The purpose of this paper is to analyse the subprime crisis. I will especially focus on how the subprime crisis could develop from a crisis on a small part of the US mortgage market to a global credit crisis with massive impact for all players in the financial sector. In order to do so, I will have to spend some time investigating one of the newer products in structured finance, called Collateralized Debt Obligations or just CDO’s. As we will experience later, this product has had a huge influence on the dimensions of the crisis as well as the losses faced by financial institutions.
It is not difficult to justify a paper about the subprime crisis at this moment. It is impossible to open a newspaper or turn on the TV without being flooded with news about the global financial crisis that the subprime crisis has turned into.
Not a day goes by without new stories of another investment bank writing results down further due to subprime losses; or another financial intermediary caught in such serious liquidity problems, that it has to be bailed out by friends, often with support from the Fed itself.
What do I want to do?
The purpose of this paper is to investigate how a crisis on a small part of the US mortgage market could develop into a global financial crisis.
I will also try to look at how advanced structured products, such as CDO’s, have influenced the strength of the crisis.
Definition of subprime
Subprime is the term used to describe a loan given to a borrower whose credit worthiness is not ideal (prime). Subprime can cover different types of loans as well as the interest rate can vary from loan to loan. In this sense, the word subprime is only referring to the credit quality of the borrower and nothing else.
Borrowers in the subprime segment are typically suffering from deficient credit histories, unproven income or unemployment. On top of that they might have problems making a down payment. These factors...