Subprime Mortgage Crisis Essay Example | Topics and Well Written Essays - 1000 words

Subprime Mortgage Crisis - Essay ExampleHowever, what was more than innovative in this whole episode is the point that banks in order to hedge themselves against the high risk lending through secrutization. Securitization is a process of bundle up or pooling the non-liquid assets into marketability securities. The idea is to recoup the liquidity lost through the sanctioning and disbursement of the loans to subprime borrowers.(Hunton & Williams LLP,2005). There atomic number 18 various ways through which the securitization can take place. Most of the times, financial institutions did so by creating picky Purpose Vehicles in order to enjoy off-balance sheet accounting not that to strenghten their balance sheets merely keep the garbage step to the fore of it. The problem started when the subprime borrowers started to default on on their repayments. These defaults created a chain reaction of events which freshman overtook the banks but subsequently created further economic prob lems for the economy.The above graphical representation suggests the two traditional models of the mortgages and how default in both the models can trigger further damage.1 Technically subprime mortgages become a problem when at the default of the payments by the borrowers financial institutions facial expression a mismatch in the cash flows. As outlined earlier that most of the financial institutions attempted to regain the lost liquidity through securitization by creating mortgage okay securities to match the cash inflows from the mortgage payments with the cash outflows from the payments to be made against those mortgage backed securities. When the inflows stop due to default by the subprime borrowers, financial institutions, in order to keep their ratings intact, started to pay out for their obligations out of other resources. This than started to create a credit crunch in the economy as those resources which were technically should project been used in more productive resour ces were being utilized in repayment of the mortgage backed securities. Thus the available credit to the organizations and firms decreased and hence their output and productivity level started to decrease which soft and steadily put pressure on various other economic pressures and hence started one of the pip economic crisis of the century.It is believed that the subprime mortgage in United States stand at almost $1.3 trillion however it only comprises a olive-sized portion of the US GDP and many believe that at such small magnitude level, it may not impact the US economy as such. (Ramady, 2008). The future seems to be more bleak as one half to two thirds of the subprime loans ar Adjustable rate mortgages means that the invade rates on those mortgages are going to increase when they fall due therefore there are estimations that more defaults are yet to come as at higher interest rates, the subprime borrowers may face further hardships to payback their due installments therefore it is feared that crisis are going to further aggravate rather than go down until and unless Federal Reserve Board (FED) does not