I hesitated about starting a new topic, but based on comments in some of the other topics thought it worthwhile in order to provide a brief outline of how subprime mortgages are connected to a global financial meltdown. I've merely listed as little as possible from the wiki link below to describe the 'stuff', how it's related, and have tried avoid going over the piles of numbers.
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe.......
Many U.S. mortgages issued in recent years were made to subprime borrowers, defined as those with lesser ability to repay the loan based on various criteria. When U.S. house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime mortgages, widely held by financial firms, lost most of their value. The result has been a large decline in the capital of many banks and USA government sponsored enterprises, tightening credit around the world.
Alan Greenspan has stated that the current global credit crisis cannot be blamed on mortgages being issued to households with poor credit, but rather on the securitization of such mortgages.[81]
Subprime lending is the practice of lending, mainly in the form of mortgages for the purchase of residences, to borrowers who do not meet the usual criteria for borrowing at the lowest prevailing market interest rate.
Traditionally, lenders (who were primarily thrifts) bore the credit risk on the mortgages they issued. Over the past 60 years, a variety of financial innovations have gradually made it possible for lenders to sell the right to receive the payments on the mortgages they issue, through a process called securitization. The resulting securities are called mortgage backed securities (MBS) and collateralized debt obligations (CDO).
Securitization, combined with investor appetite for mortgage-backed securities (MBS), and the high ratings formerly granted to MBSs by rating agencies, meant that mortgages with a high risk of default could be originated almost at will, with the risk shifted from the mortgage issuer to investors at large. Securitization meant that issuers could repeatedly relend a given sum, greatly increasing their fee income. Since issuers no longer carried any default risk, they had every incentive to lower their underwriting standards to increase their loan volume and total profit.
Investment banks sometimes placed the MBS they originated or purchased into off-balance sheet entities called structured investment vehicles or special purpose entities. Moving the debt "off the books" enabled large financial institutions to circumvent capital requirements, thereby increasing profits but augmenting risk.[83] Investment banks and off-balance sheet financing vehicles are sometimes referred to as the shadow banking system and are not subject to the same capital requirements and central bank support as depository banks.[84]
Credit rating agencies are now under scrutiny for having given investment-grade ratings to CDOs and MBSs based on subprime mortgage loans.
High ratings encouraged investors to buy securities backed by subprime mortgages, helping finance the housing boom. The reliance on agency ratings and the way ratings were used to justify investments led many investors to treat securitized products — some based on subprime mortgages — as equivalent to higher quality securities. This was exacerbated by the SEC's removal of regulatory barriers and its reduction of disclosure requirements, all in the wake of the Enron scandal.[90]
In December 2008 economist Arnold Kling testified at congressional hearings on the collapse of Freddie Mac and Fannie Mae. Kling said that a high-risk loan could be “laundered” by Wall Street and return to the banking system as a highly rated security for sale to investors, obscuring its true risks and avoiding capital reserve requirements.[95]
A 2004 SEC ruling allowed USA investment banks to issue substantially more debt, which was then used to purchase MBS. Over 2004-07, the top five US investment banks each significantly increased their financial leverage (see diagram), which increased their vulnerability to the declining value of MBSs. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007. Further, the percentage of subprime mortgages originated to total originations increased from below 10% in 2001-2003 to between 18-20% from 2004-2006, due in-part to financing from investment banks.[137][138]
Credit defaults swaps (CDS) are financial instruments used as a hedge and protection for debtholders, in particular MBS investors, from the risk of default. As the net worth of banks and other financial institutions deteriorated because of losses related to subprime mortgages, the likelihood increased that those providing the insurance would have to pay their counterparties.
The volume of CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. CDS are lightly regulated. As of 2008, there was no central clearinghouse to honor CDS in the event a party to a CDS proved unable to perform his obligations under the CDS contract. Required disclosure of CDS-related obligations has been criticized as inadequate. Insurance companies such as American International Group (AIG), MBIA, and Ambac faced ratings downgrades because widespread mortgage defaults increased their potential exposure to CDS losses. These firms had to obtain additional funds (capital) to offset this exposure. AIG's having CDSs insuring $440 billion of MBS resulted in its seeking and obtaining a Federal government bailout.[141]
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe.......
Many U.S. mortgages issued in recent years were made to subprime borrowers, defined as those with lesser ability to repay the loan based on various criteria. When U.S. house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime mortgages, widely held by financial firms, lost most of their value. The result has been a large decline in the capital of many banks and USA government sponsored enterprises, tightening credit around the world.
Alan Greenspan has stated that the current global credit crisis cannot be blamed on mortgages being issued to households with poor credit, but rather on the securitization of such mortgages.[81]
Subprime lending is the practice of lending, mainly in the form of mortgages for the purchase of residences, to borrowers who do not meet the usual criteria for borrowing at the lowest prevailing market interest rate.
Traditionally, lenders (who were primarily thrifts) bore the credit risk on the mortgages they issued. Over the past 60 years, a variety of financial innovations have gradually made it possible for lenders to sell the right to receive the payments on the mortgages they issue, through a process called securitization. The resulting securities are called mortgage backed securities (MBS) and collateralized debt obligations (CDO).
Securitization, combined with investor appetite for mortgage-backed securities (MBS), and the high ratings formerly granted to MBSs by rating agencies, meant that mortgages with a high risk of default could be originated almost at will, with the risk shifted from the mortgage issuer to investors at large. Securitization meant that issuers could repeatedly relend a given sum, greatly increasing their fee income. Since issuers no longer carried any default risk, they had every incentive to lower their underwriting standards to increase their loan volume and total profit.
Investment banks sometimes placed the MBS they originated or purchased into off-balance sheet entities called structured investment vehicles or special purpose entities. Moving the debt "off the books" enabled large financial institutions to circumvent capital requirements, thereby increasing profits but augmenting risk.[83] Investment banks and off-balance sheet financing vehicles are sometimes referred to as the shadow banking system and are not subject to the same capital requirements and central bank support as depository banks.[84]
Credit rating agencies are now under scrutiny for having given investment-grade ratings to CDOs and MBSs based on subprime mortgage loans.
High ratings encouraged investors to buy securities backed by subprime mortgages, helping finance the housing boom. The reliance on agency ratings and the way ratings were used to justify investments led many investors to treat securitized products — some based on subprime mortgages — as equivalent to higher quality securities. This was exacerbated by the SEC's removal of regulatory barriers and its reduction of disclosure requirements, all in the wake of the Enron scandal.[90]
In December 2008 economist Arnold Kling testified at congressional hearings on the collapse of Freddie Mac and Fannie Mae. Kling said that a high-risk loan could be “laundered” by Wall Street and return to the banking system as a highly rated security for sale to investors, obscuring its true risks and avoiding capital reserve requirements.[95]
A 2004 SEC ruling allowed USA investment banks to issue substantially more debt, which was then used to purchase MBS. Over 2004-07, the top five US investment banks each significantly increased their financial leverage (see diagram), which increased their vulnerability to the declining value of MBSs. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007. Further, the percentage of subprime mortgages originated to total originations increased from below 10% in 2001-2003 to between 18-20% from 2004-2006, due in-part to financing from investment banks.[137][138]
Credit defaults swaps (CDS) are financial instruments used as a hedge and protection for debtholders, in particular MBS investors, from the risk of default. As the net worth of banks and other financial institutions deteriorated because of losses related to subprime mortgages, the likelihood increased that those providing the insurance would have to pay their counterparties.
The volume of CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. CDS are lightly regulated. As of 2008, there was no central clearinghouse to honor CDS in the event a party to a CDS proved unable to perform his obligations under the CDS contract. Required disclosure of CDS-related obligations has been criticized as inadequate. Insurance companies such as American International Group (AIG), MBIA, and Ambac faced ratings downgrades because widespread mortgage defaults increased their potential exposure to CDS losses. These firms had to obtain additional funds (capital) to offset this exposure. AIG's having CDSs insuring $440 billion of MBS resulted in its seeking and obtaining a Federal government bailout.[141]
