears,exportingpowerslikeChinaJapanandsomeArabiccountries,theyexportedlargenumberoftheirproductstoothercountries.Atthesametime,theamountofimportedproductsislesswhencomparingwiththeirexport.Thisiscalledtradeimbalance.Whenone’sexportexceedsimport,therewouldbetradesurplus.Thentheywouldaccumulatealotofforeignexchangereserves.AsU.S.dollarismaintoolininternationaltrade,mostoftheirforeignexchangereservesisU.S.dollars.Inordertoavoidlossofdepreciationofthedollar,thesecountriestendtoinvesttheirmoneytobuygovernmentbondsandcorporatebonds.ThesedollarswentintofinancialinstitutionslikeFannieMaeandFreddieMac.ThesetwocompaniesplayedveryimportantrolesinU.S.houseloanmarket.Theygotenoughmoneyindirectlyfromthoseexportingpowers.Themoremoneytheygotthemoretheycouldlenttothosesubprimeborrowers.Becausetheyhaveenoughmoney,theywouldlietolendthemtomorepeopleandhavemoreprofit.Theydidnotpaymuchattentiontopeople’scredithistory,makingitpossibleforthoseactuallycannotaffordahousetobuyalargehouse.Morepeopleboughthouses,makingthehousingpriceincreaserapidlyinthattime.Butwhenhousingpricewentdown,thesubprimemortgagebegan.

TheeconomicpoliciesofU.S.FederalReserveandsupervisionofauthorities

Before2004,theU.S.FederalReservekeptthebenchmarkinterestrateatalowlevel,1%.Itaimedtopromotetheconsumptionandeconomicgrowth.Duetothelowinterestrate,peoplewouldbeeagertoborrowmoneyforconsumption.Asthehousingpricewasincreasingeveryyearatthattime,peoplewereencouragedbyhouseagenciestoborrowmoneytoinvestorbuyhouse.Actually,asubstantialnumberofpeoplewithlowincomereallydidthis.somefinancialinstitutionsalsoborrowedmoneyfrombanktoinvestinproductsthatrelatedtohouseloans.Notonlycommonpeoplebutalsofinancialinstitutionsboughtmoneyfrombanks.Agreatdealofmoneyinfluxintohousingmarket,promotingthehousingbubble.Also,theresupervisionsystemofauthoritiesdidnotworkwellonthefin