The Subprime Mortgage Crisis 2007-2009

The recent financial crisis had primarily occurred in 2007 in the U.S. and had its origins in the subprime mortgage lending sector. The loosening of lending criteria, the excessive credit expansion and the securitization of illiquid assets (especially loans) were the main causes of the crisis. All participants (borrowers and lenders) wrongly anticipated that asset prices will always move upwards and the possibility of having unsecured mortgage loans was minimal. Bennett and Conan (2010) supported that this anticipation had further increased property prices and finally caused the crisis.

The wrong lending principles resulted to the granting of mortgage loans to borrowers that finally did not have the repayment ability to repay them. As a consequence, financial institutions foreclosed their properties and tried to sell them. However, the oversupply of properties in the market caused a sharp decline in their values and the Loan-To-Value (L.T.V.) ratios exceeded the 100%.

The direct effect was the recognition of provisions for impairments for all the unsecured mortgage loans and financial institutions experienced losses in their financial statements. Furthermore, both U.S. and international institutions that invested in asset-backed securities experienced losses because of decreases in the values of their investments. Many of them, after the occurrence of losses, have tried to sell other investments in order to keep their capital adequacy ratios above regulatory limits. The worldwide “sell-off” caused sharp declines in stock exchanges and huge reported losses in companies’ financial statements. Some institutions like Lehman Brothers could not meet their capital requirements and collapsed.

Longstaff (2010, p.449) supported that “the developing of the subprime mortgage crisis was the main reason of the financial contagion spread across markets”.

References

Bennett, W and Conan, C. (2010). Risk Management Lessons worth Remembering From the Credit Crisis of 2007 – 2009. The Journal of Portfolio Management. 36 (3), pp 21-44.

Longstaff, F (2010). The subprime credit crisis and contagion in financial markets. Journal of Financial Economics. 97 (1), pp 436-50.

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