Quote:
Originally Posted by raj_007  can anyone clear a doubt about the housing subprime crisis in US....
lenders are giving loans to the customers to buy houses at the higher interest rates than the prime rates....( not considering the customers credit worthiness)...as a result the customer is going default.....that means that cusotmer wont be able to pay the debt rite....? and this lead to lack of money in the market.......is this called as crisis(subprime crisis)
and also
The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments primarily due to loss of employment or health related issues; poor judgment by either the borrower or the lender; inappropriate mortgage incentives such as buydowns and short fixed term adjustable rate mortgages, coupled with rapidly rising adjustable mortgage rates. Further, declining home prices have made re-financing more difficult.
my doubt is if the home prices are declining, then the it will be easy for the customer to pay of the loan rite....? y the customer go default...?
pls answer these querries and even if the querries are totally useles, plz elaborate about subprime crisis in simple terms.....hopin for a reply..... |
Hi raj,
Let's understand the business module of financial institutions (like banks , mortgage houses etc.) they borrow cheap and lend dear...........i mean for instance a bank will raise funds at average rate of 7% and lend the same at 11% earning a margin of 4% as income, but this doesn't mean banks with few billion assets earn this much margin as income as few the most important point is that borrower's of bank can default but bank itself can't which means any bank has to pay back all our deposits as per terms and conditions and regulator (like RBI) will ensure this all the time.
So in this light think a bank structured on financial assumptions that this much money will come plus these many loans can go bad and create losses and all and likewise bank decides a targeted interest rate which should both ensure bank's solvency and profitability.
To increase bank's chances of recovery they also ask for collateral i.e. say for e.g. a house worth 6 lacs for a loan of 5 lacs to sell house in case of default. But during financial crisis or economic downturns, suddenly many assumptions start getting wrong say the money availability starts declining, value of collateral starts falling,borrowers' income level and chance of growth starts falling.....etc. and this all puts a pressure on the entire bank's financial structure, so is more predominant are initial assumption more the heat bank has to face when market takes a U turn
So coming back to sub prime crisis in layman's terms, just imagine you have taken a bank loan of 5 lacs on a house which bank has valued on the cost assessment of 2003-04 (when prices were touching skies) at 6 lac, and everything looks fine in beginning. But then suddenly you find as prices has fallen your pending loan repayment is still 4 lacs whereas your house's worth is only 3.2 lacs..............which mean you are struggling in life to pay 4 lacs for a house which you can buy in 3.2 lacs itself.........
What will one do, and when you expand this module for entire segment, what will all loan borrowers do, and result few banks start (try start) selling few of the houses held by them in market at whatever prices.........again.....this accelerates already down spiraling house market's fall and more and more banks, need to keep more money locked in to ensure their financial health with the regulator (RBI, FED reserve etc.).
Those which can't end being history....like Bear Sterns
i guess this should be enough for now, will carry on based on your feed back.
Regards,
Andy 
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