Subprime Crisis (Part II) | MBA Term Papers

2.???? Lending standards seem to have eased more in the United States

US maintained a loose lending system as compared to other countries. It kept the rules quite lenient in documentation standards, loan to valuation ratio, and also it allowed such loans where prices are not paid at the early stage of their lives. As the consequence of this, longstanding homeowners ended up with zero or in some cases even negative value. The reason behind for misbalance between rates was due to legislative and policy changes that were made by government to encourage development in non-conforming lending sector. The other factor was that the federal government wanted to reduce dominance of Government Sponsored Enterprises (GSE) in home mortgage market. It was observed that referencing wave of 2003 had fallen with an overall fall in fee income within entire industry.? As per the report by Federal Reserve?s 2004 Survey of Consumer Finance, around 45 percent of the houses with first mortgage were refinanced within the time lag of three years.

The lenders were responsible for such ease in underwriting standards. Their prime objective was to give a strong competition to non-conforming mortgages as they were gaining strong market. Soon the lending banks made their entry into mortgage market through their mortgage lending subsidiaries. All these factors resulted into such scenario that promoted increase in arrears and default rates. While providing the loan, lenders hardly cared about the repaying ability of the borrowers; rather they where paying importance toward the collateral value.

Another reason for formation and development of financial crisis in US was the early rise in mortgage rates. The rates rose with great pace which was not at all anticipated. This was an exceptional case where as the mortgage arrear rate increased with moderate speed in other countries. Surprisingly, the increment in rate occurred before the macro economical down turn was triggered and melt down in housing sector started. It was observed by Federal Reserve?s Survey of Consumer Finance that home equity loans increased from 5 percent in 2001 to 8.6 percent in 2004. This was due to increased use of secondary mortgage, called piggy back. These loans became highly popular and people find these loans more attractive compared to paying for mortgage insurance. ?These piggy back loans were not disclosed to the first mortgage originators. Hence, this silent second line accounted for nearly 25 percentages of securitised subprime loans and 40 percent securities in 2006. The loan-to-value (LTV) ratio went on increasing and soon crossed the 100 percent financing standard. The same state in LTV ratio was also observed inUKand Netherland. ManyUSbuyers used third party funding while making down payments. Such involvement of third partly acted as a catalyst for accelerating LTV ratio.? Interest only and negative amortisation loans also gained high popularity in US during 2006 onward. As per the Loan Performance data, interest only-loans accounted for 33.7 percent of the total securitised purchased loans in US during first quarter of 2007 and 7.3 percent of the loans were negatively amortised. These negative amortisation products were commonly known as Option ARMs or pay-Option ARMs and they played a vital role in sending borrowers into a negative equity.

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3.???? Arrears rates deteriorated before the economy did

Before the onset of housing sector fall, high rise was noticed in mortgage arrear. As the result rates started in moving up with a faster rate and continued just before the economical downfall. This upward trend in economy was seen even before the rate of unemployment started booming. But as soon as the credit standards got tightened, arrear rate slowly lost their momentum.

Through tightening of the credit rate, lenders tried to reduce availability of subprime loans but this set was taken quite late, so it was unable to reduce the primary default which had already taken place. Conditions were exactly opposite in other countries. The movement in arrear rate was quite unusual if one compare it to the fall in housing prices.

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