Zusammenfassung der Ressource
Sub-Prime Crisis
- Homeowners
- Borrows money from
- Mortgages
Anmerkungen:
- A mortgage is a debt instrument, secured by the collateral of specified real estate property, that the borrower is obliged to pay back with a predetermined set of payments.
- Prime Mortgages
- Mortgages issued to owners who are proven to be
responsible citizens through proof of income and
other documents through a downpayment
- Sub-prime Mortgages
- Mortgages issued to an owner without the
need for a downpayment, proof of income or
any supporting documents
- Lenders
- Issues mortgages to
- Receives monthly payments
for each mortgage
- Parties involved
- Banks
- Supplied the other two
parties with capital to
borrow to carry out their
activities
- Mortgage
Lenders
- Issued Mortgages to the homeowners
- Investment
bankers
- Bought thousands of
mortgages from the
mortgage lender and
sold some to investors
- sells some of the
mortgages
through BONDS to
- sets aside some money from
the bond interest to pay a
Credit Default Swap (CDS) to
Anmerkungen:
- Credit Default Swap: Ensuring a portion of the interest of a bond to a Bond Insurance Company to give the bond a higher rating.
The Bond insurance company would also repay the Bond buyer the principal he/she paid for their bond if the bond is defaulted
- Bond Insurance
Companies
Anmerkungen:
- Some examples of Bond insurance companies include:
1) Standard & Poors (S&P)
2) Fitch Ratings Inc.
3) Moody's investors service
- Rates Bonds with a good
"BOND CREDIT RATING"
Anmerkungen:
- Bond Credit Rating: A rating given to a bond to indicate its creditworthiness
A triple A rating (AAA) is the highest rating and is only given to the best investments
- Collects the payment of the
mortgages through a:
COLLATERALIZED DEBT
OBLIGATION (CDO)
Anmerkungen:
- CDO: Dividing the payments of the mortgages into Tranches.
When money from the mortgages are collected, the top tranches (Senior tranches/ AAA Rated bonds) would receive the money first.
If any homeowner defaults from his/her mortgage, payments from the mortgages would stop thus the lower tranches (Junior Tranches/ CCC Bonds) may not receive any money
- AAA
- Low Risk, Low Return
- Prime Mortgages
- Low Risk: Homeowners unlikely to default
on their mortgages
- Low Return: Only source of income
comes from the homeowner's
mortgage payment
- BBB
- CCC
- High Risk, High Return
- Sub-prime Mortgages
- Why Invest in a
high-risk bond?
- 1) If a homeowner is unable to pay off his/her
mortgage, he/she would be defaulted from
their mortgage
- 2) The property of the
house would be
transferred back to the
- High Risk: Homeowners are likely to
default from their mortgages
- High Return: Usually carries a higher
interest rate which translates to more
money from a mortgage payment
- Investors
- 3) The investor would then
have the option to put the
house back up for sale
(Foreclosure)
Anmerkungen:
- Foreclosure:
1) When a Mortgage owner is unable to pay back their mortgage
2) The Mortgage and property of the house then returns back to the one who invested in the mortgage.
3) When the investor puts the house back up for sale, it is called a Foreclosure
- 4) And housing prices are
always increasing
- Due to the high number of Foreclosures
- Supply of houses went up
- CAUSED HOUSING PRICES TO DROP
(Bubble Burst)
- People were unable to pay back their loans and are
forced to file for bankruptcy leading to....
- Demand of houses dropped
- Federal
Reserve System
(FED)
- Why did the FED allow the lenders
to connect homeowners and
investors through mortgages?
- After the Dot Com Bust of 2000, the FED
overrode Anti-Predatory State Laws which
allowed the lenders to connect
homeowners to investors as this was
stimulating the economy
- The overriding of laws also allowed lenders to create
much riskier loans (Sub-prime mortgages)