The roots of the current US sub prime lending crisis can be traced back to the spiraling housing prices in the first half of this decade. Extremely low lending and borrowing rates increased the demand and supply of existing and new houses. Several institutions started offering sub prime mortgages, to borrowers who had unfavorable credit history, at lower than normal repayment interest levels with little or no down payments. Many investment banks and hedge fund owners began to bet on this new aspect of the US economy. This had allowed investors to avail themselves of loans at low interest rates and invest them in higher yielding avenues. But soon with the US Central Bank (Federal Reserve) initiating a series of interest rate hikes leading to the increase of cost of borrowing to 5.25%, which is the maximum since the last half a decade, and a simultaneous decrease in housing prices, the sub prime mortgages were reset at high rates leaving the borrowers to foreclose their accounts and miss payments. As an outcome, financial institutions and banks with mortgage securities incurred huge losses and had to trade their assets leading to sub prime lending crisis. ...
Prime debtors are the ones who are considered creditworthy. Sub prime debtors are the ones with impaired or no credit history. Sub prime lending can be defined simply as lending that involves higher credit risk. While prime loans are typically made to borrowers who have a strong credit history and can demonstrate a capacity to repay their loans, sub prime loans are typically made to borrowers who are perceived as deficient on either or both of these grounds. Since this involves risk of non-payment by the client, it is usually offered at a higher interest rate. The sub prime mortgage financial crisis refers to the sharp rise in foreclosures in the sub prime mortgage market that started in the US in 2006 and became a global financial crisis in July 2007. The sub prime lending storm did not break out overnight. The clouds had been gathering strength for the past few years. Low interest rates and ample liquidity led to unbridled credit expansion, asset growth and an increase in demand for collateralized debt.
Who are Responsible
It is quite interesting to ask who are all responsible for the worst crisis that had shocked the global financial wellness and prosperity. The major players involved in the market are sub prime lenders, home buyers, rating agency, and the Federal Reserve.
When the Federal Reserve flooded the markets with capital liquidity, the lenders found themselves with ample capital to lend. Lenders were willing to undertake additional risk to increase their investment returns. This increase in the risk appetite led the lenders to offer home loans to borrowers with poor or no credit history by requiring higher than normal repayment levels. Lenient lending norms of