Essay About Subprime Mortgage Market And Interest Rates

Argo Strategy
The roots of the financial crisis dates back as far as 1989, with the fall of the Berlin Wall ‘the iron curtain’, which brought the fall of communism and the rise of capitalism, which led to globalization. In the 90’s, Bill Clinton reversed the Glass Steagall Act, thus allowing banks to merge, grow and be more complex and highly leveraged e.g. Lehmans. Some see the both of the above as contributors to the crisis, but immediate causes. (FT, 2013)The huge growth of China led to excess global savings, so after 9/11, Allen Greenspan, the ‘Architect of the good times’ and chairman, of the US FED, cut interest rates to 1%, china’s saving forced these rates to stay this low until 2004. These low interest rates had less returns for investors, but in the banks eyes it was seen as free money. It was an incentive for banks to hunt for riskier assets with higher returns; thus subprime lending was born. Banks used this free money as leverage. (TAOR)Sub Prime essentially means, making loans to people who would not normally meet the criteria; and it charged a higher rate of interest, this is why they were so attractive to banks and investors. Thain of Merrill and Lynch described these as NINJA customers (NO INCOME JOBS OR ASSETS REQUIRED). (Nsnbc, 2010) as of 2007, the subprime mortgage market was worth $1.3 trillion. AmeriQuest is an example of a subprime lender. They sold complex ‘teaser rate mortgages’, to attract customers, offering interest rates at 2% for the first 2 years, then it goes to 8%. This resulted in defaults on loans.  They also did not require your “real income”, only your stated income- moral hazard. Some say “if you could chew gum and walk, you’d get a loan”. (TAOR)

Large no’s of these subprime mortgages were put together into pools, to make them less risky, this is known as securitization. Mike Osinski said doing this was like “you take chicken, run it through the grinder, and out comes sirloin”. Banks resold these mortgages amongst themselves, globalization of markets, and credit default swaps contributed to their attractiveness. The pooled mortgages were also used to back securities known as collateralised debt obligations, which were sought after because they were safer and offered higher returns.America’s housing market turned in 2007, defaults on sub-prime loans started to increase. Pooling and other methods did not provide investors with the promised protection. Mortgage backed securities (Toxic Assets) slumped in value, if they even could be valued. Safe CDOs became worthless; they couldn’t be sold or even used as collateral for the short-term funding. This is what ultimately brought down Northern Rock, Iceland’s banks and Lehman Brothers. (TAOR). Trust began to dissolve in 2007 banks started questioning the confidence they had in each other. Bank-to-bank loan rates doubled, this stopped lending.