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                                                 US sub prime crisis


The Sub prime Crisis is an ongoing economic problem and has resulted in reduced liquidity in the global credit market and also the banking & financial systems. This crisis has exposed the weakness in the global financial system and also the regulatory framework that is overlooking them.

Reasons for this crisis are as follows:-

  • The US Real estate market crash
  • High default rates (low and high) on Sub prime    loans &
  • Sub prime Mortgage backed securities (MBS)
    i.e. financial institutions suffered a great losses.

Types of loans:-

Prime loans:
When someone goes to a bank or to any financial institution for a loan his credibility and financial strengths are reviewed. Based on his financial status he would be rated. A customer who is very credit worthy and has a consistent cash flow with which he can meet out his loan obligations is termed as a "PRIME" customer and such a loan would be termed as a Prime Loan 


Sub prime loans:
when the credit worthiness of the customer is  not too good and he is not in a strong  financial status he is termed as a "Sub Prime" Customer. When banks disburse loans to such customers, it is termed as a  "Sub Prime Loan" Usually the rate of interest charged by banks  to sub prime customers is very high in comparison to Prime customers.


How it all started:

In the past few years, due to high liquidity and low interest rates on mortgage loans, the demand for housing properties started increasing.


What is the reason for that high liquidity & high demand for houses?  (see the above pie chart)

Due to improvement in service sector, employment opportunities And income levels of people have  increased.


And Inflation rate has came down.


It leads to high liquidity. i.e., more cash.


US federal Bank has reduced interest rates with the intention to provide loans to other sectors.


But ordinary people taken loans heavily for purchasing or constructing houses.




So, Every thing is fine, what went wrong?

  • Heavy demand for residential projects.

  • Real estates started huge number of projects. It has increased the supply.

  • Due to demand and Supply mismatch, the prices of the houses have declined.

  • Once the housing prices started to fall, the interest rates on loans started to rise.

  • Most of the borrowers were unable to make their payments on time and also due to unavailability of refinance options default on loans started to increase.

  • For most home owners, their outstanding amount on the loan was much more than the value of their houses. So, people were unable to repay the loans.

  • And all those houses kept for Sale. The only way banks could reclaim their amount was by selling these homes


The high rate of default on sub prime loans & downward movement of housing prices resulted in lower demands for the MBS securities (created out of sub prime loans). The banks & financial institutions were unable to generate the liquidity.



  • Banks have incurred losses. Their earnings came down.

  • Financial institutions have gone bust or have been taken over by bigger organizations.
  • The housing prices have plummeted.

  • The liquidity in the financial system has come down .

Compared to Banks, Financial institutions have suffered huge losses because of the following reason:

  • Banks can receive deposits and they used to leverage their financial position and continue to operate.

  • But Financial institutions can not receive deposits from public, hence they suffered huge losses.

That is the reason for US Sub prime crisis.

Thanks for Reading -------------------------------Jagan..

More to come soon ...keep watching ..





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