There is risk for the lender as well, because incase the borrower gets bankrupt, the property foreclosure is also a complicated issue as there can be multiple lenders among whom the property has to be distributed. If there is only one lender for the mortgage loan and if a borrower applies for bankruptcy, then legally the lender can foreclose the property. But when there are multiple lenders for the same mortgage, the issue gets legal complications. According to bankruptcy law, the foreclosure of the mortgage is given to the lender on the first come, first serve basis.
Otherwise, all the entities involved in this mortgage have to resolve sitting together. This makes the subprime mortgage loans more vulnerable towards disasters. If someone has a piece of property that is well maintained, it is a very good-looking piece of property, and the person needs 67 percent, then I may do it. On the other hand, if the property is run down, in bad shape, and in a poor location, then I might only loan 40 to 50 percent. A lot it is gut feeling. The more you do it, the better your gut feelings about these things (Clark and Tabacchi, 2006).
With the open market on subprime mortgage loans, people are able to buy property, which they can never afford, without subprime loan. This feature enabled many people to take hasty acquisition on wrong property and finally end up with bankruptcy. Banks and private mortgage investors benefit from subprime mortgages by imposing heavy interest rates on the borrowers, though the risk involved in giving loans to such debtors still prevail. But the strategy of these players is to look for a foreclosure of the property when the borrower goes bankruptcy. Lender gets profit from foreclosure if the market value of the property is good.
Every now and then a case comes to the forefront that is particularly egregious. Citibank was recently caught in one of those cases. In 2002, Citibank’s subprime lending subsidiary was prosecuted for deceptive marketing practices, and the company paid $240 million to settle the case (at the time, the largest settlement of its kind). (Warren and Tyagi, 2003) As the most predominant sectors for the growth of US economy are Pharmaceuticals, Banking and Computers and Technology, the affect of bank crisis plays a major role in the down fall of the whole economy in large.
Banking sector has direct affect on the Information Technology industry as the online banking applications and ATM systems have revolutionized the country’s economy past few years. According to statistics, the largest givers to US beneficiaries by industry, in 2005 are Pharmaceuticals, Banks and Computers and technology. (Insurance Information Institute, pg 10). This adds adverse affects on the employment and economy of the country. George Mason University economist Tyler Cowen says, “We’ve all heard about the defaults on subprime mortgage loans.
But so far, the real story is how little the broader American economy has suffered. Today, banks usually sell their loans to third parties. . You might have originally borrowed money from Wells Fargo, but now a bank overseas cashes your mortgage checks. . (Elder, 2007) As the international markets show the interest in investments on the subprime mortgages, and as the risk involved in this market is pretty high, Banks sell the mortgage loans to the international finance, there by when a bankruptcy happen, rather than a borrower, it’s the lender who gets suffer, and hence it impacts on the international market.
So with the mortgage crisis, not only the country but across the world this ripple affect takes place. If a large group of people can’t pay their mortgages, they may lose their homes. But the banks don’t suffer as they used to — local American lenders have already converted those loans into cash and sold off their risk. In fact, German regional banks suffered some of the most significant losses from bad American mortgages. Other European and Asian banks and hedge funds took their lumps as well.
American banks essentially bought insurance by exporting their risk overseas. (Elder, 2007) In this crisis, Government plans to give a bail out to the borrower. This kind of support is not encouraged by few financial experts, as they feel that these plans might further degrade the economy. It is also the lenders mistake to grant the loan to an individual, instead of knowing his/her financial status.
Charles Cuny, senior lecturer in finance at the Olin Business School at Washington University in St. Louis, says there is reason to have sympathy for the subset of borrowers who probably didn’t understand the terms of the loans they received. They were effectively lied to and it appears that for those people who have already lost their homes, there is nothing in the bailout plan for them (Neuman, 2008) Citibank and other banks that are into the subprime mortgage business say that they are here to give support to the middle class families. But indeed the support is so expensive that it allows an individual to break in no time, if he could not manage his finances properly.
In 2001, when standard mortgage loans were in the 6. 5 percent range, Citibank’s average mortgage rate (which included both subprime and traditional mortgages) was 15. 6 percent ( Warren and Tyagi, 2003) According to one estimate, about 17 percent of all households in the United States would see a significant improvement in their balance sheets if only they were willing to sign a bankruptcy petition.
That’s 18 million households that would profit from a bankruptcy filing, compared with the 1. 5 million that actually filed, suggesting that at least 16.5 million families are trying to pay their debts for some reason that has nothing to do with the legal rules. It would seem that bankruptcy may look like just another “financial planning tool” to the economists who study it, but it is very different for the families who actually have to file the petitions and show up in court. (Warren and Tyagi, 2003) Citibank is an international bank, established in 1812 with the name City Bank of New York, and later changed to First National City Bank of New York. Citibank, a part of Citigroup, is one of the largest companies in the world.
Charles O. “Chuck” Prince, III was former CEO and chairman of Citigroup, and because of the recent crisis, he retried and currently Vikram Pandit is the CEO of Citigroup. Citibank , one of the largest banks in the country could feel the heat of the adverse affects of the subprime mortgage in the mid 2007 as it has suffered with huge losses and the foreign investors have lined up to take their stake out, which made the situation more worst. And finally Citibank announced that it is going for layoffs.
“17,000 plus 9,500 is the amount of jobs we’re really impacting,” Citi’s Chief Operating Officer Bob Druskin About 43 percent of the job cuts will come in the United States with the rest overseas. But more than half of the expected savings of more than $10 billion will come from the domestic job cuts, the company said. (Kelley, 2007) Citibank is not only operational in US, but it has spread wide across the world. And when it gets affected with huge crisis, this is going to have an economic impact whole over the world.
Citigroup has operations in 100 countries, with over 8,000 bank branches serving 200 million customers. (Kelley, 2007) With the credit card usage in the last decade, the company made huge profits out of it. They started giving loans on the basis of the credit cards, and with increased interest rates, the money inflow was pretty high. By the end of mid-1990s, banking giants such as Chase Manhattan and Citibank, fat with profits from credit card lending, were looking for new markets to tap.
They applied the same principles to home mortgage lending that had profited their credit card divisions so handsomely: Charge high interest rates and sell, sell, sell. ( Warren and Tyagi, 2003) And when the same marketing technique is used in issuing loans based on the mortgages, allowing even the subprime debtors to be part of this scheme, initially gave handsome profits to the company. But with the increased number of bankruptcy cases, the value of property from foreclosure came out to be a liability to the company, with the down trend of the real estate market.
The real estate bubble in US is experienced due to various reasons which include inflation of home values, opening up of credit markets, low mortgage interest rates are few of the reasons, and according to Global Insight, along with most economists, realized early on that home prices could not keep appreciating at the rates experienced up until 2005. (GLOBAL INSIGHT, 2008) The company’s net income declined 13 percent to $21. 5 billion last year from $24. 6 billion in 2005.
(Kelley, 2007) There by, company has to face huge loss. As the company has foreign investors as the stake holders, the money flow drastically decreased, which immediate resulted in the liquidity crunch. This added fuel to the existing down trend. Citi said it expects savings of $2. 1 billion this year, $3. 7 billion next year and $4. 6 billion in 2009 from the job cuts. It will take a pretax charge of about $1. 4 billion to pay for one-time costs associated with the cuts. (Kelley, 2007)
Not only just Citibank, but also many other banks which are into subprime mortgage loans have to suffer the crisis. There are many more foreclosure are going to happen in the next one or two years, according to the experts. And the companies have to be prepared for that, by assuring the balance in the liquidity. Citibank has taken various measures to get increase the liquidity and one such measure is by layoff and moving various offices to a low cost places by which the expenditure is controlled and in the short run , liquidity increases.
Though some experts feel that this move at the cost of layoffs is not the right decision, instead the company should go for other approaches in building up the confidence of the investors and bring more investments to compensate the loss because of the crisis. Global Insight expects that 2008 will bring more foreclosures, slower growth of U. S. GDP, stresses for state and local government budgets, and curtailed consumer spending. (GOBAL INSIGHT, 2008)
Due to the subprime mortgage and there by the liquidity crunch, made the country to face the crisis, but with the involvement of Government in aiding the victims from bankruptcy and assuring the liquidity inflow making the foreign investments to continue, will recover the economy and it might take a year or two in restoring the economy as well as growth in the employment. And the mortgage crisis is not going to bring the economy grinding to a halt. Indeed, we expect job growth in 2008 to be 0. 85% and GDP growth to be 1. 9%. In 2009, those figures will be 1. 2% and 2. 9%, respectively. (GOBAL INSIGHT, 2008)
The study of economy by GLOBAL INSIGHT forecast that the foreclosures will effect the US economy in 2008 , 166$ billion low, as the investments on real estate will be weak and also due to this , the resale of the properties gets effected to the homeowners , and also the homes which are already foreclosed faces difficulty in selling , thereby the lenders are also in trouble, which in turn hit the construction industry and as the expenditure goes low by the customer’s decrease in spending income, the demand on other goods and services gets affected , and this might result in loss of jobs across the country.
This might impact in the revenue generation from government organizations in the form of decrease in tax revenue. The peak years for the issuance of sub-prime and other adjustable rate mortgages were 2004 and 2005, and under the most common two-year reset terms, 2006 through 2008 will see the peak number of borrowers pushed into payment difficulty. Unless institutional arrangements are made to bring mortgage holders together with buyers, 2007 will see foreclosure activity accelerate. We forecast that home price declines across the U. S. will average 7% in 2008, ranging as high as 16% in California.
There is a large risk of greater price declines. But even under our conservative forecast, foreclosure activity rises to 1. 4 million homes, representing a property value of $315. 9 billion. States. respectively. (GOBAL INSIGHT, 2008)
(2008). Credit Report Scoring. US FUNDING GROUP,INC. , Retrieved Arpril 01, 2008, from http://www. usfundinggrpinc. com/scoring. html Elder, Larry . “The Subprime Crisis Time For Government Intervention?. ” Creators Syndicate Inc. 13 Dec 2007 01 Apr 2008 <http://www. realclearpolitics. com/articles/2007/12/the_subprime_crisis_time_for_g. html>.