What impact did the subprime mortgage crisis have on global finance?
After a large amount of credit expansion and demand stimulation, the U.S. housing supply market quickly became saturated, and the housing price index reached its peak in mid-2006. Top callback. A large number of new loan products have also passed the preferential period of the first few years. Coupled with the rise in interest rates in the United States, the repayment burden of subprime borrowers has suddenly increased. The decline in housing prices has made it impossible for borrowers to refinance in the original way. The result is subprime Loan default rates are rising rapidly. As financial institutions execute mortgages and put housing back on the market, this further exacerbates the decline in house prices. It affects all aspects of the financial market and may ultimately affect the actual economic operation.
On February 27, 2007, the Shanghai Composite Index fell sharply, followed by a global stock market decline. Some people think that China's capital market is enough to impact the world market, but in fact this is just the prelude to a larger financial crisis. The crisis began to emerge in the spring, became increasingly serious in the summer and autumn, and was still developing in early 2008.
So, how did this crisis develop and evolve? How is its basic game program? What impact will it have on the U.S. and even the global financial system and actual economic activities?
The structure and mechanism of the subprime crisis
To understand the emergence and development of the subprime crisis and analyze its potential impact on the financial system and the real economy, we first need to analyze the subprime debt in detail structure, let’s see how bank credit expanded sharply under this structure, driven by innovation in financial products, and then contracted sharply.
Before the Great Depression, the U.S. residential finance market was mainly "self-sufficient." During the Great Depression, as part of the “New Deal,” the U.S. federal government vigorously intervened in the construction of the housing finance system, and its basic institutional framework continues to this day.
Starting in the 1970s, Ginnie Mae (1968) and Freddie Mac (1970) took the lead in issuing securitization products based on residential loans. (MBS), thereby promoting the liquidity of the residential loan market from "loan sales" to the "securitization" stage. At the same time, U.S. residential financial institutions are also facing severe changes in the market environment of “disintermediation”.
Since the 1980s, crises have continued to break out in Savings and Loans Associations (S&Ls), the main body of residential loans, and the traditional "originate-to-hold" business model in the residential finance market has had to give way. Located in the new "loan and securitize" (originate-to-distribute) business model. From then on, the source of funds for residential loans did not rely on deposits, but on selling loan contracts. In the 1990s, the main players in this secondary market were financial institutions with government backgrounds. After 2000, Wall Street entered and dominated the market.
The current basic structure of this market can be divided into three basic links.
The first link is the "primary market" for housing loans. The borrower applies for a loan and obtains funds and housing. The lender issues the loan and obtains the housing contract as collateral and the expected repayment cash flow. Lenders are mainly financial institutions that specialize in housing loans, such as New Century Corporation, and account for more than half of the market share. In addition, commercial banks, savings banks, credit unions, insurance companies, and government agencies related to home loans, and some residential specialty companies are themselves commercial bank affiliates.
Although some loans in the primary market are subject to credit protection by GSEs, for low-income groups, the threshold for such loans is too high and the review is too strict. In addition, these institutions have been subject to accounting regulations since 2002. Troubled by scandals and declining market share, some private label lending companies took advantage of the situation and offered various preferential terms to low-income earners, and the subprime loan market began to expand rapidly. By 2006, the size of U.S. residential mortgage loans had exceeded the Treasury and corporate bond markets, with loan balances reaching $13 trillion. From the perspective of the primary market, MBS accounts for approximately 60% of the market share of loan balances, while GSE-issued securities account for 30% of MBS, while "private brand MBS" accounts for the remaining 60%.
Since current lenders do not hold large amounts of these loans as their own assets for a long time after issuing loans, but try to transfer the loans out after charging a certain handling fee, thus forming a housing Secondary market for loans.
The second link is the secondary market for housing loans, which is dominated by large financial institutions such as Citigroup, Merrill Lynch and HSBC. They purchased residential mortgage debt from primary lenders but had no intention of holding on to the assets long-term, so they securitized them. They mix the cash flows from home mortgage-backed assets (MBS) with other assets to create asset-backed securities (ABS), which are then sold to end investors.
In the process of asset securitization, credit enhancement is very important.
There are generally two methods of credit enhancement: one is external credit enhancement, that is, through insurance through a third party such as a government agency; the other is internal credit enhancement, which is to divide securitized assets into different levels and use the cash flow generated by the underlying assets to According to the sequential repayment from high to low grades, once there is a default risk on a residential loan, the losses will first be borne by the low-grade securities, while the mid- and high-grade securities will not be affected, and investor risks will be mitigated. Since subprime loans generally do not have such insurance, they mainly rely on internal credit enhancement.
The third link is re-securitization. To further spread risks, financial institutions often re-securitize these ABS. Specific methods: First, resell some low-grade ABS to its own "special purpose vehicle" (SPV), and the SPV will mix these ABS with other assets (such as car loans, credit card loans, etc.) to form a new asset pool , turn into "collateralized debt securities" (CDO), and then sell them to final investors; first, establish a relatively independent "structural investment institution" (SIV). On the one hand, SIV purchases CDO as an asset and adopts the internal credit enhancement method. Securitize these CDOs again. In other words, reclassify these CDOs. The SIV then uses these CDOs as asset guarantees to issue short-term "asset-backed notes" (ABCP) to investors for financing. In this way, the originally high-risk subprime loans were "laundered" into low-risk and high-yield assets. In other words, Wall Street sold carrots for the price of ginseng!
It is not difficult to understand that in the process of asset securitization, rating agencies play an important role. Although there are technical difficulties in rating this new type of derivative credit product with a short history and inactive market transactions.
So, who are the ultimate investors? There are many types of investors who purchase securitized products, most of which are relatively powerful financial institutions, including robust commercial banks, insurance companies, pension funds, etc., as well as hedge funds that pursue "high returns and high risks". The geographical scope is mainly in the United States and covers the world.
From a summary of the structural framework of this subprime loan crisis, low-income households easily obtained large amounts of loans from residential loan companies. The residential loan companies resold the loans to financial institutions, and the financial institutions then resold these loans. Packaged into various securities, eventually sold to investors.
The more important question is, under this framework, why did subprime loans for low-income people grow explosively and then fall into a serious crisis?
How subprime mortgages developed into a crisis
In the subprime loan structure, it is not easy to see the cause and effect between various links. On the surface, it is an operating mechanism of borrowing first, then loans - loan securitization - and securities product sales. But in fact, there is a mutual stimulus mechanism between the primary market and the secondary market for subprime debt. The use of complex financial innovations and fierce and disorderly market competition among financial institutions in the secondary market has led to a large increase in loans in the primary market in the short term. Of course, excess global liquidity caused excess funds to flow to the United States, which stimulated a significant short-term rise in housing prices, which was the direct reason for the activation of the entire mechanism.
After entering the new millennium, the economies of developed countries were generally in recession, and a long period of low interest rate financial relaxation began in the early 2000s. Although long-term low interest rates have temporarily stabilized the economy, they have also created a global excess of "liquidity." It should be noted that during this period, inflation levels in various countries around the world were stable. In other words, these excess funds were not directly used to purchase goods for the time being, but a considerable part was invested in various assets, so there was a global The phenomenon of overheating of real estate and other asset prices.
Low interest rates + excess liquidity have an impact on both the demand and supply of residential loans. Moreover, expectations or "myths" have been formed that housing prices will continue to rise.
From the first stage, housing prices continue to rise, forming the expectation of low-income families that "it is better to buy sooner than later". The increase in loan demand further stimulates the rise in housing prices. More importantly, for lending institutions, high-grade customer loans have become saturated. In order to cater to the loan needs of low-income families, lending institutions continue to create new housing loan products. A unique feature of these products is that they significantly reduce loan review requirements and give borrowers many repayment concessions in the first few years. Of course, if the preferential period expires, the borrower's burden will increase sharply. However, as both lenders and borrowers anticipate that home prices will continue to rise, homes that have increased in price can be remortgaged and refinanced. In actual operations, many lending institutions also use more than 100 loan intermediaries to promote these "new products". As long as the intermediaries can conclude a transaction, they can obtain commission income and do not need to bear any responsibility for future risks. This kind of Asymmetric incentive mechanisms further stimulate primary market expansion.
On the other hand, lending institutions do not hold all of these loan contracts after issuing loans. After collecting handling fees, they quickly resell most of the loan contracts to large financial institutions, especially investment banks, and then Securitization is carried out by the latter. Large financial institutions use securitization to segment and transfer risks. In other words, lenders can easily raise sufficient funds in the primary market. From a causal perspective, there is a large amount of money in the market that enables lenders to issue large amounts of loans by lowering standards.
For end investors with huge funds, long-term low interest rates have caused the yields of traditional investment objects such as government bonds and corporate bonds to hover at low levels, and securitization with higher credit ratings but relatively higher returns Products have thus become the investment targets that these investors, especially hedge funds, are chasing after.
From the analysis of each link of the subprime debt expansion and the behavior of market participants in each link, it can be seen that there is a large amount of abundant funds in the market, as well as fierce competition among financial institutions, giving the entire system credit expansion. internal motivation. Under the influence of factors such as financial innovation, optimistic market expectations, and regulatory vacuum, this driving force has been transformed into actual credit expansion, manifested in the extraordinary growth of the scale of the subprime debt market.
However, everything remains the same. No matter how long and complex the chain of financial innovation is, the fundamental problem is that the ultimate value of all financial assets depends on the actual value of their original assets. That is, once housing prices begin to fall, the above process will be reversed, and likely to accelerate. As a result, financial institutions holding subordinated debt and related securitization products will inevitably suffer huge asset losses.
This is also true. After massive credit expansion and demand stimulation, the U.S. housing supply market quickly became saturated, and the home price index peaked and fell back in mid-2006. At the same time, a large number of new loan products have also passed the preferential period of the first few years. Coupled with the rise in U.S. interest rates, the repayment burden of subprime borrowers has suddenly increased. The decline in housing prices has made it impossible for borrowers to refinance in the original way. The result is The default rate of subprime loans increased rapidly. From April to June 2007, the default rate of subprime loans reached about 14%. As financial institutions execute mortgages and put housing back on the market, this further exacerbates the decline in house prices.
This means that the value of the underlying products in the subprime debt market has shrunk severely, and financial institutions have suffered huge losses. These losses occurred in the following links:
First, the credit ratings of the subprime securitized assets held by the banks themselves were continuously downgraded, resulting in assessment losses.
Second, when a bank sells securitized assets, it is usually accompanied by an agreement. If there is a risk of default within a certain period, the final investor has the right to demand compensation from the issuer.
Third, although there is a so-called "Bankruptcy Remote" arrangement in law between banks and SIVs established with their own capital, and although the balance sheets of the two are not directly connected, in order to improve the profitability of SIVs, Credit ratings facilitate the issuance of ABCP. Banks usually have financing commitments for SIVs, which is a contingent liability; and the asset size of SIVs has reached US$400 billion, the financial leverage is very high, and the maturity of assets and liabilities does not match. Once the assets depreciate, , the own capital will soon be written off, resulting in actual losses for the bank.
Fourth, in order to offset losses and balance the relationship between assets and liabilities, banks have to sell their securitized assets at low prices.
As a result, the entire system has entered a downward vicious cycle, manifested as credit contraction and liquidity tightness, affecting all aspects of the financial market, and may ultimately affect the actual economic operation.
What is subprime debt and the "subprime mortgage crisis"
The so-called "subprime debt" generally refers to the loans issued to borrowers with low credit ratings in US residential mortgage loans. The "subprime mortgage crisis" refers to the emergence of large European and American financial institutions since the beginning of 2007. Due to the large number of overdue defaults of "subordinated debt", the credit ratings of securitized products based on them have dropped sharply, and the market transaction value and appraisal value have seriously shrunk. A series of events that caused huge losses and spread from the United States to the global financial market, triggering a comprehensive liquidity shortage and credit crunch, and gradually began to have a negative impact on the real economy. This crisis is still in the process of development.
The English name for "subprime debt" is Subprime Mortgage or Subprime Loan. "Subprime debt" is actually the lowest grade loan, and there are intermediate grade loans above it. When American residential financial institutions issue loans, they establish a set of "credit score" standards based on the applicant's past credit history, borrowing amount, current income status and other indicators, which are divided from top to bottom into "prime loans", "prime loans" and "prime loans". Alter-A loans” and “subprime loans”. "Subprime loan" borrowers have lower incomes (generally annual income is less than $35,000), poor credit records, down payments of less than 20%, and monthly repayments accounting for more than 50% of their income.
In the 1990s, subprime loans accounted for about 2% of all residential loans. By the end of 2006, subprime loans had miraculously grown to $1.3 trillion, accounting for about 13% of the U.S. residential mortgage market.
Three major stages of deepening in the evolution of the subprime mortgage crisis
The first stage: the emergence of the problem.
At the end of February 2007, the global stock market experienced a simultaneous decline. Since it happened to start with the fall of the Shanghai Composite Index in Shanghai, China, some people attributed it to the "China Shock", but the keen market soon discovered that the root of the problem lay in the U.S. subprime bond market.
In order to cope with possible losses on subprime debt, the top three banks in the United States have significantly increased their bad debt provisions, causing market uneasiness. Shares of residential lenders fell sharply after public statistics showed subprime loan defaults were rising. In March, the U.S. Congress held a hearing on the subprime debt issue and confirmed that the balance of subprime debt loans is as high as 1.3 trillion U.S. dollars. Subprime loans use special loan products and have now entered a period of high repayment. It is estimated that there are about 1 million households. American households may not be able to repay their loans. On April 2, New Century Financial Corporation, the second largest subprime loan company in the United States, filed for bankruptcy protection.
However, at that time, the market generally believed that its impact was local and would not affect concessional loans, let alone other sectors. For example, the then Federal Reserve Chairman Ben Bernanke also believed this. Shortly thereafter, as the economic prosperity of various countries increased, the stock market temporarily returned to calm and continued to rise.
The second stage: crisis outbreak.
In the summer of 2007, the market once again began to worry about securitized products based on subordinated debt. In mid-June, two hedge funds owned by the large investment bank Bear Stearns went bankrupt due to heavy losses in their large investments in CDOs based on subordinated debt. In mid-July, the three major rating companies downgraded more than a thousand residential loan MBS. Investors generally felt that credit risks increased sharply. Countrywide Financial, the largest housing loan company in the United States, reported loan losses and deteriorating performance.
In Europe, the subprime mortgage crisis also began to erupt. At the end of July, Germany's Bundesbank (IKB) announced significant losses related to subordinated debt. On August 9, French BNP Paribas announced that it would temporarily freeze the assets of three of its funds due to difficulties in asset valuation. Affected by this, short-term financial market liquidity in the Eurozone was tight, and short-term market interest rates rose sharply.
In mid-September, Northern Rock experienced the first “cash run” in the UK in nearly 140 years. The bank directly holds less than 1% of its total assets in financial products related to U.S. subprime debt. However, due to the maturity mismatch problem in its asset-liability structure, its funding sources mainly rely on the short-term market. When the U.S. subprime mortgage crisis spread to Europe's short-term In the capital market, liquidity was scarce, and Northern Rock Bank encountered financing difficulties, triggering a run.
In order to prevent the market from falling into a liquidity crisis, European and American central banks actively intervened. The European Central Bank injected 94.8 billion euros into the market on August 9 last year, and the Federal Reserve injected $24 billion into the market on August 10. On August 17, the Federal Reserve lowered the discount rate by 0.5% (from 6.25% to 5.75%) and further relaxed discount loan conditions. By absorbing MBS and related securities, the three major banks (Citigroup, Merrill Lynch and JPMorgan Chase) It can provide US$25 billion in credit to its subsidiaries. On September 18, the Federal Reserve FOMC decided to lower the federal funds rate from 5.25% to 4.75% and the discount rate from 5.75% to 5.25%. Central banks of various countries also joined forces to provide a large amount of liquidity. There was optimism in the market, mistakenly believing that the subprime debt crisis was over, and stock indexes rose again.
The third stage: crisis deepening and development.
By late October 2007, major European and American financial institutions successively announced their third-quarter financial results. The huge financial losses far exceeded previous forecasts and exceeded market expectations, and the market began to panic. Central banks have once again joined forces to intervene.
After entering 2008, major U.S. financial institutions announced new quarterly reports, and losses once again exceeded expectations. Among them, Merrill Lynch, Citigroup, UBS, etc. suffered huge losses; Japanese financial institutions represented by Nomura Securities and Mizuho Group suffered a total loss of more than 6 billion US dollars. The impact of the credit crunch caused by subprime debt on the real economy began to show, and the annual economic growth rate of the United States dropped to 0.6% in the fourth quarter of 2007. In addition, major economic indicators such as the unemployment rate and retail goods index began to deteriorate in early 2008; the IMF lowered its full-year economic growth forecast by 0.5 percentage points in early February 2008.
Assessment of the Subprime Mortgage Crisis: Losses in the United States and Losses in Other Markets
How big are the losses on subprime debt itself? As the subprime crisis developed, estimates of losses continued to change. For example, financial institutions' own estimates always multiply after the fact. The Fed chairman's losses were estimated at $100 billion in July 2007, rising to $150 billion by October. On the one hand, subjective estimates tend to be conservative; on the other hand, from the perspective of the mechanism of subordinated debt losses, the losses themselves are also dynamic. So far, most researchers are willing to cite the IMF's estimates in its Financial Stability Report (October 2007).
The report assumes that subprime loans are US$1.3 trillion and Alt-A loans are US$1 trillion, accounting for 15% and 11% of total U.S. residential loans respectively; assuming that the default probability of subprime loans is 25%, Alt-A loans are The probability of default is 7%; assuming that the probability of eventual loss after a subprime loan defaults is 45%, and the default probability of Alt-A is 35%, the estimated loss of the entire subprime loan is US$145 billion (13000·25% ·45%); Alt-A’s estimated loss is $25 billion (1000·7% ·35%); the total is $170 billion. This figure is roughly equivalent to 1.3% of US GDP in 2006. In addition, with the occurrence of loan losses and the decline in residential prices, the valuation loss of MBS is approximately US$65 billion; the valuation loss of ABS CDO is US$120-130 billion, totaling approximately US$200 billion, accounting for about 1.5% of GDP. . So, can the U.S. financial system and real economy sustain these losses? The last housing financial crisis in the United States occurred in the 1980s, which was the Savings and Loan Association (S&L) crisis. Although its absolute scale was not as large as the subprime mortgage crisis, the losses accounted for roughly the same proportion of GDP. Judging from the financial statements of the five major U.S. banks in the third quarter of 2007, the ratio of non-performing assets was about 2%. Compared with the recession in the early 1990s and 2001, it was not serious. The entire banking system was still sound. In addition, according to estimates by Japan's Mizuho Financial Group, by the end of 2006, the net income of global listed banks and securities companies was approximately US$650 billion, and their own capital was approximately US$4 trillion. Judging from these factors, the United States should be able to absorb the losses from this crisis. However, on the other hand, it should also be noted that the above estimates of subprime loan losses are still relatively conservative, and most of them are static estimates. The special feature of this subprime loan crisis is that securitization is linked to credit expansion, which is reflected in the following aspects. First, the issuance of multiple securitized securities may promote credit expansion. For example, many investment funds (hedge funds, private equity funds, etc.) among the final investors of securitized assets are themselves highly leveraged and have multiple credit expansion mechanisms. Once a reversal occurs, a multiple credit contraction mechanism will form, exacerbating fluctuations in the financial system and the real economy. Second, securitization is a "double-edged sword". On the one hand, it diversifies the long-term risks of residential loans. On the other hand, due to securitization and re-securitization, the ultimate source of risks is easily ignored by the market and is not easy to track. , securitization itself may also amplify risks. Moreover, once the risk breaks out, it is not easy to find a focus for policy decisions. Third, with the development of financial globalization, risks in the U.S. residential financial market are sold around the world through securitization. It is precisely because of the above characteristics that we see that the U.S. financial system dispersed risks in the short term through securitization, stimulated the expansion of bank credit in the residential market, and led to the excessive expansion of residential supply beyond actual affordability. Finally, in 2006 Adjustments began to occur in the mid-term. The decline in residential prices first directly hit the U.S. construction industry. This industry currently accounts for about 14% of U.S. GDP, and it also has a strong multiplier effect on other industries. Usually, the adjustment of the housing market is relatively slow, with a long lag period. The adjustment of the housing market that started in mid-2006 is expected to last for at least 2 to 3 years. This means that our analysis of subprime loan losses cannot be limited to short-term flow analysis, but must also be analyzed in conjunction with the more basic housing market inventory adjustment. For example, American Professor Shiller believes that the value of U.S. residential assets is approximately US$23 trillion. The Chicago Mercantile Exchange's residential price index futures will further fall by 7% to 13% by August 2008, and the actual loss of residential value may be as high as 3 trillion US dollars. From this perspective, the losses on subprime loans of financial institutions are likely to continue to expand, and accordingly there will be a general credit crunch. Financial institutions had to shrink loans to companies, raise credit review standards for personal consumption, and scale back leveraged buyout loans, resulting in a decrease in M&A activity. In addition, the bank credit crunch will also lead to a credit crunch in the bond market, and the issuance of corporate bonds, especially small and medium-sized enterprise bonds, will encounter great difficulties. From a global perspective, the subprime mortgage crisis has had a particularly large impact on Europe. This is because the European continent's financial system itself is dominated by mixed industries, and its investment banking business has developed rapidly in recent years. After European monetary integration, economic competition and mergers and acquisitions require huge amounts of capital, which has led to the activity of credit and credit derivatives markets. In addition, after monetary integration, foreign exchange transactions within the Eurozone have decreased, requiring more active outward investment to diversify risks. The situation in Japan is not serious because the investment banking business of Japanese financial institutions is not very developed. Japanese banks introduced the Basel Accord control requirements in March 2007. In order to enrich their capital, just before the full-scale subprime mortgage crisis broke out in the United States, many financial institutions Institutions have sold their own securitization products. As for China, officials have not disclosed relevant information. It is reported that Chinese financial institutions hold more than US$12 billion in subordinated bond-related financial assets. As for the specific types of assets, purchase timing, actual losses, etc., it remains to be seen. Regardless, given that the U.S. economy accounts for about one-third of the global economy, nearly half of China’s exports go to the United States. Therefore, the development of the U.S. subprime mortgage crisis and its impact on the U.S. economic trend require close attention.