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The Ultimate Fall out of the Subprime Crisis - Term Paper Example

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The author states that ultimate fall out of subprime mortgage crisis can be multiple in nature as it has shown up in the form of economic variables. The credit crunch which has reduced the amount of credit available to firms who rely on the financial institutions to meet their capital requirements…
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The Ultimate Fall out of the Subprime Crisis
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Download file to see previous pages Securitization is a process of bundling or pooling the non-liquid assets into marketability securities. The idea is to recoup the liquidity lost through the sanctioning and disbursement of the loans to subprime borrowers. (Hunton & Williams LLP,2005). There are various ways through which the securitization can take place. Most of the times, financial institutions did so by creating Special Purpose Vehicles in order to enjoy off-balance sheet accounting not only to strengthen their balance sheets but keep the garbage out of it. The problem started when the subprime borrowers started to default on their repayments. These defaults created a chain reaction of events which first overtook the banks but subsequently created further economic problems for the economy.
The above graphical representation suggests the two traditional models of the mortgages and how default in both models can trigger further damage.1 Technically subprime mortgages become a problem when at the default of the payments by the borrowers; financial institutions face a mismatch in the cash flows. As defined earlier that most of the financial institutions attempted to regain the lost liquidity through securitization by creating mortgage-backed securities to match the cash inflows from the mortgage payments with the cash outflows from the payments to be made against those mortgage-backed securities. When the inflows stopped due to default by the subprime borrowers, financial institutions, in order to keep their ratings intact, started to pay out for their obligations out of other resources. This then started to create a credit crunch in the economy as those resources which were technical should have been used in more productive resources were being utilized in repayment of the mortgage-backed securities. Thus the available credit to the organizations and firms decreased and hence their output and productivity level started to decrease which slowly and steadily put pressure on various other economic pressures and hence started one of the worst economic crisis of the century.  ...Download file to see next pages Read More
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