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Article: Will the Bubble Burst be revisited?

05 April 2015 | Pat Aditya

The debacle of financial system in the United States in 2008 has been attributed to the subprime lending in mortgage sector, securitization of these subprime mortgage loans and taking aggressive positions in the resulting mortgage backed securities (MBS) and corresponding opposite positions in credit default swaps (CDS). The subprime loans during 2008 constituted 41% of total consumer lending. Absence of regulations along with improper assessment of liquidity in the financial system fueled the ripple effect of recession across the world. Since then, many regulations have come into place across various jurisdictions thereby increasing transparency, strengthening the KYC norms and improving the regulatory oversight.

However, still no regulations are in place limiting the banks' exposure to subprime loans. Since the start of the financial crisis (in 2008), loans to customers with low credit scores have increased drastically. This time the bubble is not in the mortgage markets, but a bubble is being formed in the Auto Loans, Personal Loans and Credit Cards markets.

The attached PDF titled "Will the Bubble Burst be revisited?" contains more details on the bubble being formed; why there is  a huge need for subprime lending even though it is risky; will this bubble burst have a similar or even worse effect on the financial stability as it had in 2008 and finally my view on the negative impact of defaults in the payment of these subprime loans.


Comments

There's something to be said for minimum underwriting standards applied carefully to all forms of credit. The thing which really made this a systemic issue for mortgages was the assumption that different parts of the U.S. were not correlated when in fact all went bad at the same time. Is this true of the asset classes here or not?

There's something to be said for minimum underwriting standards applied carefully to all forms of credit. The thing which really made this a systemic issue for mortgages was the assumption that different parts of the U.S. were not correlated when in fact all went bad at the same time. Is this true of the asset classes here or not?

Jon,

I am afraid that these loans are distributed across various parts of the U.S. However, there is no concrete data indicating the area wise exposures to these subprime loans.

Couple of things to be focussed upon:
1. SIFIs are less invloved in these subprime loans. Most of the players are the financial arms of auto firms.
2. Even if there is a series of defaults in these subprime loans, the maximum negative effect would be to auto firms and some financial entities thereby hitting their profits very badly. This would in turn affect the auto sales (one of the major drivers of economy), thereby pulling down the U.S. economy as a whole.

With current regulations already in place, the financial stability would remain intact. But the U.S. economy would be affected to certain extent, which I speculate might force the Fed to pull down the interest rates again to minimum levels.