2007 Subprime mortgage financial crisis
The subprime mortgage financial crisis refers to the sharp rise in foreclosures in the subprime mortgage market that began in the United States in 2006 and became a global financial crisis in July 2007. Rising interest rates increased newly-popular adjustable rate mortgages and property values suffered declines from the demise of the housing bubble, leaving home owners unable to meet financial commitments and lenders without a means to recoup their losses.
The sharp rise in foreclosures after the housing bubble caused several major subprime mortgage lenders, such as New Century Financial Corporation, to shut down or file for bankruptcy, with some accused of actively encouraging fraudulent income inflation on loan applications, leading to the collapse of stock prices for many in the subprime mortgage industry, and drops in stock prices of some large lenders like Countrywide Financial.
Subprime lending is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history or the ability to prove that they have enough income to support the monthly payment on the loan for which they are applying. Subprime loans or mortgages are risky for both creditors and debtors because of the combination of high interest rates, bad credit history, and murky financial situations often associated with subprime applicants. A subprime loan is one that is offered at a rate higher than A-paper loans due to the increased risk. Subprime, therefore, is not the same as "Alt-A", because Alt-A loans qualify for the "A-rating" by Moody's or other rating firms, albeit for an "alternative" means.
The slide started innocuously in April after New Century Financial, a mortgage lender whose principle borrowers were Americans with less-than-stellar credit, filed for bankruptcy protection.
Its customers were people who may have been late on credit card payments, maybe even filed bankruptcy in the previous years, but still wanted that shot at the American dream: a home of one's own.
Lenders, flush with cash and eager to exploit new markets so they could, in turn, lend more money and increase their profits, were only too happy to oblige.
Hedge funds and banks worldwide saw a market flush with opportunity and took their fill, buying mortgage-backed securities to bolster their own bottom lines.
A month later, USB AG, the giant financial company, said its hedge fund business had lost 150 million Swiss francs in the first quarter largely on the back of investments it made in the U.S.subprime mortgage fieldd. Then in July, Wall Street's Bear Stearns closed a pair of hedge funds after it lost more than US$20 billion on mortgage-backed investments.
The company called them isolated incidents, trying to dismiss their importance but investors weren't convinced and its shares slid, resulting in the dismissal of co-chief operating officer Warren Spector.
Markets came to head late last month and early in August as concern mounted that those mortgage securities may not have been as firm as people thought. It was capped by the August 6 bankruptcy by Melville, N.Y.-based American Home Mortgage Investment Corp.
American Home, once the nation's 10th largest mortgage lender, said it fell victim to "extraordinary disruptions" that effectively cut off the funding it needed to make new loans. Falling U.S. home prices and a spike in payment defaults scared investors away from mortgage debt, including bonds and other securities backed by home loans.
By then, banks worldwide were looking at their portfolios and finding sizable exposure and hedge funds were closing down in a bid to stave off investors who wanted to redeem their stakes, essentially, a modern day run on a bank.
On Thursday, France's biggest bank, BNP Paribas, froze US$2.2 billion held in three funds because their exposure to subprime prime mortgages in the U.S. solidified fears that risk was spreading worldwide.
With cash reserves running low, banks were refusing to lend to each other and the interest rates that banks charged each other rose well above the 4 percent level set by the ECB, prompting its unprecedented injections on Thursday and Friday, followed in part by the U.S. Federal Reserve and central banks in Asia, too.
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