Subprime Mortgage Crisis 2008 Summary

Subprime Mortgage Crisis 2008 Summary


Economic history records 2008 as a terrible year, Annus Horribilis. The subprime mortgage crisis has brought down the economy of the United States (US). Who would have thought that this crisis could eventually bankrupt the number four largest financial institution in the US, which is already 158 years old, namely Lehman Brothers, with losses of hundreds of billions of US dollars.


Not enough with that, Citigroup, Bank of America, AIG, JP Morgan Chase, Goldman Sachs, Morgan Stanley, Amex, Chrysler, and General Motors also face serious financial problems that have to be bailed out by the US government with funds reaching US$ 700 billion.


As a result, pessimism spread throughout the world. Investors are so worried the bad news hasn't all come out yet.


In fact, since Lehman went bankrupt, the world's financial industry has lost US$ 1 trillion in a matter of months and caused hundreds of thousands of people to lose their jobs.


Compare this figure with our country's Gross Domestic Product (GDP), which was only half at that time, which was US$ 500 billion. No wonder the IMF called the 2008 crisis the worst crisis in the last 60 years.


In the first half of the decade of the 2000s, the business environment looked promising. Optimism hit all market participants. Many risk assets and innovative financial products are created and offered in attractive derivative packages. This is what is meant by securitization.


This is no exception for derivative products sourced from second-class housing loans or subprime mortgages, which are packaged into mortgage-backed securities (MBS) or collateralized mortgage obligations (CMO).


Prior to the existence of derivative products, banks were very prudent in channeling their loans because they were long-term and risky to default. Residents who are not bankable because they do not have a fixed income, making it very difficult for them to get a mortgage (mortgage).


The existence of a third party who is willing to buy up bank credit has caused banks to no longer be conservative. Odd workers and other second-class citizens, it becomes easy to get a bank mortgage.

With the sale of these loans, the risk of poor quality credit is transferred from the bank to a third party. Ironically, the third party (investment bank) bought the credits not for their portfolio.

They, the investment banks, then package it into MBS or CMO or Collateralized Debt Obligation (CDO) derivative products to be resold to investors. From these conditions, a time bomb and a major disaster began.

To make this MBS or CDO attractive in the eyes of investors and can be sold at a high price, third parties hire rating companies such as S&P, Fitch, and Moody's to give them a good rating to the highest, namely AAA. Worse, the rating agencies are willing to comply with the wishes of the third parties. It is very likely that the rating companies are asking for high fees, because they understand that the underlying asset of MBS and CDO is low-quality property debt (subprime).

With an investment grade rating, institutional investors such as banks, pension funds, insurance companies, asset management, and hedge funds do not hesitate to buy them for their portfolios.

When the Fed's interest rate is only 1% p.a. and subprime mortgage interest rates of around 1.5%-2% above it, before 2004, all parties were happy. Mortgage recipients are happy because they can have a house. Property developers are happy because the sales are selling well. Credit distribution banks are also successful. When almost no debtors fail, investors in CDO are also satisfied and happy because they are not losing money.

Investment banks make huge profits and their officials enjoy huge bonuses. Insurance companies that sell credit default swaps (CDS), which is a kind of insurance for MBS and CDO derivative products, are also happy because there are few defaulters, so their profits are skyrocketing. Leaders and employees also receive multiple commissions.

The situation reversed when the Fed raised interest rates 17 times in a row starting in mid-2004, 25 basis points each, to touch 5.25% in July 2006. This interest rate lasted until September 2007, before starting to be lowered to 0%- 0.25% in December 2008 due to the explosion of the subprime mortgage case.

Since then, the price of asset-based derivative products and mortgages has fallen drastically. The impact of the housing loan default was that all companies holding MBS and CDO derivatives in their portfolios had to bear huge losses. The price of the shares of this company also plunged due to the low market price of the portfolio of assets owned.

The problem is that through increasingly integrated interconnections between financial institutions, this financial crisis quickly spread throughout the world. All stock markets experienced a fall so that global market capitalization was cut 47.6% from US$ 60.9 trillion in 2007 to US$ 31.9 trillion at the end of 2008.

The IDX is also not spared. The Composite Stock Price Index (JCI) fell 50.6%, from 2,745.8 to 1,355,4 during 2008, the fourth worst in Asia Pacific. If at the end of 2007, the total market capitalization on the IDX was Rp. 1,988 trillion, at the end of 2008 its value had shrunk to only Rp. 1,029 trillion.

Even more sadly, the fall in subprime mortgage-based securities was also followed by a decline in the prices of most commodities due to the sluggish market and declining global demand.

Like a hurricane, a wave of financial crisis that initially only hit the US and a number of European countries began to attack countries in other corners of the world.

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