SUB PRIME CRISIS
What is Sub-Prime?
Sub-Prime lending (‘less than prime’, ‘second chance lending’) is a term used by financial institutions for lending money to low credit worthy customers. It involves giving loans in ways that do not meet ‘prime’ standards and are hence put in the riskiest type of consumer loans, typically sold in the secondary market. The credit standards are determined by various factors such as the size of the loan, borrower credit rating, ratio of borrower debt to income or assets, ratio of loan to value or collateral, documentation provided on those loans which do not meet Fannie Mae or Freddie Mac underwriting guidelines for prime mortgages etc.
Sub-prime lending encompasses a variety of credit types, including mortgages, auto loans, and credit cards.
Sub-prime borrowers show data on their credit reports associated with higher default rates, including limited debt experience, excessive debt, a history of missed payments, failures to pay debts, and recorded bankruptcies.
Sub-prime lenders often take on risks associated with lending to people with poor credit ratings or limited credit histories
Securitization: The process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors. The process can encompass any type of financial asset and promotes liquidity in the marketplace.
Mortgage-backed securities are a perfect example of securitization. By combining mortgages into one large pool, the issuer can divide the large pool into smaller pieces based on each individual mortgage's inherent risk of default and then sell those smaller pieces to investors.
The process creates liquidity by enabling smaller investors to purchase shares in a larger asset pool. Using the mortgage-backed security example, individual retail investors are able to purchase portions of a mortgage as a type of bond. Without the securitization...