Subprime crises:what it means,why Big Firms sank?

Subprime crises:what it means,why Big Firms sank?

These days friends you are reading headline that companies in financial sector daily sinking and filing application for bankruptcy and these companies are not like a "vijay di hatti" or small companies ,they have status of one of the first 100 in world in their respective fields .Stock market goes roller coaster these days and making record single day loss and single day gain in world ,moving up down as good as in 6-10 % range in a day (diff between low & high of the day).why this is happening ,Though there might be many reason behind it but one which we are discussing here is most discussed is "SubPrime Crises".



Meaning of SubPrime :Meaning of sub prime commonly used where bank is landing a person at little bit higher rate than normal(prime) rate due to

• Loan to that person is little bit more risky than normal
• Person does not satisfy the condition for taking the loan
• less income than required
• Ratio of loan repayment /income is adverse
• Property involved is in area where rates of property is volatile and not stable
• Risk is high of repayment or some what speculative.

In brief they are landing to a person who is not otherwise eligible as per normal banking condition at higher rates.It does not mean that they are landing to any body without checking any thing but with a knowledge that risk is there, and due to more risk involved , they charge more interest from the party.These Type of loan generally mortgaged by Property or other assets.



If a lay man read this than he can also predict that the bank doing such practices will sooner or later have losses..........?but why the best brain of the world(so called) in US are unable to predict the crises. And Bank/companies which has never shown losses in their history of 140 years ,sank in one quarter losses..



Refinancing:Means bank giving loans directly to the customer,takes loan from other big company on the guarantee that they will pay back the money,as soon as it is received from the client.



Securitization :simple meaning of the securitization is giving loans out of balance sheet and have more cash to give more loan by transfer the mortgaged loans to special purpose vehicles (SPY) created for this purpose by the big houses. After securitization of mortgage assets ,Loan given will not shown in balance sheet and after securitisation of loans banks have good capital adequacy ratio and solvency margins, can give more loan ,but servicing/default risk of all loan remains with the institute and does not transfer to the SPV.



Step by step of reason of Crises

• The bank/companies which are giving loan at sub prime rates ,are small in the size.
• They have more specific information about the consumer and lend money to them on consideration other than financial .
• Then they have refinance their loans from the other big houses like Lahman ,Merrill lynch,AIG or other in the market
• With the money refinanced from the big company they gives more loan and so on
• They have given loan much more than what they have actually owned.
• Rates of property in USA is going south.And interest rates were going up.
• Some client which have Purchased property on loan for capital appreciation/or on the basis of some speculation like future increase in income , in the property was not able to return the loan
• Banks enforcing the foreclosures and taken the properties from the client or properties has been put to sale in the declining price market,Feeding more stock(property for sale) in the market and leads to further price fall
• Small companies collapses on default of some major customers as they are not able to manage cash flows.
• After default from customer they are unable to service the funds refinanced from big company.
• As I have explained above sub prime loans are more risky than normal ,this whole process of collapsing is so fast and have much cascading effect .
• The securitisation of laons also have a role as after securitization of laons companies have more clean balance sheet and one can not judge the Inherent risk involved in that due to less disclosures norms and other reasons.
• And we have now much longer list of casualties like Lahman Bros,Merill Lynch,AIG,Bear stearn,Fannie Mae and Freddie Mac...........and so on .This is not end of story more will come.

and more reason which leads to the crises is securitization ,simple meaning of the securitization is giving loans out of balance sheet and have more cash to give more loan by transfer the mortgaged loans to special purpose vehicle (SPY) prepared for this purpose by the big houses. After securitization of mortgage assets ,Loan given will not shown in balance sheet and after than they have good capital adequacy ratio and solvency margins, can give more loan ,but servicing/default risk of all loan remains with the institute and does not transfer to the SPV.



So ,In brief we can say bad practices have a bad results....



thanks for reading ,Now please give comment on the above.