Comprehensive Report: Causes, Impacts, and Recovery of Subprime Crisis

This report provides an in-depth analysis of the subprime crisis that occurred in 2007-2008 in the United States, examining its origins, mechanisms, and far-reaching consequences. The report identifies key factors contributing to the crisis, including the mortgage loan schemes of financial institutions, investor greed, and unsustainable real estate valuations. It details the collapse, the impact on the US economy, and its global repercussions, particularly in the Middle East, China, and Europe. The report further explores the financial rescue plans implemented to mitigate the crisis and discusses the beginnings of economic recovery, offering a critical perspective on the events and their impact on the global financial landscape. The author emphasizes the roles of unethical investor behavior and insufficient government control as primary drivers of the crisis.

Running head: SUB PRIME CRISIS
Subprime Crisis 2007-2008
Name of the Student:
Name of the University:
Author note:

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Executive Summary
The purpose of this report is to discuss the subprime crisis that happened in 2007-2008 in the US
and affected the economy of the country. The financial loan and credit schemes of the financial
institutions affected the purchasing behavior of the consumers. The over greed of the investors
affected the market volatility making it vulnerable to unsystematic risks identified in the
mortgage crisis. The rapid increase in the real estate property valuation and unsustainable
indicators income of the US citizen also one of the reason that led to this crisis. The prime
lenders in US are the most important contributors in this crisis by faulting on the large amount of
loans at that time.

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Table of Contents
Introduction......................................................................................................................................2
1. Reasons that led to crisis..........................................................................................................2
2. Beginning of the collapse.........................................................................................................3
3. The mechanisms of the failure.................................................................................................4
4. Impact of the crisis in US economy and in the of the world Middle East, China, Europe......4
5. The financial plans to rescue....................................................................................................6
6. The beginning of the recovery..................................................................................................6
7. My opinion...............................................................................................................................7

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Introduction
The financial crisis happened in year 2007 and the previous scenario of this situation was
lucrative for the financial institutions. The Financial institutions developed a mortgage loan scheme that
was very lucrative for the people in USA as well as the lenders near 2001. After the scheme was
announced, without calculating the credit risk the companies started to lend money using the scheme. The
Credit crunching in the banking sector was the main reason for the economic downtown in the year 2007.
The “Housing bubble” was also the main reason for the companies to enter into the unstable valuation of
the real estate market (Dzikowska & Jankowska, 2012). The rapid increase in the real estate property
valuation and unsustainable indicators income of the US citizen also one of the reason that led to this
crisis.
Discussion
Reasons that led to crisis - The mortgage debts increased beyond compare. The debt increased beyond
the property valuation. The low interest rates of the US economy were also a reason that led to the higher
valuation of the properties. The main criteria for the company were to check the relation between the
long-term lower interest rates, which was the reason for higher valuation of the company. The imperfect
data regarding the inflation rate and interest rates also came out to be costly in the matter. The Federal
reserve board increased the interest rates from 1% to 5.25 % during 2006 but it was too late and they did
not increased it further out of fear of downturn of the real estate market and housing property valuation
(Masera, 2011). The subprime borrowers’ played a role in this by increasing the loan amount and leisure

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spending on the debts. The prime lenders are the most important contributors in this crisis by faulting on
the large amount of loans. Decline in the risk premiums and emergence of the new kind of lender in that
time (Masera, 2011). The lax lending standards such as no documentation of the stated income and higher
risk loans were also formulated during that time. The securitization of the real estate property is one of the
most important parts of this crisis. The Mortgage backed securities are favorite debt instruments for the
lenders and the credit rating agencies helps in formulating loans with higher rate of default were
originated. This securitization enabled the investors to grade the higher risk default and it was easy by the
lenders for this instrument to transfer the risk to others (Korngold, 2012).
Beginning of the collapse – The beginning of the collapse began in 2005 when the housing bubble has
burst and the foreclosure rates increased during that time. The collateralized debt obligation (CDO) of the
homeowners, credit risk and decline in the risk premium, mortgage and hedge funds dysfunction all led to
the crisis. During the late 2006 and early 2007, the number of subprime borrowers has risen drastically
(Fratianni & Marchionne, 2010). In spite of the lending terms and warning signals the numbers of lenders
and borrowers kept rising. In 2000, the state of Massachusetts had the subprime loans fueled by refinance
instruments were 1.6% (Friedman & Posner, 2011). However, subprime loans in Mortgage Backed
Securities rose above 12.3 % in 2006 in the state only (Fratianni & Marchionne, 2010). The higher than
expected foreclosure rates of the mortgage backed securities started to change the scenario of US.
Ameriquest was the first lender that got hit because of the down turn of the economy and laid off 3800
employees to recover the money lended. Ameriquest also made a settlement of $ 325 million. More than
25 lenders in US has reported bankruptcy (Friedman & Posner, 2011). The stock of the country’s largest

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subprime lender New Country Financials reported around $ 100 million of liabilities as well as bad debts
(Masera, 2011). By 2007 June, the bigger investment companies predicted that the mortgage backed
securities trade would get hit because of the crisis especially, Bear Stearns, Goldman Sachs, Merrill
Lynch, Lehman Brothers and Morgan Stanley. Once the subprime crisis broke out in the market, the
predicted $100 billion of loan will default, which came to be $ 925 billion after the full hit of the impact
The mechanisms of the failure – the mechanism of the failure lied in the Securitization of the real estate
properties in US. The actual special purpose vehicles (SPV) were very complex transaction entities that
added to the fall of the real estate market and people who borrowed money from banks could not meet the
principle rate of the houses and defaulted on the loans. However, the interest rates were made higher by
the Federal government who came to know about the amount of credit lent to the prime lenders. The
prices of houses fell drastically and the lenders occurred losses due to that. The financial institutions were
the one who were the centre of the crisis. Some of the largest investment institutions occurred huge losses
due to credit defaults. While the credit risks were increasing, the consumers were saving less and
spending more on the credits got from the banks and financial institutions. By 2008, the credit grew to
14.5 trillion dollar. An average person gets more than 13 credit cards and their spending was 134% of
their non-disposable income. Less than 1% low interest rates during that time was also a stimulator in that
credit crisis. The financial markets suffered great losses in the country. Through 2007 the US stock
market occurred $ 8 Trillion dollar losses in the holdings. The value of the consolidated holdings declined
from $ 20 Trillion to $ 12 Trillion. The losses in the countries were shocking.

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Impact of the crisis in US economy and in the of the world Middle East, China, Europe – the impact
of this crisis was huge in terms of monetary losses and value degradation of the real estate market.
Therefore, indirectly the stock prices of the real estate market were influenced in the US economy.
Moreover, the moral hazards were in the core of the crisis. The Dow Jones dropped more than 13000
points and S&P crossed the negative territory (Masera, 2011). This affected other share markets too in the
Korea composite Stock price. The affect of this was virtual but the impact of this was better. The
mortgage asset devaluation percentage was high. More than $ 80 Billion dollar was written down, the
metal and mining companies were the most affected industry of the economy. The GDP of US economy
contracted and did not start to begin grow slowly until 2010. The unemployment rose by 5% as many
companies lay off their employees to control cost (Carrington, 2014). The unemployment rate rose higher
than expected in different European Country like Greece, Spain, Portugal, Ireland, and the UK. The
impact was high in those states and their GDP employment rate decreased drastically. The budget deficits
in the countries affected the whole economy and led to depression. 4.3 million jobs were lost during that
time. The Persian Gulf Banks reported $ 1.5 Billion losses due to speculation loss money of on S&P. The
Bank of China Wrote off 1.3 billion dollar, due to loss in the speculation money and risk exposure in the
subprime investments (McConnell & Blacker, 2011). The Sovereign wealth funds invested approximately
48.5 Billion in the S&P and occurred losses. Though the previous situation was a boom to the housing
and real estate business, there were losses in the Norway, Canadian Lumber Towns and Mexican villages.
Canada freezed 32 billion dollar in the country, which was asset backed commercial paper (Carrington,
2014). The Lebanon, Jordan, Iraq and Iran were indirectly hit by this global crisis. The Jordan’s financial
performance was favorable in spite of the crisis. The slowdown in the sector where the Foreign Direct

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Investments were committed was impacted. The export earnings declined. The export of oil decreased
which affected the oil prices to fall and the exported occurred huge losses. Syria projected budget deficit
in 2009. The GDP of the country declined by 28.7 % to 18.2% (Dymski, 2012).
The financial plans to rescue – the impact of this were so high that some of the largest investment banks
lay off millions of workers and employees. The banks had to write off billions of dollars from their
balance sheets using the bad debt. The banks occurred more losses as to repackage the houses sold in the
mortgage loan (Dymski, 2012). The credit crunch has begun for the new asset backed mortgages. The
bank loans were wiped off from the balance sheets. The credit crunching and investigation of the reliable
documents were started. The standards of credit availability were set higher than before. The insurance of
the banks, which were saved by the government, were the first of the step to get the people to rescue
(Korngold, 2012). Government saved both Fannie Mae and Freddie Mac. Lehman Brothers asked for help
to the government but was turned down at last. Later they declared bankrupt and shut down the company.
The meltdown led to great depression. President Bush and Treasury secretary announced loans of $ 700
billion to the banks to restore the faith of people in the government (Oesterle, 2013). The capital
injections were very important part of this country and asset backed securities were also important part of
government’s interventions. The debt guarantees were very important part of the economy and thus were
very important. Average market capitalizations rate of the large investment banks were reviewed and
given emphasis during that time.
The beginning of the recovery – the beginning of the recovery was also a step of the government to
avoid this kind of risk and crisis further in the country. The moral hazards were related to the risks

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transferability of the company (Hardie & Maxfield, 2012). Home Mortgage disclosure act was one of the
most important declines at that time. Full disclosure agreements were encouraged and made mandatory in
the financial institutions. Mortgage brokers and underwriters adopted unethical approach in the company
for compensations. They also profited from this schemes, which had lax standards.
My opinion - In my opinion, the crisis happened because of the unethical nature of investors as well as
the consumers. The government of the economy has lesser control of the consumers spending , this also
affected the prime consumer’s nature in more spending in the real estate on credit .greed of the investors
to grow in the monetary terms. This also led to the complication that happened in the securitization. The
downturn of the real estate market led to the recession in all the country directly or indirectly related to
the US. The short-term profit-gaining motive of some people affected the world economy. The lack of
proper standards and control in the economy was also one of the reasons that led to downturn of the
market. Government’s regulatory policies and greed of the consumers to own excessive property also a
contributing factor in this crisis. Less saving and more spending characteristics of the consumers were
also reason to this crisis according to me. The encouragement of government to spend more in the
economy was also a contributing factor. Moreover, the Government’s regulatory policies were not
effective at that time. The crisis of the downturn of the market was very influential as the impact was on
all the regional stock markets of China, UK, Australia and India. Therefore, it can be concluded the
negligence of the proper ethics in investments affected the country’s economy.

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