2008 Woodie Awards
Effects of the subprime crisis and why students should care
Christina Piazza
Issue date: 3/14/08 Section: News
"The subprime crisis? What is that? I haven't heard of it, but it sounds bad. If I knew more about it, I would probably be worried," said senior Erica Bouteiller.
News reports and headlines threatened our economy with this crisis since August. But what is it all about?
"The subprime crisis is in fact the ongoing crisis in the financial sector stemming from a large number of defaults on mortgage loans, thus also home foreclosures, said Dr. Lucjan Orlowski, professor of economics and international finance.
Many borrowers were not able to pay their loans back which resulted in significant losses throughout the economy.
"In 2007, as many as 1.3 million properties in the United States were subject to default notices, auction notices and bank repossessions," said Orlowski.
A great deal of the loans that were defaulted on were a specific type of mortgage loan called a subprime loan. A subprime loan is granted to higher risk borrowers, whom have lower credit scores, undocumented income and uncertain income projections, according to Orlowski.
This loan starts off at a higher rate than a typical loan due to risk and is an adjustable rate mortgage (ARM), where the interest rate fluctuates. Therefore, the interest rate tends to increase progressively throughout the loan term.
The trouble behind this crisis began in 2002 when housing prices started to soar and banks gave out numerous loans.
"Eager to maximize profits, the larger U.S. banks began granting mortgage loans to more risky borrowers, mainly on the basis of adjustable interest rates. At the same time, the banks were able to transfer the credit risk to financial market investors through a sale of collateralized mortgage obligations (CMOs)," said Orlowski.
A CMO is where banks sell their mortgage debt (money owed to them) to investors who combine all debts into a security which yields a higher profit than traditional interest payments.
However, as interest rates increased borrowers began to default on their loans, greatly diminishing the value of CMOs in addition to banks losing loan principals.
News reports and headlines threatened our economy with this crisis since August. But what is it all about?
"The subprime crisis is in fact the ongoing crisis in the financial sector stemming from a large number of defaults on mortgage loans, thus also home foreclosures, said Dr. Lucjan Orlowski, professor of economics and international finance.
Many borrowers were not able to pay their loans back which resulted in significant losses throughout the economy.
"In 2007, as many as 1.3 million properties in the United States were subject to default notices, auction notices and bank repossessions," said Orlowski.
A great deal of the loans that were defaulted on were a specific type of mortgage loan called a subprime loan. A subprime loan is granted to higher risk borrowers, whom have lower credit scores, undocumented income and uncertain income projections, according to Orlowski.
This loan starts off at a higher rate than a typical loan due to risk and is an adjustable rate mortgage (ARM), where the interest rate fluctuates. Therefore, the interest rate tends to increase progressively throughout the loan term.
The trouble behind this crisis began in 2002 when housing prices started to soar and banks gave out numerous loans.
"Eager to maximize profits, the larger U.S. banks began granting mortgage loans to more risky borrowers, mainly on the basis of adjustable interest rates. At the same time, the banks were able to transfer the credit risk to financial market investors through a sale of collateralized mortgage obligations (CMOs)," said Orlowski.
A CMO is where banks sell their mortgage debt (money owed to them) to investors who combine all debts into a security which yields a higher profit than traditional interest payments.
However, as interest rates increased borrowers began to default on their loans, greatly diminishing the value of CMOs in addition to banks losing loan principals.
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