Causes of the Sub-Prime Crisis Essay Example
Causes of the Sub-Prime Crisis Essay Example

Causes of the Sub-Prime Crisis Essay Example

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  • Pages: 8 (1960 words)
  • Published: September 29, 2017
  • Type: Research Paper
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The crisis of 2008-2009 on the World Wide Web was significantly influenced by borrowers with a damaged or limited credit history, as defined by

This essay will investigate the events that ultimately resulted in numerous mortgage delinquencies and foreclosures among subprime borrowers, compelling insurance company AIG and several other banks to seek bailout funds from the American government in order to prevent another major economic crisis. Previously,

Traditional mortgage loans were exclusive to banks and dependent on the borrower's financial position and credit evaluation. If a borrower had a low credit rating, the bank would deny them a mortgage loan due to the risk of default. In contrast, subprime lending catered specifically to borrowers with both bad credit ratings and weak financial standings.

Subprime loans, which have greater risk and higher


interest rates, led to increased risks and profits for lenders. To understand the origins of the subprime crisis, we need to go back to 2001 after the dot-com bubble burst. At that time, Alan Greenspan, as Chairman of the Federal Reserve, lowered interest rates to 1% in an effort to boost the housing market and avoid another economic downturn. These reduced rates injected a substantial amount of extra money into the economy, resulting in a surge in the housing market.

The Gramm-Leach-Bliley Act was put into effect by the Clinton administration in 1999. This act led to the creation of financial powerhouses such as Citigroup, Bank of America, and J. P. Morgan Chase, each with a multitude of branches.

Banks engaged in stock trading and corporate mergers. The sudden influx of money prompted banks to devise new methods of lending in order to generate more revenue. Their response

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was subprime loans. This occurred before the stated events.

Obtaining a loan from the bank was extremely challenging for sub premier borrowers with poor credit evaluations. Nevertheless, the introduction of a reduced interest rate has made it simpler to secure such loans, albeit with a higher default rate imposed by the bank. Consequently, numerous individuals who were unable to pay their mortgage or would face difficulties in the future received many sub premier loans. However, can they truly be held accountable? After all, this occurred during a time of economic prosperity.

As the money supply continued to expand, investors expected increased profits and believed that the value of their stocks would increase. They were confident that betting against this trend would not be profitable. Consequently, banks focused on lending to borrowers with lower credit ratings who belonged to this group. This gave rise to a market for these particular loans, resulting in substantial wealth for banks and traders, estimated at $3.

Between 2002 and 2007, households were given a combined sum of 2 trillion in loans. The issue arises regarding the banks' decision to lend money to individuals with low credit scores, who posed a significant risk of not being able to repay their debts. Nevertheless, it seems that the banks had a broader plan - they introduced a new financial instrument known as collateralized debt obligations (CDOs). With CDOs, banks could bundle and trade their mortgages as bonds to potential investors.

These CDOs were categorized as asset-backed bonds, signifying that they had financial assets supporting them. Nevertheless, it is important to not be deceived by the terms "assets" and "bonds," as they were deceitfully used to inspire trust

in decision-making. The mechanism of these CDOs involved combining subprime loans with prime loans (loans with favorable credit ratings) and marketing them as a consolidated investment for other banks and organizations to purchase. These CDOs created an inaccurate sense of security since their true nature was undisclosed.

In typical situations, good and bad mortgages are intertwined. When investing bundles are sold in this manner, there should be some indication of whether the investment is reliable or not. An evaluation agency is necessary to determine the creditworthiness of the investment. This applies to any company.

Bank authorities or an investing institution were involved in the crisis along with three celebrated evaluation bureaus, namely Standard & Poor’s (S&P).

Moody’s and Fitch Group provide evaluations, an example would be giving a rating of AA+ to a large internet search company like "Google".

Despite being of low quality, many of these CDOs were given excellent ratings like AAA+, the highest possible rating from any evaluation agency. These CDOs did not deserve these ratings since they consisted of mortgages from borrowers who could not afford to pay them back. The reason for such a high rating was straightforward.

In the past, the purchaser used to pay evaluation bureaus to assess the assets they intended to invest in. However, in the 1970s, the system shifted where it became the seller who paid the agency for evaluations, based on a per-rating basis. This change created incentives for evaluation bureaus to conduct more assessments and be more lenient in their evaluations.

The involvement in evaluating CDOs led to a significant increase in revenue for evaluation bureaus. Moody's, for example, earned approximately US $1 billion annually in 2005 and 2006.

Given that each evaluation earned an average of $300k, it was a lucrative business. Moreover, competition compelled them to provide favorable ratings. Consequently, evaluation bureaus had a strong incentive to rate more CDOs.

Recognition evaluation bureaus have transitioned from independent judges to advisors for banks, offering guidance on asset modification and improved evaluations. Banks profited greatly from collateralized debt obligations (CDOs) and were willing to lend mortgages to individuals unable to afford payments due to the belief in rising property prices. As a result, banks would still retain an asset value higher than the initial loan amount even if someone abandoned their house.

Contrary to the belief that property prices always increase, it has been revealed that this notion is false. By the conclusion of 2006, a significant surge in mortgage foreclosures occurred, setting unprecedented records. The collapse of the CDO market led to billions of dollars worth of unpaid loans.

The housing bubble, which had been beneficial for banks, was now deteriorating as defaults and falling property prices increased. Consequently, major concerns arose regarding CDOs and unsold real estate.

In 2008, American lodging prices declined by 20%, causing many borrowers to have zero or negative equity. This resulted in their mortgages being higher than the value of their homes. Consequently, numerous banks suffered financial losses or collapsed due to flawed CDO investments, leading to a market crash. Lehman Brothers experienced this on September 15, 2008.

The situation deteriorated when the fourth largest investment bank went bankrupt. Prior to this event, American International Group (AIG) had been selling credit default swaps (CDS), which are a form of derivative. The aim of these CDS was to assess any financial losses caused

by collateralized debt obligations (CDO).

AIG agreed to compensate the investor for their losses in exchange for a quarterly fee. The difference was that unlike traditional insurance, the CDS could be purchased by almost anyone, including the banks that sold the CDOs initially. Because there was no regulation, AIG didn't have to allocate capital for potential repayments in case the CDOs failed, which is a requirement for regulated insurance.

Furthermore, the AAA+ ratings given to the CDOs suggested that they were unlikely to fail, but they ultimately did. The collapse of this massive insurance company, deemed "too large to fail," was primarily driven by greed. This occurred on September 17th.

The US Federal Reserve provided AIG with $85 billion to prevent them from going bankrupt. The next day, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke met with key lawmakers to propose an emergency bailout of $700 billion by purchasing toxic assets. Bernanke cautioned that if this action was not taken, the economy might collapse by Monday. President George Bush announced this on October 4th.

The current president of the clip signed a $700 billion bailout measure to assist the weakness troubled assets. The Bankss perpetrated one of the biggest Ponzi strategy of planetary proportions and the revenue enhancement remunerators had to pay the monetary value for their greed. It was a downward spiral from here on terminal as, a hebdomad after the come-on out, the stock market faces its worst hebdomad as stock monetary values plummet in frights of a recession on the manner.

The bailout had a significant effect, as seen in the bankruptcy announcement of an automotive manufacturing giant that has been around for a hundred

years. This period also had far-reaching consequences worldwide, with manufacturers facing a substantial decrease in sales because U.S. consumers spent less. China exemplifies this trend, relying heavily on exports.

China's GDP growth rate declined from 13% in 2007 to 9% in 2008, leading to the bankruptcy of numerous export-focused private firms in coastal regions and causing around 20 million unskilled workers to become unemployed. This demonstrates that the subprime crisis not only affected the US economy but also had a significant impact on the global market, which efforts are still being made to recover from.

There is disagreement on whether the subprime crisis could have been prevented. Looking back, I believe it could have been avoided if the US had imposed tighter regulations on banks' manipulation of the stock market. The problem started with the Gramm–Leach–Bliley Act, which removed a part of the Glass–Steagall Act of 1933. This allowed for numerous mergers between banks and insurance companies. If any of these entities were to fail, it would result in a collapse of the market.

The US authorities' intervention prevented the subprime loans from causing significant market damage by reducing the initial lending capacity of banks. Additionally, inadequate regulation of derivatives by the US government led to the emergence of protective instruments such as CDOs and CDS for banking investments. Furthermore, throughout this period...

The Securities and Exchange Committee (SEC) permitted banks to boost borrowing for purchasing, aiming to enhance the production of collateralized debt obligations (CDOs). This led to a substantial rise in CDO numbers and ultimately contributed to the emergence of the subprime crisis. In essence, both bank greed and inadequate government regulation were responsible for the subprime

crisis. Stricter control over complex derivatives such as CDOs, improved oversight of rating agencies that prioritized incentives over independence, and more cautious decision-making regarding increased bank borrowing could have prevented these issues. If any of these preventive measures had been implemented earlier...

The subprime crisis may have been prevented.


  1. hypertext transfer protocol: //www. thinkplaninvest. com/2008/12/what-is-subprime-crisis/
  2. hypertext transfer protocol: //specials. rediff. com/money/2008/sep/25slid1. htm
  3. hypertext transfer protocol: //www. businessinsider. com/10-myths-about-the-subprime-crisis-2009-7
  4. hypertext transfer protocol: //www. lewrockwell. com/rozeff/rozeff203. hypertext markup language
  5. hypertext transfer protocol: //en.

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You can find a blog discussing the 25 people responsible for the financial crisis at com/blog/2009/02/25-people-to-blame-for-the-financial-crisis/. Additionally, there is a wikinvest page detailing collateralized debt obligations (CDO) at hypertext transfer protocol: //www. wikinvest. com/wiki/Collateralized_debt_obligation_ ( CDO ). Moreover, you can read an article from The New York Times magazine about reconsidering the crisis at hypertext transfer protocol: //www. nytimes. com/2008/09/28/magazine/28wwln-reconsiderpagewanted=print. Lastly, there is a page on MoneyWeek discussing the financial crisis at hypertext transfer protocol:http://www.moneyweek.

The Great Credit Rating Scandal,
Economic Crisis Timeline, and
NPR Story

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