The term ” subprime ” became known in French as a result of the subprime crisis in the United States , which triggered the financial crisis from 2007 to 2011 . It means more risky loans for the lender (and more efficient) than the category premium , especially to denote some form of mortgage credit (in English : mortgage ).
The lending rate 1 premium is the interest rate granted to the borrowers considered the most reliable, for the lender the advantage is a minimal risk but the disadvantage is a low return. A subprime loan is granted to less reliable borrowers who are required to pay a higher rate; for the praetor the risk is stronger but the yield more interesting; finally, even more risky but even better, we find the category junk 2 (literally: “rotten”). For a subprime creditremains attractive for the borrower, sophisticated mounts with variable rates and complex financial products could keep rates low at the beginning of the loan.
For creditors, subprime loans were considered individually risky, but overall safe and profitable. This perception was based on a rapid and continuous rise in the price of real estate . If a borrower could not pay, the resale of the property allowed the lender to recover his due 3 .
Subprime loans have developed mainly in the United States and the United Kingdom . In 2006, they accounted for 23% of all home loans subscribed in the United States . In France the subprime market has grown little despite the favors of some policies 4 . In 2007, nearly three million five US households were in situation of default .
Characteristics of these credits
Accounts receivable were low-income households with late payments or past due payments. Every individual has a credit score, established by a private agency based on their socio-professional characteristics, that will vary according to the events of his life (employment, unemployment, marriage, payment incidents, use of discovered, etc.). The scale of scores ranges from 300 to 850. By extension to the type of loans they can subscribe, borrowers are named ” Premium ” when they are considered the most creditworthy (> 700 generally), and ” Subprime For at-risk borrowers (less than 620, the terminal being indicative). Between the two, the intermediate category is called “Alt-A” or, more rarely, ” Mid-prime “.
Creditors were banks and specialized credit institutions, which securitized a portion of these receivables , placed by credit enhancers with various investment funds ( hedge fundsin particular but not only), banks and insurers. The US credit market is not as integrated as in France, for example, where the same institution generally provides the entire banking relationship and the completion of the preliminary study loan until recovery in the event of litigation. In the United States, each step can be outsourced to a different stakeholder with a credit seller who is “sourcing” the borrowers, a lender to unblock the funds (usually without savings in the face: the organization is funding itself even in the short term on the markets, which is an additional problem in the event of a liquidity crisis), an organization to recover the monthly loan payments (a “servicer”), an organization to pack loans in order to to make marketable securities in a market, etc. As a consequence, the notion of bank does not always cover the same reality as in France.
Interest rates varied with a variety of terms. The first, the benchmark against which the rate was calculated, could be the key rate of the US central bank but also frequently the rate at which banks lend money to each other on the London market ( ” Libor rate This added to the confusion of the borrowers, who were totally unaware of the consequences of using such an index. The most palpable was that when the US Federal Reserve lowered its rates to reduce the monthly payments of subprime loans, this had an impact only on loans made with this index but absolutely none on Libor Index loans. This rate was then increased by a margin and could last up to 30 or even 35 years. Other possible methods: – the loan could be at a fixed and low rate during the first years then calculated against an index, which could lead to a sudden increase in monthly payments and make them unbearable for the household budget (loans reset, called “2/28” – 2 years fixed rate low then 28 years at variable rate – or “3/27”). – the loan could be negative amortization (NegAm). The consequence ? The capital borrowed does not decrease but increases the first years, which allows for lower monthly payments but in return, an increase in indebtedness. – The repayment could initially relate only to interest (interest-only or IO), a mechanism similar to that of the loan in fine as it is practiced in France. Guarantees were most often for housing, with a mortgage. Until early 2007, the average value of housing increased and in case of default of the borrower the lender could be reimbursed by the resale of housing.
The period of subprime expansion began in early 2004 and stopped in mid-2007. The two major credit derivatives ( ABS and CDOs ) that opened up a sub-prime market both grew very fast at the same time.
Securitization of receivables consisted of bundling them in bundles (more than 1,000) from several US states, in order to theoretically allow for risk diversification, or decorrelation, into a bond called asset-backed security(ABS) resold to a booster . ABS could then be mixed with lower-risk bonds to issue CDOs, bonds used by banks to offer investors guaranteed return investments. The securitization transaction enabled the receivables (loans) to be taken out of the bank’s balance sheet. In fact, a lending bank must have a reserve of capital to cope with any difficulties the borrower may have (internal precautionary mechanism followed by the regulator ). By securitization (loans agglomerated to be converted into bonds sold to investors ( Collateralised debt obligation , or CDO)), the bank could thus take out the loan on its balance sheet and avoided immobilizing this reserve of own funds. Thus, it could continue to place new credits, and thus re-fuel a process that does not
Difficulties encountered from the beginning of 2007
Between 2004 and 2007 , the US Federal Reserve raised its key interest rate from 1% in 2004 to more than 5% in 2007. Indebted families with variable interest rates interest during the first years of the loan, then failed to honor monthly maturities sharply higher. But the development of subprime is still recent, a majority of them still benefited from the very low promotional rate of the first years.
The high profitability of these receivables led the lending institutions to offer families uninformed of the risk of seizure of housing, then to get rid of them by turning them into representative securities , called asset-backed security . These ABS were resold to banks or credit enhancers , who in turn used them to create collateralised debt obligations (CDOs), financial products presented as safe, because blending these real estate debt with bonds issued by governments, to receive the best financial rating , the AAA.
Property bubble risks denounced as of September 2006
In September 2006, experts such as Nouriel Roubini , Raghuram Rajan , Meredith Whitney (in) or Steve Eisman (in) , concerned about the development subprime raised the alarm on the risk of real estate bubble . Towards the end of 2006 , the US real estate market stopped rising. And from February 2007 , ABS real estate debt swaps almost stopped. Lenders have been intractable with late payment families. Seized homes were put on the market, gradually lowering their prices in 2007.
In a context of falling real estate prices, the resale of houses is no longer sufficient to ensure the lender recovery of its claim. Personal bankruptcies of borrowing families have added a series of financial difficulties for lenders and their bankers.
At first, the subprime crisis 6 led to a moderate fall in stock prices in the summer of 2007, expected by specialists. The deepest decline occurred in the fall of 2008 when it became apparent that many banks did not have enough reserves to cope with their losses. In fifteen months, the liquidity crisis led to a solvency crisis and then to an international financial crisis .
Notes and references
- ↑ premium or premium means, in English, the superior quality.
- ↑ like junk bonds
- ↑ Washington organized the rescue of Lehman [ archive ] – Le Monde , September 14, 2008
- ↑ Bayrou back to back capitalism and socialism [ archive ] – Le Monde , October 28, 2008
- ↑ ( en ) Mortgage Foreclosures by the Numbers [ archive ] – Center for American Progress , March 26, 2007
- ↑ Dominique Doise, in Subprime: the price of transgression / Subprime: Price of infringments , Law Review of International Affairs (IBLJ) / International Business Law Journal (IBLJ), No. 4, 2008 [ read online [ archive ] ]