MAHARSHI DAYANAND COLLEGE OF ART, SCIENCE AND COMMERCE. S.Y.B.

com (FINANCIAL MARKETS)

SUBJECT :- BUSINESS ETHICS
Name Of Student Siddhesh . S. Bhingarde. Aditya .P. Gamre
Chirag. B. Jain Prathamesh Matare Amit. B. Sawardekar Uday .R. Shinde

Roll No. 04 09
17 28 42 45

INTRODUCTION
The US subprime mortgage crisis was one of the first indicators of the late2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages. Approximately 80% of U.S. mortgages issued to subprime borrowers were adjustable-rate mortgages.After U.S. house sales prices peaked in mid-2006 and began their steep decline forthwith, refinancing became more difficult. As adjustable-rate mortgages began to reset at higher interest rates, mortgage delinquencies soared. Securities backed with mortgages, including subprime mortgages, widely held by financial firms, lost most of their value. Global investors also drastically reduced purchases of mortgage-backed debt and other securities as part of a decline in the capacity and willingness of the private financial system to support lending. Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the world and slowing economic growth in the U.S. and Europe

Process of mortgage
A mortgage is a stream of cash flows Mortgage originators consist of banks, mortgage bankers and mortgage brokers. The mortgage broker connects the family with the lender. The broker collects commission. The family is then able to buy the house that they went. After the mortgage is sold, it is usually put in a group with other mortgages into a mortgage backed security, or MBS. The riskier portions of these securities are made into collateralized debt obligations, or CDOs. These are the portion of the MBS that other investors do not want. Private sector commercial and investment banks developed new ways of securing subprime mortgages: by packaging them into CDOs and then dividing the cash flows into different "tranches" to appeal to different classes of investors with different tolerances for risk.

Leading up to the crisis

Dean Baker, an analyst, identified the housing bubble in August 2002 that led up to the crisis. He said that between 1953 and 1995 the prices of houses reflected inflation, after 1995 however the price increases in houses were well over inflation. He predicted that a crisis would result from this but no one in the Federal Reserve would listen to him. Bakers analysis was confirmed by economist Robert Shiller who had proven that the real price of houses had not changed from 1895 to 1995.

The Subprime Mortgage Crisis

Up until 2006, the housing market in the United States was flourishing due to the fact that it was so easy to get a home loan. Individuals were taking on subprime mortgages, with the expectations that the price of their home would continue to rise and that they would be able to refinance their home before the higher interest rates were to go into effect. 2005 was the peak of the subprime boom. At this time, 1 in 5 mortgages was subprime. However, the housing bubble burst and housing prices had reached their peak. They were now on a decline.

Responses to the Crisis

Many programs have been enacted and legislation passed to help those who have been hit the hardest by the crisis. Some examples include the Emergency Economic Stabilization Act of 2008 and the Homeowners Affordability and Stability Plan. Former President Bill Clinton and former Federal Reserve Chairman Alan Greenspan indicated they did not properly regulate derivatives, including credit default swaps. A bill called the Derivatives Markets Transparency and Accountability Act of 2009 has been proposed to further regulate the CDS market. This bill would provide the authority to suspend CDS trading under certain conditions

Impacts of the Subprime Mortgage Crisis

Major banks suffered from huge losses. Lehman Brothers went out of business. Merrill Lynch had to sell itself to Bank of America for a fraction of its former value Countrywide Financial Corporation, the biggest U.S. mortgage lender, eventually gets taken over by Bank of America. The Federal Reserve began guaranteeing loans to Bear Stearns and other banks to prevent an all-out financial failure. Mortgage defaults led subsequently to the collapse and government rescue of Fannie Mae and Freddie Mac.

Growth of housing bubble

The housing bubble grew alongside the stock bubble in the mid 1990s. The stock bubble increased the wealth of people, which led them to spend money on consumption including bigger and better houses. The increased demand led house prices to rise. Then the stock bubble burst, which only caused the housing bubble to grow more. This is because people lost faith in the stock market and thought investing in a home would be a much safer alternative. Also going on at this time was the slow recovery from the 2001 recession. This led the Federal Reserve Board to cut interest rates in an effort to stimulate the economy. Fixed-rate mortgages, as well as other interest rates hit 50 year lows. This was a huge incentive to buy a home.

Identification of housing bubble

According to Shiller, the real price of houses was relatively flat from 1890 to 1997, but since 1998, they have climbed 6 percent per year in the aggregate. He determined this by looking at housing price data he obtained from multiple sources 18901934 from Grebler, Blank, and Winnick (1956) 19531975 from the home-purchase component of the CPI-U 19751987 from the Office of Federal Housing Enterprise Oversight 19872005 from the Case-Shiller-Weiss index To fill in the gap, Shiller constructs an index of house prices from 1934 to 1953 by compiling data on the sales price of houses from five major cities based on newspaper advertisements.

statistics of the housing bubble

The USA home ownership rate increased from 64% in 1994 (about where it had been since 1980) to an all-time high of 69.2% in 2004. Between 1997 and 2006, the price of the typical American house increased by 124% In 2006 the national median home price was 4.6 times the national median household income. The housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation. USA household debt as a percentage of annual disposable personal income was 127% at the end of 2007, versus 77% in 1990.

High-risk mortgage loans and lending/borrowing practices

A mortgage brokerage in the US advertising subprime mortgages in July 2008. In the years before the crisis, the behavior of lenders changed dramatically. Lenders offered more and more loans to higher-risk borrowers, including undocumented immigrants. Subprime mortgages amounted to $35 billion (5% of total originations) in 1994, 9% in 1996, $160 billion (13%) in 1999, and $600 billion (20%) in 2006. A study by the Federal Reserve found that the average difference between subprime and prime mortgage interest rates (the "subprime markup") declined significantly between 2001 and 2007. The combination of declining risk premia and credit standards is common to boom and bust credit cycles. In addition to considering higher-risk borrowers, lenders have offered increasingly risky loan options and borrowing incentives. In 2005, the median down payment for first-time home buyers was 2%, with 43% of those buyers making no down payment whatsoever.By comparison, China has down payment requirements that exceed 20%, with higher amounts for non-primary residences.

Mortgage fraud
In 2004, the Federal Bureau of Investigation warned of an "epidemic" in mortgage fraud, an important credit risk of nonprime mortgage lending, which, they said, could lead to "a problem that could have as much impact as the S&L crisis". The Financial Crisis Inquiry Commission reported in January 2011 that: "...mortgage fraud...flourished in an environment of collapsing lending standards and lax regulation. The number of suspicious activity reportsreports of possible financial crimes filed by depository banks and their affiliatesrelated to mortgage fraud grew 20-fold between 1996 and 2005 and then more than doubled again between 2005 and 2009. One study places the losses resulting from fraud on mortgage loans made between 2005 and 2007 at $112 billion. Lenders made loans that they knew borrowers could not afford and that could cause massive losses to investors in mortgage securities." New York State prosecutors are examining whether eight banks hoodwinked credit ratings agencies, to inflate the grades of subprime-linked investments. The Securities and Exchange Commission, the Justice Department, the United States attorneys office and more are examining how banks created, rated, sold and traded mortgage securities that turned out to be some of the worst investments ever devised. As of 2010, virtually all of the investigations, criminal as well as civil, are in their early stages.

US Balance of Payments
U.S. Current Account or Trade Deficit In 2005, Ben Bernanke addressed the implications of the USA's high and rising current account deficit, resulting from USA investment exceeding its savings, or imports exceeding exports.[168] Between 1996 and 2004, the USA current account deficit increased by $650 billion, from 1.5% to 5.8% of GDP. The US attracted a great deal of foreign investment, mainly from the emerging economies in Asia and oil-exporting nations. The balance of payments identity requires that a country (such as the USA) running a current account deficit also have a capital account (investment) surplus of the same amount. Foreign investors had these funds to lend, either because they had very high personal savings rates (as high as 40% in China), or because of high oil prices. Bernanke referred to this as a "saving glut"[144] that may have pushed capital into the USA, a view differing from that of some other economists, who view such capital as having been pulled into the USA by its high consumption levels. In other words, a nation cannot consume more than its income unless it sells assets to foreigners, or foreigners are willing to lend to it. Alternatively, if a nation wishes to increase domestic investment in plant and equipment, it will also increase its level of imports to maintain balance if it has a floating exchange rate.

Effect on jobs in the financial sector

According to Bloomberg, from July 2007 to March 2008 financial institutions laid off more than 34,000 employees. In April, job cut announcements continued with Citigroup announcing an extra 9,000 layoffs for the remainder of 2008, back in January 2008 Citigroup had already slashed 4,200 positions Also in April, Merrill Lynch said that it planned to terminate 2,900 jobs by the end of the year.[15] At Bear Stearns there is fear that half of the 14,000 jobs could be eliminated once JPMorgan Chase completes its acquisition. Also that month, Wachovia cut 500 investment banker positions, Washington Mutual cut its payroll by 3,000 workers and the Financial Times reported that RBS may cut up to 7,000 job positions worldwide. According to the Department of Labor, from August 2007 until August 2008 financial institutions have slashed over 65,400 jobs in the United States.

Effects on Individuals
According to the S&P/Case-Shiller housing price index, by November 2007, average U.S. housing prices had fallen approximately 8% from their mid-2006 peak and by June 2008 this was approximately 20%.Sales volume (units) of new homes dropped by 26.4% in 2007 versus the prior year. By January 2008, the inventory of unsold new homes stood at 9.8 months based on December 2007 sales volume, the highest level since 1981. Housing prices are expected to continue declining until this inventory of surplus homes (excess supply) is reduced to more typical levels. As MBS and CDO valuation is related to the value of the underlying housing collateral, MBS and CDO losses will continue until housing prices stabilize. As home prices have declined following the rise of home prices caused by speculation and as re-financing standards have tightened, a number of homes have been foreclosed and sit vacant. These vacant homes are often poorly maintained and sometimes attract squatters and/or criminal activity with the result that increasing foreclosures in a neighborhood often serve to further accelerate home price declines in the area. Rents have not fallen as much as home prices with the result that in some affluent neighborhoods homes that were formerly owner occupied are now occupied by renters.