US Subprime Mortgage Market (B): Crisis and its Aftermath


Code : ECC0029

Year :

Industry : Banking, Insurance and Financial Services

Region : US

Teaching Note: Available

Structured Assignment : Available

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End of Housing Market Bubble The US housing market started to boom in the late 1990s and it continued up till 2006. From 1998, housing market gained 86%in real inflation-corrected value and peaked in early 2006. According to Robert Shiller, a top US economist, "this degree of asset value inflation was unwarranted, and driven by excessive investor enthusiasm for housing as an investment."

Rising Foreclosures From early 2001 to mid-2004, a low interest rate environment existed that facilitated the growth of US subprime market. During this period, the Fed's interest rate was lowered 13 times, from 6.25%to 1.00%. This low interest rate environment led to growth of investments in the mortgage market. Many individuals could take loans at low rates to buy homes By 2007, due to the end of introductory 'teaser rates' and beginning of higher interest rates, mortgages and their monthly payments have become expensive – leading to rise in foreclosures and defaults.

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Effect on the Participants in the Subprime Mortgage Market The first to be hit are the mortgage originators; some have filed for bankruptcy, others have gone out of business. These include New Century (filed for bankruptcy), HSBC (showed huge losses), People's Choice Home Loan (filed for bankruptcy). Even if they do not face extensive losses, they find financing – from conventional sources to carry on their business – get squeezed up, as in the case of Countrywide Financial that not only suffered huge losses but also its credit spreads have almost doubled.

Effect on Other Capital Markets A rapidly spreading credit crisis triggered by subprime defaults hit the stock market. The stock market dropped 6.4%from its high in July 19th 2007 and even went as far down as 10%in the third quarter of 2007. The index number of the Implied US equity market volatility, which started at 16 in July 2007 nearly doubled, hitting a high of 31 onAugust 16th 2007. By the end of September 2007, it ended at 18...

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