Question

Use the America’s Subprime Mortgage Crisis discussion thread to discuss the mortgage crisis that the United States is witnessing.

How did the collapse of companies like AIG, Lehman Brothers, Washington Mutual, Royal Bank of Scotland, etc. impact mortgages in and throughout the United States? As homeowner’s, how concerned were you about the safety and security of your mortgage or the mortgage of a friend or family member? Why were subprime mortgages a major contributor to the global financial crisis?

Answer 1

Subprime borrower is the category of borrowers who do not have the excellent credit rating or credit history compare to the prime borrowers and have the greater chance of default. In 2007, when home prices were skyrocketing, everyone was buying houses thinking prices will not go down. Banks in the urge of making more money through loans started giving loans to the subprime borrowers. Big banks such as AIG, Lehman Brothers, Washington Mutual, Royal Bank of Scotland, etc. made the big chunk of loans, which is even beyond manageable for them. To cop-up with their increased exposure, they made established special purpose vehicles (SPV’s) and made small trenches of their loans and sold them through mortgage-backed securities. However, when home prices went down these banks were not able to defend their risky position and collapsed due to a large number of defaults. Failure of one bank leads to the correlation risk in which failure of one leads to the failure of another, due to the increased risk. Correlation risk leads the entire financial system to burst down.
As a homeowner, one should be careful about the safety of mortgage. It’s a hard earned money to put into the home mortgage, and any crisis can lead value of your home substantially lower leaving you with the high amount of mortgage debt with very less value of your home.
Subprime crisis initiated correlation risk into the American financial system. Since American financial system influences a lot in the world and many countries did invest in these mortgage-backed securities ran by banks like AIG and Lehman Borther’s etc. So financial crisis happened to these banks spread globally.