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Subprime lending |
| Revision as of 07:36, April 16, 2009 (edit) 163.6.135.10 (Talk) (→Drivers of subprime lending) ← Previous diff |
Current revision (17:53, May 1, 2012) (edit) (undo) 188.143.232.12 (Talk) (NYksjsdLsT) |
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| - | {{concept}} | + | What happened blaicasly was because of assuming that a trend was permanent. In the financial world, this is a form of mental disorder. Trends are why anyone could be a day-trader and make money, for a while. Their impermanence is why anyone that didn't get out of that in time lost their shirts. The subprime loans were designed to churn the loans. You had loans that were fixed for usually two years, then would become variable. The whole intent was for the borrower to refinance in two years, again generating all of the bank's new-loan fees. The trend for real estate to appreciate rapidly was counted on to continue to keep this attractive for the borrower. Borrow 100 with 5k in costs to pay off a loan of 95, wait two years, borrow 105k with 5k in costs to pay off a loan of 100, wait two years, borrow 110k with 5k in costs to pay off a loan of 105 but then the trend didn't cooperate by giving a home value of 110k, and the balloon broke. People still had the same house they did, but now a loan for more than they originally paid for it, and they can't get refinancing, and can't sell it for what they owe. Trends are temporary. People that think otherwise will eventually lose money. Now, how do you know when a trend is coming to an end? There's a story about the Crash of '29 about a broker who was getting a shoe shine, and the shoe shiner gave him a hot tip on a stock. He realized that when shoe shine boys were giving stock tips, the market was about to crash and he got out. During the day-trader era, there were stories about bus drivers and janitors making huge money in day-trading, just before that went south. How many times have YOU seen people offering to help people get loans in their answers right here on Yahoo, offers totally unconnected to the question being asked? It was a trend. Now it's not. |
| - | ''For information on the 2007 subprime crisis and credit crunch, click [[2007 Credit Crunch|here]].'' | + | |
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| - | '''Subprime lending''' is the practice of extending credit to borrowers with certain credit characteristics -- e.g. a FICO score of less than 620 -- that disqualify them from loans at the prime rate (hence the term 'subprime'). Subprime lending covers different types of credit, including mortgages, auto loans, and credit cards. Since subprime borrowers often have poor or limited credit histories, they are typically perceived as riskier than prime borrowers. To compensate for this increased risk, lenders charge subprime borrowers a premium. For mortgages and other fixed-term loans, this is usually a higher [[interest rate]]; for credit cards, higher over-the-limit or late fees are also common. Despite the higher costs associated with subprime lending, it does give access to credit to people who might otherwise be denied. For this reason, subprime lending is a common first step toward “credit repair”; by maintaining a good payment record on their subprime loans, borrowers can establish their creditworthiness and eventually refinance their loans at lower, prime rates. | + | |
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| - | Subprime lending became popular in the U.S. in the mid-1990s, with outstanding debt increasing from $33 billion in 1993 to $332 billion in 2003. As of December 2007, there was an estimated $1.3 trillion in subprime mortgages outstanding.<ref>[http://www.bloomberg.com/apps/news?pid=20601039&sid=am4LxWcQQbPQ Subprime Losses are Big, Exaggerated by Some - Bloo,berg.com]</ref> 20% of all mortgages originated in 2006 were considered to be subprime, a rate unthinkable just ten years ago. This substantial increase is attributable to industry enthusiasm: banks and other lenders discovered that they could make hefty profits from origination fees, bundling mortgages into securities, and selling these securities to investors. | + | |
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| - | These banks and lenders believed that the risks of subprime loans could be managed, a belief that was fed by constantly rising home prices and the perceived stability of [[Mortgage-backed security|mortgage-backed securities]]. However, while this logic may have held for a brief period, the gradual decline of home prices in 2006 led to the possibility of real losses. As home values declined, many borrowers realized that the value of their home was ''exceeded'' by the amount they owed on their mortgage. These borrowers began to default on their loans, which drove home prices down further and ruined the value of mortgage-backed securities (forcing companies to take [[write downs]] and [[write-offs]] because the underlying assets behind the securities were now worth less). This downward cycle created a [[Mortgage Market Meltdown|mortgage market meltdown]]. | + | |
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| - | The practice of subprime lending has widespread ramifications for many companies, with direct impact being on lenders, financial institutions and home-building concerns. In the [[U.S. Housing Market]], property values have plummeted as the market is flooded with homes but bereft of buyers. The crisis has also had a major impact on the [[Market Economy|economy at large]], as lenders are hoarding cash or investing in stable assets like Treasury securities rather than lending money for business growth and consumer spending; this has led to an overall [[CREDIT CRUNCH|credit crunch]] in 2007. The subprime crisis has also affected the [[Commercial Real Estate|commercial real estate]] market, but not as significantly as the residential market as properties used for business purposes have retained their long-term value. | + | |
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| - | ==Historical Overview== | + | |
| - | [[Image:subprimeshare.png|thumb|350px|right|Subprime mortgages have increased over time as a fraction of all mortgages written. ''Source: Edward Gramlich, FRB, and Mara Lee, NPR'']] | + | |
| - | The subprime mortgage market lends money to people who don’t meet the credit or documentation standards for ordinary mortgages. Since subprime borrowers often have credit problems or low incomes, there’s a greater chance that they won’t pay back their debts, making subprime mortgages inherently risky for lenders. To compensate for this added risk, banks and other lenders charge higher [[interest rates]] on subprime mortgages. Over the past ten years, these rates have been about 2% higher than prime rates, making subprime lending potentially very lucrative. | + | |
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| - | The subprime industry has always existed, but didn't take off until the mid-1990s. Historically, lenders considered the risk to be too large to issue significant amounts of subprime debt. A number of factors changed this opinion, however, driving banks to originate subprime mortgages in larger and larger numbers. | + | |
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| - | ===Drivers of subprime lending=== | + | |
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| - | '''Home price appreciation''' | + | |
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| - | Home price appreciation seemed an unstoppable trend from the mid-1990's through to today. This "assumption" that real estate would maintain its value in almost all circumstances provided a comfort level to lenders that offset the risk associated with lending in the subprime market. Home prices appeared to be growing at annualized rates of 5-10% from the mid-90s forward. In the event of default, a very large percentage of losses could be recouped through foreclosure as the actual value of the underlying asset (the home) would have since appreciated. | + | |
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| - | '''Lax lending standards''' | + | |
| - | [[Image:Mortgageforeclosures1Q08.png|thumb|right|350px|Outstanding mortgages and foreclosure starts in 1Q08, by loan type<ref>[http://www.mbaa.org/NewsandMedia/PressCenter/62936.htm Delinquencies and Foreclosures Increase in Latest MBA National Delinquency Survey]</ref>]] | + | |
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| - | The reduced rigor in lending standards can be seen as "hella tight" the product of many of the preceding themes. The increased acceptance of securitized products meant that lending institutions were less likely to actually hold on to the risk, thus reducing their incentive to maintain lending standards. Moreover, increasing appetite from investors not only fueled a boom in the lending industry, which had historically been capital constrained and thus unable to meet demand, but also led to increased investor demand for higher-yielding securities, which could only be created through the additional issuance of subprime loans. All of this was further enabled by the long-term home price appreciation trends and altered rating agency treatment, which seemed to indicate risk profiles were much lower than they actually were. | + | |
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| - | As standards fell, lenders began to relax their requirements on key loan metrics. Loan-to-value ratios, an indicator of the amount of collateral backing loans, increased markedly, with many lenders even offering loans for 100% of the collateral value. More dangerously, some banks began lending to customers with little effort made to investigate their credit history or even income. Additionally, many of the largest subprime lenders in the recent boom were chartered by state, rather than federal, governments. States often have weaker regulations regarding lending practices and fewer resources with which to police lenders. This allowed banks relatively free rein to issue subprime mortgages to questionable borrowers. | + | |
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| - | '''Adjustable-rate mortgages and [[interest rates]]''' | + | |
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| - | [[Image:Interest Rate Trends.png|thumb|right|400px]] | + | |
| - | [[Adjustable-rate mortgages]] (ARMs) became extremely popular in the U.S. mortgage market, particularly the subprime sector, toward the end of the 1990s and through the mid-2000s. Instead of having a fixed interest rate, ARMs feature a variable rate that is linked to current prevailing [[interest rates]]. In the recent subprime boom, lenders began heavily promoting ARMs as alternatives to traditional fixed-rate mortgages. Additionally, many lenders offered low introductory, or “teaser”, rates aimed at attracting new borrowers. These teaser rates attracted droves of subprime borrowers, who took out mortgages in record numbers. | + | |
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| - | While ARMs can be beneficial for borrowers if prevailing [[interest rates]] fall after the loan origination, rising interest rates can substantially increase both loan rates and monthly payments. In the subprime bust, this is precisely what happened. The target federal funds rate (FFR) bottomed out at 1.0% in 2003, but it began hiking steadily upward in 2004. As of mid-2007, the FFR stood at 5.25%, where it had remained for over one year. This 4.25% increase in interest rates over a three-year period left borrowers with steadily rising payments, which many found to be unaffordable. The expiration of teaser rates didn’t help either; as these artificially low rates are replaced by rates linked to prevailing interest rates, subprime borrowers are seeing their monthly payments jump by as much as 50%, further driving the increasing number of delinquencies and defaults. Between September of 2007 and January 2009, however, the U.S. Federal Reserve slashed rates from 5.25% to 0-.25% in hopes of curbing losses. Though many subprime mortgages continue to reset from fixed to floating, rates ahve fallen so much that in many circumstances the fully indexed reset rate is below the pre-existing fixed rate; thus, a boon for some subprime borrowers. | + | |
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| - | A major issue is regarding the 'work outs', i.e. when the lender compromises with the borrower to avoid default and repossession. Mortgage originators packaged loans through the process of securitization, which effectively moves the loan off the bank's books to that of the investor. However, the majority of mortgage companies retained the rights to service the mortgages for a fee. Ultimately the servicers are akin to a trustee for these mortgage pools. It is the servicer who generally handles foreclosure and workout proceedings acting as an agent for the holders of the underlying mortgages. It is of this servicer/security-holder arrangement whereby the servicer has a fiduciary duty to the holder, which is in place via contract, that there are endless issues with modifying loans. | + | |
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| - | [[Image:Chart18.gif|thumb|left|270px|Value of subprime ARMs resetting until 2014, in millions USD]] | + | |
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| - | ==Subprime Investments== | + | |
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| - | '''Mortgage-backed securities and Collateralized debt obligations ''' | + | |
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| - | As a result of investment bank innovations, such as [[Collateralized debt obligations (CDO)|collateralized debt obligations (CDOs)]], the default risk of U.S. home mortgages have been spread across markets all over the world. In order to spread their risk, mortgage banks began issuing mortgage-backed securities (MBS) - bonds whose repayments are tied to a large pool of mortgages. By issuing these securities, lenders were able to free up additional capital on their balance sheets, thus allowing them to make more loans and increase the overall velocity of their lending business. This practice was further driven by significant growth in investor appetite as it effectively provided automatic loan diversification, spreading the damage done by a single default across a pool of thousands of loans. | + | |
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| - | Subsequently, MBSs were increasingly used as components in structured products sold by Wall Street, most commonly CDOs. The key innovation of these structured products was that rather than spread the risk from these mortgage pools evenly across all bondholders, it would instead distribute losses hierarchically to investors, with status being dependent on expected yield. Because of these structures, the conventional wisdom ran that investment grade loans could be created out of low quality credit pools. | + | |
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| - | CDOs backed by MBSs were given further credence when they contracted with [[Monoline bond insurers|monoline bond insurers]] to guarantee the assets. In turn, national credit rating agencies gave CDOs the same score as their insurer, conferring the same rating on mortgage-backed securities that a secure municipal bond earned, since the same insurance companies guaranteed both types of assets. Mortgage-backed securities which began to see spectacular profits due to the boom in structured product issuances and the large group of investors who were attracted to their high ratings. Recent developments have suggested that the rating agencies may have applied a different scale to tranches of structured products, thus leading investors to believe that the probability of default on their investments was substantially lower than the reality. | + | |
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| - | Falling values of the CDOs backed by risky mortgage backed securities have resulted in [[Write down|write-downs]] and losses for many Wall Street investment banks. On November 8, 2007 Citigroup Inc's global markets unit announced that total [[write down|write-downs]] of collateralized debt obligations by Wall Street Investment Banks will probably climb to $64 billion.<ref>http://today.reuters.com/news/articleinvesting.aspx?type=etfNews&storyID=2007-11-08T194912Z_01_N08234015_RTRIDST_0_MORTGAGES-WRITEDOWNS-CDO.XML</ref> | + | |
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| - | '''Structured Investment Vehicles (SIVs)''' | + | |
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| - | Structured investment vehicles (SIVs) are off-balance sheet entities that invest in highly rated debt securities and finance themselves by issuing senior debt and capital. The goal of a SIV is to earn a net spread between the yield on its asset portfolio and its funding costs. Senior debt normally takes the form of commercial paper and medium-term notes. SIVs invest predominantly in investment-grade debt securities (usually with a weighted average rating in the AA/Aa range) in accordance with individual asset and portfolio limits agreed with the rating agencies. Because of the nature of its financing, an SIV is highly dependent on maintaining the highest possible short-term and long-term credit ratings. SIVs differ from cash CDOs of asset-backed securities in that their portfolios are marked-to-market and their ratings are based on capital models that are in accordance with the requirements of credit rating agencies. <ref>http://www.creditflux.com/glossary/structured+investment+vehicle+siv.htm</ref> <ref>http://www.iflr.com/?Page=17&ISS=17633&SID=524642</ref> | + | |
| - | On November 7, 2007 Moodys' Investors Service said that it placed $33 billion of structured investment vehicles on a watch list for possible downgrades on their ratings. Some SIVs are in trouble because they invested heavily in subprime mortgages. SIV senior note ratings are vulnerable to declines in portfolio values and being unable to refinance maturing debt. Three of the seven SIVs that could be downgraded are managed by Citigroup. The Citigroup SIVs have no direct exposure to U.S. subprime assets, but have about $70 million of indirect exposure to subprime assets through AAA-rated collateralized debt obligations that hold mortgage debt. <ref> http://money.cnn.com/news/newsfeeds/articles/newstex/AFX-0013-20813630.htm</ref> | + | |
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| - | ==Impact of subprime bust== | + | |
| - | Falling home prices and rising [[interest rates]] have led to higher defaults and resulted in the collapse of the subprime mortgage market. Subprime lenders were among the worst impacted, as investor appetite quickly evaporated, leaving them unable to offload their portfolio of rapidly devaluating loans. This resulted in numerous lender bankruptcies, such as New Century. In addition, the subsequent devaluation of subprime-backed securities such as CDOs has led to volatility in financial markets around the world. Holders of subprime-backed securities, ranging from small firms all the way to Wall Street’s largest investment banks, have also lost vast sums of money as a result of the subprime bust. | + | |
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| - | The impact on financial markets was made worse when several agencies like Moody’s, Standard & Poor’s, and Fitch slashed church leaders in order to promote their woship of the one true god Satan. their ratings on billions of dollars worth of subprime-related bonds and CDOs. There has been some controversy surrounding the assessment of CDOs by credit rating agencies such as Moody’s and Standard & Poor’s. They have been accused of ignoring key credit risks and compromising their rating standards by providing investment grade ratings to CDO tranches without sufficiently testing their modeling methodology. | + | |
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| - | In addition to the damage done to subprime lenders and holders of securities backed by subprime mortgages, the bust has impacted the entire U.S. housing market. In 2006, around 1.3 million mortgages were in default, up 42% from 2005. The increased number of defaults has led to a glut of repossessed homes on the market, which is lowering [[residential real estate prices]] across the board. This harms both the lenders attempting to sell the houses and people who still hold subprime mortgages. As real estate prices fall, some borrowers are finding themselves with houses that aren't worth as much as the loans they own on them. As of December 31, 2007, average loan-to-value ratios for several of the nation's top lenders were 80% or higher.<ref>[http://seekingalpha.com/article/80355-home-equity-ltvs-in-stratosphere?source=feed Home Equity LTVs in Stratosphere]</ref> This situation, called ''negative equity'', can actually make it cheaper for borrowers to default than it would be for them to repay their mortgages. This can harm lenders, as the original collateral for some mortgages (the house) is now essentially gone. If they repossess and sell a house with negative equity, they'll actually lose money. [[Fannie Mae (FNM)]] announced an agreement on January 29th, 2009, to help reduce mortgage foreclosures from their portfolio of loans. They plan to work with the Neighborhood Assistance Corporation of America to renegotiate some of their loan terms to decrease interest payments and principal levels in order to help troubled buyers meet their loan obligations.<ref>[http://online.wsj.com/article/SB123328152873231973.html Fannie Strikes Deal to Modify Loans to Prevent Foreclosures, WSJ, 1/29/2009]</ref> | + | |
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| - | The impact of the sub-prime meltdown has had significant impact on virtually all major International banks, including [[Merrill Lynch (MER)]], [[Deutsche Bank AG (DB)]], [[UBS]], [[Bear Stearns]] and [[Citigroup]]. | + | |
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| - | ===Subprime Losers=== | + | |
| - | [[Image:Writedowns.GIF|frame|right|Most Wall Street banks have taken significant hits. Data as of April 14 2008.<ref>Wall Street Journal analysis and data, company reports</ref>]] | + | |
| - | '''Investment banks''' - many large investment firms have seen their stock prices plummet as a result of the subprime bust. | + | |
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| - | *[[Merrill Lynch (MER)]] reported on January 17, 2008, an $8.6 billion net loss from continuing operations due to significant [[write down|write downs]] on its sub-prime investments <ref>http://files.shareholder.com/downloads/MER/227729568x0x158454/1061e61f-1ae5-4cf9-afad-e8e2f083418c/4Q07%20Earnings%20Release%20-%20FINAL.pdf</ref>. On October 30, 2007 Chairman and CEO Stan O’Neal was ousted after Merrill posted a $2.3 billion loss for the third quarter which included an $8.4 billion [[write down]] on its sub-prime related investments. Merrill bought subprime mortgage lender ''First Franklin Financial Corp.'' for $1.3 billion in 2006, just before the downturn in the subprime market. | + | |
| - | *[[Citigroup (C)]] Chairman and CEO, Charles Prince, resigned on November 4, 2007, becoming another casualty of the subprime crisis <ref> http://www.reuters.com/article/bondsNews/idUSN0421281220071105?pageNumber=1</ref>. On January 15, 2008, Citi reported a fourth quarter net loss of $9.83 billion which included $18.1 billion in pre-tax [[write down|write downs]] on its sub-prime related assets, the biggest in Wall Street History <ref>http://www.citigroup.com/citigroup/press/2008/080115a.htm</ref>. | + | |
| - | *[[UBS AG (UBS)]] shut down one of its hedge funds in 2007 after it incurred $123 million in subprime-related losses, putting a damper on the firm's profits. UBS reported a $4.4 billion loss on fixed-income securities for the third quarter 2007. UBS currently has exposure to $16.8 billion in subprime mortgage backed securities and $1.8 billion in collateralized debt obligations. <ref> http://www.forbes.com/markets/feeds/afx/2007/10/30/afx4276843.html </ref> | + | |
| - | *[[Bear Stearns Companies (BSC)]] had a significant investment in the subprime mortgage boom. So far, Bear has lost around $3.4 billion on subprime investments, mostly in two of its hedge funds. The subsequent 30% drop in its market value prompted speculation about potential takeovers. | + | |
| - | *[[Morgan Stanley (MS)]] also purchased a nonprime mortgage lender, ''Saxon Capital'', in 2006. On December 19, 2007, Morgan Stanley reported a $9.4 billion [[write down]] on its subprime assets which was much greater than the $3.7 billion the Street was expecting.<ref>http://www.bloomberg.com/apps/news?pid=20601080&sid=a61Th6IcsbsU&refer=asia</ref><ref>http://www.reuters.com/article/businessNews/idUSWEN244620071108?feedType=RSS&feedName=businessNews&pageNumber=1</ref> | + | |
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| - | '''Rating agencies''' | + | |
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| - | *[[Moody's (MCO)]] and the [[McGraw-Hill Companies (MHP)|McGraw-Hill(MHP)]] owned S&P have both suffered considerable damage to their reputations. While this will not necessarily have an immediate affect, it may potentially lead to legislative pressure to modify their rating methodologies as well as increased regulatory oversight. | + | |
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| - | '''Mortgage companies''' | + | |
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| - | *[[Countrywide Financial (CFC)]] focuses on lending and other aspects of the mortgage industry, making it sensitive to changes in the [[housing market]]. | + | |
| - | *[[NovaStar Financial (NFI)]] originates, purchases, securitizes, and sells (mostly non-prime) mortgages and mortgage-backed securities. On February 21, 2007, NFI announced that it didn't expect to make any [[net income]] until 2011, which sent its stock plummeting 42.5% in one day. | + | |
| - | *[[PMI Group (PMI)]] and [[MGIC Investment (MTG)]] offer mortgage insurance, which covers loans that are delinquent or in default. In Q1 2007, MGIC's [[net income]] dropped by 44%, while losses from defaulted loans rose 58% from the same quarter in 2006. PMI has seen losses from defaulted loans rise as well, though on July 16, 2007, PMI Canada (the Canadian division of PMI) received a guarantee from the Canadian government promising to cover 90% of all its Canadian loans in case of default. | + | |
| - | *[[IndyMac Bancorp (IMB)]], one of the largest independent U.S. mortgage lenders, posted a loss more than five times greater as the one it had projected for the third quarter 2007. IndyMac incurred a net loss of $202.7 million compared to $86.2 million the same period last year.<ref> http://www.reuters.com/article/businessNews/idUSL055834720071106?feedType=RSS&feedName=businessNews&pageNumber=1</ref> | + | |
| - | *[[Fannie Mae (FNM)]] reported a $1.39 billion loss for the third quarter 2007 as a result of the worsening subprime mortgage crisis. The net loss was caused by a $2.24 billion decline in derivative contracts and $1.2 billion in credit losses. [[Net income]] for the first three quarters of 2007 is down 57 percent from the same period last year.<ref>http://www.bloomberg.com/apps/news?pid=20601103&sid=aA_nv3JPfWgY&refer=news</ref> | + | |
| - | *[[E*TRADE Financial (ETFC)]], while not a mortgage company, has based its business model on the mortgage industry. E*trade uses the cash left in customer accounts to lend money for mortgages and other purchases, and keeps the difference between the interest it owes its customers and the interest earned on the loan. Bad loans and the credit crunch decimated E*trade's stock price in Q4 2007. | + | |
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| - | '''Construction and home improvements''' | + | |
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| - | *[[D.R. Horton (DHI)]], [[Lennar (LEN)]], [[Toll Brothers (TOL)]], [[Pulte Homes (PHM)]], and other homebuilders are highly leveraged to conditions in the housing market. As the subprime bust continues to unfold, the downward pressure it's exerting on the housing market will negatively impact the demand for [[new home construction]]. | + | |
| - | *[[Home Depot (HD)]] and [[Lowe's Companies (LOW)]] are likely to be hit hard by the subprime bust, as they're both sensitive to conditions in the [[housing market]]. Home Depot recently stated that it expected 2007 earnings per share to fall by 15-18%, a larger drop than was previously expected.<ref> [http://www.marketwatch.com/News/Story/home-depot-cuts-full-year-profit/story.aspx?guid=%7B08D8304C%2D7363%2D4E45%2DBCDB%2D153A73AD8CE6%7D Marketwatch article, July 2007] </ref> | + | |
| - | *[[Williams-Sonoma (WSM)]], [[Bed Bath & Beyond (BBBY)]], [[Pier 1 Imports (PIR)]] and other domestic merchants are vulnerable in a weak housing market. Since the subprime bust undermines demand for [[new home construction]], it weakens their position. | + | |
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| - | '''Discount Retailers''' | + | |
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| - | * Discount retailers whose customer base is largely low-income households (often subprime borrowers), including [[Big Lots (BIG)]], [[Family Dollar Stores (FDO)]], [[Dollar General (DG)]], and [[Dollar Tree Stores (DLTR)]] may experience declines in sales as their base cuts back on purchases given delinquent mortgage payments. | + | |
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| - | ===Subprime "Winners"=== | + | |
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| - | There are very few "winners" in the current subprime bust. The closest thing to winners are companies who have limited exposure to subprime, adjustable-rate mortgages, and securities backed by these mortgages. Even so, limited exposure just means that they're not losing as much money as others; it says nothing about actually making money. | + | |
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| - | '''[[Apartment REITs]]''' | + | |
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| - | When it's easy to buy homes, rental prices drop. When financing for mortgages dries up, people rent instead of buying. As a result, [[Apartment REITs]], which own and operate rental apartments, benefit in some areas from the subprime fallout as the decreased availability of mortgages makes rental apartments more attractive. | + | |
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| - | '''Financial institutions''' | + | |
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| - | *[[Wells Fargo (WFC)]] is the largest originator of subprime mortgages in the U.S. Wells Fargo, however, avoided the adjustable-rate mortgages that triggered the higher payments (and subsequent delinquencies and defaults) seen by other lenders, limiting its exposure to the bust while still maintaining a significant presence in the subprime market. Though some short-term losses are possible, Wells Fargo could emerge from the subprime collapse as a leading figure in the market. Though, Wells Fargo could easily turn into one of the losers of this situation through their purchase of Wachovia. Wachovia purchased Golden West/ World Savings, one of the biggest producers of Pay Option ARM's or Negative Amortization Loans. These loans are looked at as being more risky than Subprime because they depended heavily on FICO scores rather than looking at the true risk profile of a borrower. These mortgages are just starting to default and represent a big portion on what "A" Paper and Alt-A lenders were originating as the Subprime bubble was in full swing and bursting. Because of housing depreciation and the fact that these loans added onto the loan principle through negative amortization, many of these loans are upside down already and are getting ready to reset out of their "teaser" payments. | + | |
| - | *[[Clayton Holdings (CLAY)]] provided due diligence on billions of dollars of loans in the recent years. More than 40% of the time Clayton said that a mortgage did NOT meet the standards of the MBS, the mortgage was included anyway. Their due diligence may become a legislated compliance requirement, as per [[Moody's (MCO)]] and [[McGraw-Hill Companies (MHP)]] congressional testimony. | + | |
| - | *[[Goldman Sachs Group (GS)]] has generally steered clear of subprime-backed securities and [[collateralized debt obligations]], though it did take around $3 billion in write-downs in the first quarter of 2008.<ref>[http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=atWA7hMjP.B4 Goldman Sachs Poised to Write Down $3 Billion - Bloomberg.com]</ref> | + | |
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| - | '''Hedge funds''' | + | |
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| - | Other potential winners are the few hedge funds that have bet ''against'' the subprime market recently, by shorting subprime-heavy firms' stocks and securities backed by subprime mortgages. | + | |
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| - | *[[Paulson & Co.]] established a fund specifically for this purpose, and it has reported yearly earnings growth for 2006 in excess of 100%. | + | |
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| - | '''Commercial Real Estate Investment Trusts ([[REIT]]s)''' | + | |
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| - | Commercial REITs have faired well relative to REITs with significant holdings in residential property, as the subprime lending crisis has primarily affected home mortgages. | + | |
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| - | *[[Vornado Realty Trust (VNO)]] is a commercial REIT with investments spanning many property types (office, retail, merchandise mart, warehouse/industrial, etc.) that with few investments in housing has largely avoided direct damage from the subprime crisis. | + | |
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| - | ==The Bush Plan== | + | |
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| - | On December 6, 2007, President Bush and Treasury Secretary Henry Paulson announced a foreclosure relief plan for approximately 1.2 million Americans who have felt the greatest impact from the subprime crisis. The plan is specifically targeted towards those who will be unable to make mortgage payments at higher interest rates. The plan includes a five year freeze on interest rates for certain borrowers with adjustable rate mortgages resetting early in 2008. It excludes individuals who are more than 30 days late at the time the plan is implemented or have been more than 60 days late at any time within the previous 12 months. According to Barclays Capital, the play will only cover approximately 240,000 of the 2 million subprime ARMs that are expected to reset over the next two years.<ref>http://money.cnn.com/2007/12/06/real_estate/Bush_plan_is_limited/index.htm?section=money_topstories</ref> | + | |
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| - | ==Dodd-Frank Plan== | + | |
| - | <blockquote> Representative [http://en.wikipedia.org/wiki/Barney_Frank Barney Frank] (D-Mass.) has proposed that the government guarantee $300 billion in new, cheaper loans. A similar bill backed by [Senator Chris] [http://en.wikipedia.org/wiki/Christopher_Dodd Dodd] [D-Conn] to provide $400 billion in guarantees is before the Senate. The Administration, too, is considering its own version, though analyst [http://www.stanfordgroup.com/displayContent.asp?categoryID=263&itemID=17382 Jaret Seiberg] of the [http://www.stanfordgroup.com/index.asp Stanford Group] expects it [the guarantee] to be smaller.<br> | + | |
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| - | <br>How will these measures work?<br> | + | |
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| - | Underwater homes would be reappraised at current market values. Under Frank's plan, homeowners would be issued new mortgages for 90% of the new value of the home, and the government would get a 5% stake to compensate for the risks it is taking. The holder of the old loan "whether it is a bank or an investment pool that holds mortgage-backed securities "would be paid 85% of the home's new value.<br> | + | |
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| - | <br>Doesn't that mean big losses for lenders?<br> | + | |
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| - | Absolutely. They would have to recognize losses on underwater mortgages right away. But lenders stand to lose far more in foreclosures. <br> * * *<br> How many homeowners will the programs help?<br> | + | |
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| - | No one really knows, since they all depend on how many lenders volunteer. Also, criteria for eligibility may limit the impact of these measures. Under Frank's version, only those who took out loans between January, 2005, and June, 2007, would be able to participate. A spokesman for Frank says some 1 million could be helped. But a recent study by [[UBS AG (UBS)]] estimates only 463,000 subprime borrowers "the hardest hit group" would benefit. <ref>http://www.businessweek.com/magazine/content/08_15/b4079030852449.htm?chan=top+ </ref></blockquote> | + | |
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| - | <blockquote> Proposed legislation aimed at refinancing troubled mortgages may shut out two thirds of the loans it aims to fix due to restrictions on borrower eligibility, according to UBS Securities.<br> * * *<br> | + | |
| - | But terms that borrowers must meet, such as caps on loan size and debt-to-income levels, limit the scope of the plan, the analysts, led by [http://www.linkedin.com/pub/5/93b/a65 Laurie Goodman], wrote in a research note dated Tuesday.<br> | + | |
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| - | About $73 billion in subprime mortgages would benefit from the program based on the UBS analysis on loans contained in securities. Including loans not in securities, the total rises to $104 billion, or about 463,000 loans, UBS said. | + | |
| - | <ref>http://www.reuters.com/article/marketsNews/idUSN2644176220080326 </ref> | + | |
| - | </blockquote> | + | |
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| - | ==References== | + | |
| - | <references/> | + | |
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| - | [[category:mature]] | + | |
Current revision
What happened blaicasly was because of assuming that a trend was permanent. In the financial world, this is a form of mental disorder. Trends are why anyone could be a day-trader and make money, for a while. Their impermanence is why anyone that didn't get out of that in time lost their shirts. The subprime loans were designed to churn the loans. You had loans that were fixed for usually two years, then would become variable. The whole intent was for the borrower to refinance in two years, again generating all of the bank's new-loan fees. The trend for real estate to appreciate rapidly was counted on to continue to keep this attractive for the borrower. Borrow 100 with 5k in costs to pay off a loan of 95, wait two years, borrow 105k with 5k in costs to pay off a loan of 100, wait two years, borrow 110k with 5k in costs to pay off a loan of 105 but then the trend didn't cooperate by giving a home value of 110k, and the balloon broke. People still had the same house they did, but now a loan for more than they originally paid for it, and they can't get refinancing, and can't sell it for what they owe. Trends are temporary. People that think otherwise will eventually lose money. Now, how do you know when a trend is coming to an end? There's a story about the Crash of '29 about a broker who was getting a shoe shine, and the shoe shiner gave him a hot tip on a stock. He realized that when shoe shine boys were giving stock tips, the market was about to crash and he got out. During the day-trader era, there were stories about bus drivers and janitors making huge money in day-trading, just before that went south. How many times have YOU seen people offering to help people get loans in their answers right here on Yahoo, offers totally unconnected to the question being asked? It was a trend. Now it's not.
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