The Winners of the Crisis

Although some people were left with nothing after this crisis it is important to note that some people made a fortune by recognising that the housing bubble was going to burst. There are several individuals who bet against the housing bubble and the first is John Paulson. He became one of the richest men in the world in the space of a year through his own hedge fund. By betting against the housing market as early as 2005 and in 2007 his fund was up 590% net of fees. He went from owning a relatively small and unknown hedge fund in 2005 to having the third largest in the world with assets of $32 billion in 2010. Although not officially reported it is believed that the fund made $1 billion in one day in 2007.

The second is Philip Falcone who founded Harbinger capital partners and just like Paulson bet that subprime mortgages would fail. The fund made $10 billion in 2007 from this one transaction and Falcone himself brought a staggering $1.7 billion home. This guy was seriously swimming in money from being one of the only people in the world to recognise what was going to happen to subprime mortgage loans.

Kyle Bass is another hedge fund owner who made an astonishing amount on gambling against the subprime mortgage saga. He himself made $500 million in betting against the subprime saga and he obviously has an eye for this. He has started to bet against European countries and if Greece were to default he is set to make a 650% profit. This link leads to a very interesting video of an interview with him. He explains how it occurred, when he recognised the problem and then goes on to talk about the current European problem.

http://www.thedailyeconomist.com/2011/11/hedge-fund-manager-kyle-bass-lays-out.html

Warren Buffet made an extraordinary comment "Be fearful when others are greedy, and greedy when others are fearful." These three hedge fund managers did exactly this and they were wary when others were being greedy and turned out to be the winners of the crisis.

Thank you very much for reading my blog, I hope you enjoyed.

The losers of the crisis

There have been estimated losses of several hundred billion dollars due to the recession caused by the subprime mortgage lending saga. There have been some massive losses and collapses due to this and it seems to be the majority of the public that have suffered financially.

The most recognisable and arguably the largest investment bank loser of the crisis was the Lehman Brothers. In September of 2008 they filed for bankruptcy and the collapse of this bank had catastrophic effects worldwide as they had dealings in most countries in the world. There was a very sour feeling when the bank was allowed to collapse among Lehman followers because earlier that year Bear Sterns was in a familiar position and they were bailed out by the Federal Reserve. This may have caused moral hazard within Lehman Brothers and they may have been taking larger risks than they would have if they thought the Federal Reserve wasn’t going to bail them out.

The credit crisis has had horrible effects on individuals with regards to their investments, savings and pensions. By the end of 2008 five trillion dollars had been wiped off private pensions and remarkably Ireland was one of the hardest hit countries in the world. In the year of 2008, Irish pension funds had fallen by an average of 30%, people’s years of savings were vanishing in front of their eyes and there was nothing they could do.

People who have invested their money in the housing market have also taken a massive financial hit. Some were unlucky to buy houses in 2007 around the peak of the housing bubble and they will almost certainly never see the price of their house return to the price they purchased it for. Many investors are too scared to take a loss and this has crippled them even more. When prices started to drop people were scared to take a loss of £20,000 on their home, now the value of many homes has halved, and some could have sold for nearly £1,000,000 and would be lucky to sell it for £500,000 five years on.

The recession inevitably damaged businesses and more people are spending less. This in turn has caused the level of unemployment to rise. Since 2008 the UK unemployment rate has been rising at a dramatic rate and it doesn’t seem to be slowing. In the last quarter of 2011 the number of unemployed rose by 48,000 to a 17 year high of 2.67 million. This has catastrophic effects on families and puts mounting pressure on the government to pay more benefits.

This link shows the top 25 subprime lenders and biggest losers. The corporation with the largest losses had a massive $97.2 billion of subprime loans.

http://crisis.lenderwatch.org/news/597

In my next post I will be looking at the winners of the crisis.

What Occured

The Subprime mortgage problem is believed to have started as early as the year 2001, but just didn’t catch up with the market until August of 2007. It is believed that it can go back to this year as this is when the Federal Reserve lowered the interest rate to 1%, which was the lowest in years. This encouraged many buyers to take out large mortgages to fund the “American Dream” and purchase a home to call their own, but just how costly it would prove to be for them no one could predict. They believed that they would be able to benefit from the low interest rates and that house prices would always rise, and never fall. The graph below shows how the prices have risen since 1990 until 2007 and then when the markets realised what was happening there was a dramatic deterioration in prices.

Figure 1 Median U.S. Home Price: 1990–2008

Source: Federal Reserve System

The loans that were affected the most were the variable mortgagees based on short term interest rates, which enticed borrowers with their initial very low interest rates, which were highly responsive to Federal Reserve policy. Prime mortgages went to the better off, and sub-prime mortgages to people who had never qualified for a mortgage before.  Banks were writing mortgages for customers who previously would have been classified as being at a high risk of not repaying with poor credit ratings. Surely this was not practical as the smallest of change in the interest rate would indicate these customers would be unable to keep up with the payments. This was exactly what happened and by the time interest rates were starting to raise in 2004 many borrowers were unable to repay their loans. When it got to the stage when borrowers were unable to keep up with their mortgage repayments an alarming number of homes were repossessed causing the property bubble to burst, which caused the large fall in house prices.

Behind the scenes the banks were involved in dealings that no one else knew of. The US banks were parcelling together different types of mortgages and selling them off to investors. These parcels were notoriously known for paying a high rate of return at a time of low interest rates which was very appealing to large investors. The real problem with the way they were being securitised was that respected names were endorsing these loans so no one questioned the quality of the packages, but in reality Sub-prime mortgages were being disguised as first class assets.

The ratings agencies had a huge part to play in the sub-prime mortgage events because of the ridiculously high ratings that many of the parcels were receiving, and when they finally decided a dose of reality was needed they issued downgrades for sub-prime linked debt. This had to be done, but it brought to light even greater debts that anyone could have imagined and highlighted just how toxic some of the securitised parcels were and this is when the panic began as no one wanted to be left with the parcels.

In my next post I will be looking at who lost out throughout the crisis.

What is Subprime Lending?

In the finance world subprime lending is when loans are made to people who are going to struggle to maintain the repayments. With these types of loans there normally comes higher interest rates to try and compensate for the high levels of risk being taken with the customer.

Being classified as a subprime lender comes from an individual’s credit rating, or lack of one. This can be classified by a history of late payments or a failure to repay historic debt completely or even the current amount of debt the individual currently holds. You can also fall into this category through the lack of experience you have, for example if you have limited debt experience or nothing to use as a security against loans. This is how so many first time buyers fell into this category and became subject to the subprime mortgage lending sharks. 

Introduction

Over the subsequent weeks I will be looking at who the winners and losers of the subprime mortgage lending saga were. I will firstly give a brief outline of what occurred and then move on to look at who won and lost and then discuss how they did so.