Akshit Sharma
C. Praveen
Venkat Achyuth
Overview
What is the Subprime crisis?
What were the main reasons of crisis
What was the impact on leading
companies
What were the risks involved
How the Fed responded
Conclusions
Traditional US Housing
Market
Traditional fixed 30-year mortgage
2/28 mortgages
Subprime borrowers: loan applications did not
meet existing standards poor credit records,
high existing debt-to-income ratios, or even no
income proofs
Subprime loans had higher interest rates and
fees compared to Prime loans: 29% of the home
loans made in 2006 had high interest rates .
Between May 2004 and May 2006, the Fed raised its
interest rate from 1.25 percent to 5.25 percent in part
because of concerns over increases in inflation.
Securitization
into MBS
Financial
Institutions
packaged
securities.
assumption
Under
that
the
the
housing
would
perform.
the
lower
tranches
10
Subprime Meltdown
As sophisticated financial instruments were
developed and traded, it became difficult to
know how much exposure an individual bank
had to this risk.
The investors who were holding these
mortgage-backed securities often turned out to
be the large commercial and investment banks
themselves.
The declines in housing prices and the stock
market combined with leverage to threaten the
solvency of many financial institutions.
Subprime Meltdown
Sept 29, 2008: The
biggest single-day
loss ever in the
history of the Dow
occurred on, when
it dropped 777.68
points, or
approximately $1.2
trillion in market
value.
15
Subprime Meltdown
16
Subprime Meltdown
17
Impact
Credit Risk
Asset Price Risk
Liquidity Risk
Counterparty risk
Systemic Risk
Shadow Banking ??
to allow primary dealers to give their troubled assets to the in exchange for
more liquid Treasury Securities
Swap Lines
Fed temporarily removed all limits on its swap lines with major central banks in
Europe
Further Action
Signaling through rate cuts
Expansion of Balance sheet Credit
Easing
Mortgage Lending Rules - HOEPA
Open market operations purchasing
ABS
Conclusion
Deflation
Increased Money Supply
Moral Hazard ??
Rent Shiller
Rating Agencies or Investment
bankers