I kept hearing that word on the radio and couldn’t even spell it. Well, here it is : subprime, and it refers to the special rates charged to borrowers with insufficient resources. In short, this is what I think I have understood ( but you’d better read some reliable resource like the BBC to check it out!) : This credit is often offered with a normal rate at the beginning and the rate increases dramatically in the following years ( for example the 2/28 with 2 year at a rate of about 3%, raising up to 11% in the course of the 28 following years). It was designed for people who needed a home for their family and expected their revenues to increase a lot in the coming years, like students for example. But the problem came because some people didn’t see the improvement in their situation that they expected and could no longer pay the loan, and some other people in the US and the UK started using this credit to buy houses and sell them with a benefit in the first 2 years (they could repay the loan and still make enough benefit to live from it), moreover, some banks issued those type of credits to enable people with low or no income to refinance another loan. This broke the market, and then the borrowers could no longer pay the bank back, and the bank couldn’t even sell the house which was offered as a guaranty at a price which would cover their investment. Soon, the real estate market fell drastically, the price of the houses could no longer cover the mortgage and the banks started having problems. Consequently, the banks started borrowing from other banks to cover their losses, and the problem increased with a snowball effect and resulted in the subprime meltdown.
Definitions
« the Prime Rate: The interest rate that banks charge their most creditworthy customers.
Subprime – A term referring to borrowers with a less-than-perfect credit history, also called B&C credit. «
http://www.guarantybanking.com/glossary_l.aspx
« B&C (subprime) Credit : Borrower credit that generally does not meet the credit underwriting guidelines of Fannie Mae or Freddie Mac, who purchase mostly « A » credit loans. B&C credit is part of a grading system that ranges from A to D or F. «
http://www.imfpubs.com/glossary/
« Subprime lending can be defined simply as lending that involves elevated credit risk. »
http://www.federalreserve.gov/boarddocs/Speeches/2004/20040521/default.htm
« Mortgage loans are typically classified as either prime or subprime, depending on their credit risk. »
http://research.stlouisfed.org/publications/mt/20070601/cover.pdf
« A subprime mortgage loan is a mortgage that is specifically designed for people who are denied prime or standard mortgages by traditional or hard money lenders. A subprime mortgage may be suitable for people who have a poor credit rating or have difficulty proving a regular, reliable income. » (definition form a mortgage company)
http://www.adverse-mortgage-centre.co.uk/subprime-mortgage.html
« A subprime mortgage is a type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages. Because subprime borrowers present a higher risk for lenders, subprime mortgages charge interest rates above the prime lending rate. (from a finance encyclopedia by Forbes.)
http://www.investopedia.com/ask/answers/07/subprime-mortgage.asp
Articles
From the BBC
The BBC explains the problem clearly and relates it to other financial crisis like the crash of 1929, but they even go back to 1866.
Questions and answers about subprime lending
http://news.bbc.co.uk/2/hi/business/5144662.stm
» is the credit crush finally over? » : a beginner’s guide to the crisis
http://news.bbc.co.uk/2/hi/business/7003139.stm
« financial crisis, a lesson from history » ( 1866, 1890, 1829, 1985, 1987, 1998, 2000
http://news.bbc.co.uk/2/hi/business/6958091.stm
From the Federal Reserve of the US
read this article dated from 2004
http://www.federalreserve.gov/boarddocs/Speeches/2004/20040521/default.htm
with tables (don’ t miss the homeownership by race and household income!)
http://www.federalreserve.gov/boarddocs/Speeches/2004/20040521/default.htm#table1
From NERA (economic consulting)
This article, « The Subprime Meltdown: A Primer »
http://www.nera.com/image/SEC_SubprimeSeries_Part1_June2007_FINAL.pdf
won a « 5-star » award for being the most-read US article on Monday during July 2007
http://www.mondaq.com/content/awards.asp?id=6A36CF9C-05DB-48ED-9C60-A98B7C9F5A0E
From NBC (with a video news report)
« Will subprime mess ripple through economy? »
http://www.msnbc.msn.com/id/17584725/
From Wikipedia
the content of this article on wikipedia might not be fully accurate or reliable, but you can use the long list of references at the end of the page (from CNN, reuters, USA today, the federal bank, bloomberg, the BBC, IHT, the Telegraph, and so on)
http://en.wikipedia.org/wiki/Subprime_meltdown
A visual explanation from the Wall Street Journal
On e-teach, Véronique Laffargue recommends this interactive diagram from the Wall Street Journal, which explain to those who can understand it, the making of a mortgage CDO (Colateralized Debt Obligation). You follow the process through 6 steps, the first on starting with : « The creator of a subprime residential mortgage-backed security – or RMBS – buys loans from all over the country, often from several different lenders…. ».
