What is this "sub-prime" problem in the US?

Question

I read in the news that several Banks are affected by the Sub-prime

problem in the US.

Answer 1

It's a product of poor lending practices.  Developers who built new subdivisions encouraged people to buy the homes, whether or not they had the money to buy them, on the assumption that the value of the homes would be enough collateral to support the mortgage.  Banks then issued the mortgages, often through a deal with the developer, without really taking into account the borrowers' current income and ability to pay the mortgage back.  Finally, the borrowers themselves got caught up in the dream of home ownership, without taking into account their own ability to make the payments.  The mortgages were made as ARM's (Adjustable Rate Mortgages), which meant they started out on a low (sub-prime) interest rate, but the interest rate went to a higher rate in a few years.  The banks and developers were not disclosing the real dangers of ARM's, for the most part, so many people didn't really understand what they were getting themselves into.  As a result, many people who purchased the homes were unable to afford the new payments when the rates changed.

As more and more people were unable to afford their payments, the value of homes went down, because there was a glut of homes on the market.  Developers who were in the middle of building subdivisions then were no longer able to unload the new homes that hadn't been sold yet, and were also stuck with the land they'd bought to sell.  They then also defaulted on their loans, and many have declared bankrupcy, even the developer who created the very first suburb, Levittown, in the late 1940's.  And because many banks are stuck with all these houses they'd repossessed, many of which were now worth less than the original mortgage, they are underfunded, and some are being closed by the FDIC (Federal Deposit Insurance Corporation), a government agency, and are now being run by the government to keep depositers from losing everything.  Hope this helps you understand.      

Answer 2

To add to the above answer, in order to make sub-prime loans affordable, many banks created new vehicles for lending.  Unluckily, when interest rates started heading upward, folks with these sub-prime loans saw their payments jump (some doubled or more) as their loans readjusted to the new rates.  Concurrently, the housing market started heading south, and market values dropped.  So there are folks out there with mortgages worth more than their house is worth.  Sine banks will only finance up to the appraised value of a house, these people could not re-finance to lock in lower rates (which they had counted on) and, not being able to afford the new payments, are defaulting on their mortgages.  Now banks are stuck with foreclosed houses not worth the loan amount and have to take losses.

Answer 3

In Non-jargon terms:

Once upon a time...

Greedy American businessmen seeking to profit even further during the recent housing boom started irresponsibly giving mortgages to American citizens who really couldn't afford them. These mortgages were given based on terms so horribly against the homeowner (details not important) that the second the value of their property began to decline the mortgage would collapse. (details not important)

The greedy lenders realized this potential and although they greatly enjoyed collecting huge payments of nothing but interest from these poor, yet misguided homeowners, they realized that if they couldn't pay their mortgage then they would be stuck with a defaulted loan against a property that was not worth very much.

So the greedy businessmen decided that they would take these ticking timebombs and package them up with a pretty bow (called AAA American paper) and get some equally greedy stockbrokers and international money managers (Hello Bear Stearns Hedge Fund) to sell them to the public. The public, in this case included indivduals, institutions, wealthy investors, municipalities all over the world and even governments.

When the economy tanked and put downward pressure on house prices

the loans collapsed and the investments these people held became worthless.

And so that explains how a lower-middle class blue collar worker from Jacksonville, Florida helped to bankrupt an entire town in Western Germany halfway across the world.

The End?

Answer 4

The term "sub-prime" refers to people who have a not so perfect credit rating.  Banks are affected by the problem because more and more people who live in the U.S. are struggling with money problems, many of which affects credit scores.  "Prime" refers to those who have a score of 650 or higher.  "Sub-Prime" refers to those who are lower than that.