Jiangdian-Wang-term-paper - ST 810J Term Paper A Survey of...

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ST 810J Term Paper A Survey of 2007 Subprime Financial Crisis Jiangdian Wang Introduction In the summer of 2007, a global financial crisis shocked private banks, hedge funds and other financial institutes around the world. Its negative effect has impacted American’s housing and mortgage market, and global economy. Compared with the financial crisis happening in Asia 10 years ago, more countries were affected in this crisis. Observers believe that the reasons of this subprime financial crisis are diverse and complex. The term paper briefly reviews the causes of this crisis from varied points of views. It also discusses the impact on corporations and investors, and stock markets. The paper ends with lessons learnt and possible strategies from risk management to deal with these “black swan” events in financial markets. Reasons This crisis is the consequence of subprime mortgage. Subprime mortgage refers to the practice of lending loans to subprime borrowers (most applicants with a credit score below 620 in United States), who are not supposed to qualify for market interest rates because their credit history is not good enough or they fail to prove enough income to support the monthly payment on the loan. Both lenders and borrowers have to take risks for subprime loans or mortgages based on the combining effects of high interest rates, bad credit history, and murky financial situations most associated with mortgage applicants, who are viewed as having larger-than-average risk of defaulting on the loan [1]. The risk of inability of homeowners to pay their mortgage loan spread with asset securitization, started a chain effect, and aroused a series of impacts. There are two major aspects of causes to this crisis. In housing market . 5 years ago, when investors took all possible advantages from prime market, they started to pay more attentions to earn money from those with low credit histories (the poor, new immigrants, etc.). Around 2003 and 2004, mortgage rates dropped to a surprising low level, and remain for a few years. That was the second lowest mortgage rate since 1980. (See Fig 1., House owners pay 7% or 8% during the mid- to late-'90s, and double-digit rates were the norm throughout the '80s and early '90s [2]). Financial companies loaned money with low interest rates to almost anyone who applied to keep mortgage payments comfortable. 1
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ST 810J Term Paper Fig 1. National Average Contract Mortgage Rate, 1963-2007 [2] (http://mortgage-x.com/trends.htm) The subprime mortgage boom was stemming from the low mortgage rate. Low interest rate motivated peoples (especially lots of borrowers with low credit history) buy as much house as they could afford – part of American dream. The boom of housing market kept the housing price rising. Borrowers then refinanced their houses
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Jiangdian-Wang-term-paper - ST 810J Term Paper A Survey of...

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