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

Subprime Mortgage Crisis - Essay ExampleHowever, what was more innovative in this whole episode is the fact that banks in order to hedge themselves against the high jeopardy lending through secrutization. Securitization is a process of bundling 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 Special Purpose Vehicles in order to enjoy off-balance plane accounting not only to strenghten their balance sheets but keep the garbage let on of it. The problem started when the subprime borrowers started to default on their repayments. These defaults created a chain reaction of events which firstly overtook the banks but subsequently created supercharge economic problems for the econom y.The above graphical representation suggests the both 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 face a mismatch in the currency flows. As delineate earlier that most of the financial institutions attempted to regain the lost liquidity through securitization by creating mortgage backed 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 stopped 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 have been used in more productive resources were be 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 slow and steadily put pressure on various other economic pressures and hence started one of the worst economic crisis of the century.It is believed that the subprime mortgage in United States jut at almost $1.3 trillion however it only comprises a tiny 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 interest rates on those mortgages ar 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 go ing to further aggravate rather than subside until and unless Federal Reserve Board (FED) does not