Started in late-2006, then rapidly spread to Europe and other regions during 2007 and 2008, this is the so-called ‘subprime (mortgage) crisis’ which began in the United States. (Wikipedia, 2008) In this assignment, we will have an overview on what the subprime crisis is, how it affects the U.S. and the Europe, and then, we are going to focus on its impact on New Zealand financial institutions and markets.
2.1 About the Subprime Crisis
2.1.1 Before the Crisis
Figure 1: U.S. Median Price of Houses Sold including Land Price
Data Source: Economagic.com
By looking at Figure 1 we see that in recent years, the U.S. house prices have been steadily increasing till reaching the roof at US$257,000 in mid-2006. Since American saw prices had been growing year by year and they believed the trend would retain in the future as well, thus, many people wanted to buy houses. However, not all people had enough income or credit history to apply for prime mortgage loans from financial institutions, therefore, they switched to the subprime mortgage loans which were offered by these financial institutions. These rates are higher than the ‘prime rates’ as default rates on these loans are higher as well. However, as people believed the prices would keep growing, they reckoned they can refinance in the future. On the other hand, in order to hedge the default risks, those financial institutions issued mortgage-back securities (MBS) and collateralized debt obligations (CDO) to third-party investors. And the majority of these investors are banks and financial institutions from Europe. (Wikipedia, 2008)
2.1.2 Crisis Started
In mid-2006, the U.S. house prices reached the highest value and stopped increasing, meanwhile, the U.S. Central Bank had been increasing the interest rate year by year. Therefore, many subprime borrowers could not afford to pay back their loans. Also, it was hard for them to...