The subprime crisis: Definitions, causes and consequences

Extract

[...] Confronted by this decrease in the demand for risky assets, the banks found it difficult to sell their loans and mortgages, and had to bring themselves to keep them in their balance-sheet. The result was thus a substantial reintermediation of credit, with three consequences: with their balance-sheets changing profile drastically, certain banks were confronted with unexpected situations as they needed more liquidity to maintain all their engagements, they lent to the borrowers less easily, preoccupied with guarding themselves against new surprises. [...]

[...] And on this subject, the representatives of G7 called for more transparency in the work of these credit rating agencies Consequences 1. Economic consequences The consequences of the subprime crisis extended beyond the United States. Indeed, it was a crisis which touched Europe due to the refinancing of American banks thanks to the dissemination of the debt claims (securitization). When the banks realized that they could no longer measure the risks borne by their counterparts: a crisis of confidence was seen and led consequently to the sudden stop of refinancing. [...]

[...] The market would also have been encouraged by a legislation of 1977 (Community Reinvestment Act), which obliges the credit institutions to lend to people with modest incomes to whom such loans would otherwise not be granted This phenomenon inflated the real estate bubble and aggravated the consequences of its burst. Let us note that when the economic situation is favorable, this system functions well: the borrower mortgages his house, which is thus used as a guarantee, and the establishments can obtain comfortable profit margins thanks to these customers at risk. [...]

[...] Thus, the controller is not able to determine the exact amount of risks and the losses caused by the subprime crisis. Moreover, uncertainty in deceleration of loans, unbalances the estimates and allocates resources on unfounded bases The financial risk of rates (rise of the interest rates) The position to be held from the point of view of risk management, a sudden increase in volatility, uncertainty and risk in the balance-sheet. Initially a strong reduction of the positions - i.e., in the case of banks, reducing loans - then, very slowly, start to rebuild leverage, but only when uncertainty and volatility decline and the shareholder base is restored. [...]

[...] There are few doubts about the scenario to come, only the extent of the consequences remains to be determined Consequences for the banking sector Faced with the drop in value and the anger of shareholders, the chairmen of large investment banks started to resign. The evidence of increased losses, always unaudited in the official balance-sheets, saw the light of the day. The risks of implosion of the financial sector increased. The next few quarters should have proven to be fatal for the balance sheets of the banking sector, with a consequence of reduction of credit facilities, causing a contraction of monetary liquidity. [...]