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Term Paper On
Subprime crisis and its impact on a particular given sector

Business Environment

Submitted To Submitted By
Respected Sanjeev Kumar
Baljeet Singh Saini Roll No A-08
RegdNo-10809682
Section RE17b1
Btech MBA
CONTENTS

 Introduction
I. Sub Prime

II. Sub Prime Mortgage Crisis

III. Sub Prime Loans

 Reasons that causes Recession in 2001

 Sub Prime Lending’s
Who opt subprime lending?
 How the sub Prime Crisis stated
 Result of the Sub Prime Crisis

 What about solution?

 Effect of subprime crisis in some sectors

 Bibliography
 ACKNOWLEDGEMENT
The enthusiasm and remarkable co-operation shown by everyone, even remotely concerned
with the preparation of this term paper all, we wish to extend our faithful thanks and
acknowledgement to complete this to the H.O.D. sir for providing us a very efficient staff, a
good facility to complete our term paper, because our self are not so intelligent to complete
this term paper.

I express my deep gratitude to Respected” Baljeet sir” for his valuable inspiration and
guidance given to us wherever we felt need at the height. He gave me, his appreciable ideas
and views wherever we felt help. His experience helps us very much to make our term paper
successful.

Last but not the least, we pay our thanks to my colleague whose provide a necessary help in
this term paper.
Introduction

Sub Prime
Sub Prime as the word defines, means subordinate to primary.
The word is used in the lending industry to define a borrower who does not have a good
credit history and hence is not able to qualify for best market rates vis-à-vis the prime
category borrower.
The term "subprime" reflects not the lending rate but the borrower's credit status.
Sub Prime lending is also called as a
•B-Paper,
•near-prime

Secondly

Subprime is the cause of USA Economy melt down. It is the very popular news among
everyone and it is become very serious than expected. It caused more damage to all the
industries. Subprime crisis caused big loss to the banks and now it is affecting the other
industries like Auto Mobile companies. In this blog I will write about what exactly is the
Subprime crisis and why USA banks created such a big mistake in their era. Some experts
comparing this disaster with the 1930 Economy slow down in USA.

Sub Prime Mortgage Crisis

The subprime mortgage crisis is an ongoing real estate crisis and financial crisis triggered by
a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major
adverse consequences for banks and financial markets around the globe.

Approximately 80% of U.S. mortgages issued in recent years to subprime borrowers were
adjustable-rate mortgages. After U.S. house prices peaked in mid-2006 and began their steep
decline thereafter, refinancing became more difficult. As adjustable-rate mortgages began to
reset at higher rates, mortgage delinquencies soared. Securities backed with subprime
mortgages, widely held by financial firms, lost most of their value. The result has been a
large decline in the capital of many banks and U.S. government sponsored enterprises,
tightening credit around the world.
Although there are many reasons responsible for bringing the world to the doorstep of
financial doom, the main cause of this financial disaster is said to be the sub-prime loan.'

Sub Prime Loans

Sub-prime mortgage loans (or housing loans or junk loans) are very risky. But since profits
are high where the risk is high, a lot of lenders get enough to be given a loan when judged
under the strict standards that should normally be followed by a bank or lending institution.
Into this business to try and make a quick buck.

Sub-prime loans are dicey as they are given to people with unstable incomes or low
creditworthiness. These individuals are not financially sound.

Reasons that causes Recession in 2001

Subprime problem is more severe then what we saw in the 2001 recession. The real fact is
that, 2001 what happened is Dot Com Bubble followed by the recession. Since the invention
of internet, there is dozens of new companies coming up with the Dot Com dreams. There is
lot of hype around Dot Com is that any company can make the billions of dollars. So, people
started investing more on the Dot Com companies and the prices of the share value is
increased dramatically. The price of the stock market is overvalued. A small company
without any profit valued as a billion dollar company. Even they don’t have clear idea on
how will they make profit.

To keep running the company, they are spending investors money and promising that they
will make profit in future. After some period of time, investors realized that company is not
making any profit and stared selling the shares. When selling shares is more than buying
shares, the value of the share will be coming down. It caused sudden fall on the stock market
and the companies tumble to survive. Dozens of small companies vanished and only few big
companies like Yahoo, Amazon, eBay, etc. has managed to survive on the burst.

So, whoever working on Dot Com companies lost their jobs immediately, when there is
increase in the unemployment will decrease the country’s GDP growth. If there is two
quarters continuous fall in the GDP, it is called as recession. This is what happened in the
USA’s 2001 recession. What we are seeing as Subprime is different from the 2001 burst.
Sub Prime Lending’s

Subprime Mortgage Loans (or housing loans or junk loans) are very risky. But since profits
are high where the risk is high, a lot of lenders get into this business to try and make a quick
money. These loans are given to people who have inability to repay the loan and they don’t
have stable income. For example, a person who is working on IT Company earns Rs.40000
per month and he doesn’t have any other income or assets. When the bank gives him loan of
some lakhs, the EMI for the month would be Rs.20000-Rs.30000. If he lose the job, there is
no possibility for him to pay the EMI, he will just surrender the house to bank and go away.
This is the one simple example how Subprime problem starts.

Who opt subprime lending?

Individuals who have experienced severe financial problems are usually labeled as higher risk
and therefore have greater difficulty obtaining credit, especially for large purchases such as
automobiles or real estate. These individuals may have had job loss, previous debt or marital
problems, or unexpected medical issues, usually these events were unforeseen and cause a
major setback in finances. As a result, late payments, charge-offs, repossessions and even
foreclosures may result. Due to these previous credit problems, these individuals may also be
precluded from obtaining any type of loan for an automobile. To meet this demand, lenders
have seen that a tiered pricing arrangement, one which allows these individuals to pay a
higher interest rate, may allow loans which otherwise may not occur.

How the sub Prime Crisis stated

The subprime lending is 9% in 1996 but in 2004 it is 21%. Due to securitization, investor
appetite for mortgage-backed securities (MBS), and the tendency of rating agencies to assign
investment-grade ratings to MBS, loans with a high risk of default could be originated,
packaged and the risk readily transferred to others. In addition to considering higher-risk
borrowers, lenders have offered increasingly high risk loan options and incentives to them.

Homeowners had been using the increased property value experienced in the housing bubble
to refinance their homes with lower interest rates and take out second mortgages against the
added value to use the funds for consumer spending. Between 1997 and 2006, American
home prices increased by 124%.Easy credit combined with the assumption that housing
prices would continue to appreciate also encouraged many subprime borrowers to obtain arm
they could not afford after the initial incentive period. With housing prices now depreciating
moderately in many parts of the U.S., refinancing has become difficult, leaving homeowners
with higher payments than anticipated.

Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers
have begun to refer to as a meltdown. A steep rise in the rate of subprime mortgage
foreclosures has caused more than 100 subprime mortgage lenders to fail or file for
bankruptcy, most prominently New Century Financial Corporation, previously the USA’s
second biggest subprime lender. The failure of these companies has caused prices in the $6.5
trillion mortgage backed securities market to collapse, threatening broader impacts on the
U.S. housing market and economy as a whole.

However, the crisis has had far-reaching consequences across the world. Sub-prime debts
were repackaged by banks and trading houses into attractive-looking investment vehicles and
securities that were snapped up by banks, traders and hedge funds on the US, European and
Asian markets. Thus when the crisis hit the subprime mortgage industry, those who bought
into the market suddenly found their investments near-valueless. With market paranoia
setting in, banks reined in their lending to each other and to business, leading to rising interest
rates and difficulty in maintaining credit lines. As a result, ordinary, run-of-the-mill and
healthy businesses across the world with no direct connection whatsoever to US sub-prime
suddenly started facing difficulties or even folding due to the banks’ unwillingness to budge
on credit lines.

Result of the Sub Prime Crisis

Right now there is “liquidity crisis” on Wall Street. Basically, because so many subprime
loans are in default, Wall Street investors are no longer supplying money to market which
lenders use to lend out over and over again. They make money by originating a loan and
selling it to someone else who pays the lender a premium based on future revenue. If lenders
cannot “sell” these loans they cannot generate new business. Since guidelines are now so
tight, many of these “subprime” borrowers will not be able to refinance their loan. They took
short term adjustable loans (2-3yr fixed) which are now adjusting to much higher rates. They
can’t afford the new payment and they can’t refi either due to no equity or poor credit.
In the UK, some commentators have predicted that the UK housing market will in fact be
largely unaffected by the US subprime crisis, and have classed it as a localized phenomenon.
However, in September 2007 Northern Rock, the UK’s fifth largest mortgage provider, had to
seek emergency funding from the Bank of England, the UK’s central bank as a result of
problems in international credit markets attributed to the sub-prime lending crisis.

What about solution?

Loan modification, pumping money into market may slow down the crisis.

 Establish rescue funds for borrowers facing short-term problems caused by illness,
layoffs or other one-time events.
 Establish a bond fund to pay for switching borrowers out of unaffordable ARMs.
 Refinance loans for victims of predatory lending. This would involve working with
Fannie Mae, the quasi-governmental corporation.

Changing loan terms is a mess, borrower and lender must accept to the terms, lenders may be
unwilling to change terms but Fed interference will work out. But lender will accept to
change in terms to avoid foreclosures.

Pumping money into markets, reducing bank reserves may temporarily weaken the crisis, but
these this is twofold operation, pumping money will increase inflation which will results in
increase in subprime lending, and reducing bank reserves to small extent is better but as
whole destabilize the whole financial system.

Sub Prime crisis in

It all started in 2006 with US Market tumbling down due to defaults by the subprime
borrowers.
Increase in interest rates and simultaneously fall in property prices, hit the market leading to
subprime mortgage crisis. Between the years 2000-2005,

Low interest rates, high property prices.

In 2005, the property prices started falling, interest rates started touching the roof top, leaving
no room for the subprime borrowers.
In 1994, less than 5% of total mortgages were subprime in US. But within 2005, that figure
went up to 20%.
However, in 2005, the rates of interest began to increase. Therefore, demand for home came
down which also brought down the property prices leading to start of subprime crisis…….

Sub Prime Impact on Indian

The ongoing US subprime crisis may not have a direct impact for the time being, but is likely
to hit Indian markets in various other ways.
No hit for the HDFC Bank of the US subprime crisis.
HDFC’s non performing loan is below 1%.
The companies, including outsourcing units and IT enties that heavily depend on their

overseas clients for getting their revenues, may get affected in days to come.

Sub Prime effect on several Sectors

IT sector & outsourcing: Limited impact
Growth will happen but at 22-23 percent it will be lower than in
the last two-three years.
IT-enabled services (ITES) such as business process outsourcing
(BPO) comprising voice and data, captives may get affected.
In the next two-three quarters, clients in the financial sector will be conservative, withhold
spending on new projects and delay expansion.

Real Estate: Harsh impact

RBI had already increased the interest rates to contain inflation.
RBI has already put restriction on Indian banks to finance real estate companies in the
country.
Google has cut its expansion plan substantially in the NCR region. Earlier, the global major
has expressed intention to take lease of 5 lakh sq feet of the office space. But now, it is learnt,
it has cut its requirement to only 3 lakh sq feet.
Also
German major SAP, which had shown interest to open its operation in Gurgaon in the NCR
region, has now postponed the plan. Global consultancy firm- With the cancellation and
postponement of the expansion plan of companies, many of the regions like NCR, Bangalore
and Pune.The rentals in these areas are projected to fall by 25 to 30% in
the next 12 months. The worsening condition in the demand for office space will
affect the demand for the residential space also.

HR Policies: India Inc looks for renewal

Hewitt Associates (HR consultancy firm) study: A strong salary increase of 14.8% in 2008.
Average salary projections for the coming year are lower by only a percentage point at
13.9%.
Also 20% are resorting to a slowdown in hiring or a complete freeze and 57% are looking to
d balance the effect of inflation and lower HR budgets by increasing productivity and 31%
are developing their manpower towards better efficiency.

Auto Industry: Minimal impact according to Ford and GM

Ford and GM are not overly dependent on their American parents for capex (capital
expansion), and the BRIC operations of both are profitable enough to cushion the American
problem. No loan crisis to affect Indian market; limited exposure to Lehman crisis

Banking Sector: Negative Impact

According to one estimate, global majors like Citibank, Merrill Lynch and Deutsche Bank,
have lost over US$180 billion due to the subprime crisis. ICICI bank’s loss: India's largest
private bank is faced with a loss of Rs10.56 billion till January 2008.
BIBLIOGRAPHY

Now In order to improve my knowledge about this topic I have made search on the book
Business Environment” written by sheikh saleem.

Secondly to acquire knowledge about this topic I had made search on the following websites
such as –

(a) Www. Google .com

(b) Www. Wikipedia.com
(c) www.answer.com