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  • 1.Housing Finance

2. Due to scarcity of Finance, Housing remains a distant dream for many people. To boost investment in the housing industry, the Government established the Housing Development Finance Corporation in 1977. 3. Numerous tax concessions were announced like currently interest and repayment of borrowed capital and capital gains rollovers. 4. NHB In July, 1998, the government announced the setting up of National Housing Bank fully owned by RBI with the objective of providing Housing finance to all sections of society. The NHB also functioned as a regulatory body for the housing finance industry and issued regulatory directions and guidelines to the Housing Finance Companies (HFCs) 5. Till the 1990s , it was largely a sellers market. With the entry of commercial banks and private sector banks, marketing began to play an important role. HFCs marketed their schemes through agents known as DSAs (Direct Selling Agents) 6. Disbursing a house loan The first step is determining whether or not, the applicant satisfies the eligibility criteria. HFCs consider factors such as an applicants age, income level and stability of income streams. Generally three types of appraisal are conducted by the HFCs 7. Credit Appraisal This is conducted to assess the applicants repayment capacity over the loan tenure. The factors considered are: Income Age Academic Background Employment stability 8. Family background Assets and liabilities Etc. 9. Legal Appraisal The documents submitted are verified by a lawyer to confirm whether the holder will be able to generate a mortgage in favor of the HFC or not. 10. Technical Appraisal The applicants original documents are verified. All other information submitted is also verified. Checks to ensure of the quality of the material of the house. 11. Loan amount Loan amount can be disbursed in entirety or in instalments. Repayments are by way of EMIs Disbursement is generally done on the basis of fixed or floating rate of interest. 12. Fees charged 13. Processing fee Charged at the time of processing the application. Generally 0.8% to 1% of the loan amount. 14. Administrative Fee Charged when the loan is sanctioned. Generally 1-2% of the loan amount. 15. Early redemption charges For prepayment of the loan. Generally 2% of the outstanding balance 16. Bank may waive any of these fees for specific categories of customers. The registration papers of the property are held by the HFC till the loan is fully repaid. 17. The primary source of funds for any HFC is the interest on loans disbursed. HFCs make money on the spread between the cost at which they source their funds and the rates charged to customers. 18. Fannie Mae Fannie Mae was a Depression-era creation of the federal government that had been charged with establishing a secondary market for home loans. By purchasing qualifying residential mortgages from home-loan issuers, it provided these institutions with funds for the continued issuance of mortgages, thereby promoting the governments goal of increased homeownership. 19. In November 1931, President Herbert Hoover outlined a plan for the creation of twelve regional Federal Home Loan Banks (FHLBs) with the capacity to lend upwards of $2 billion to member mortgage institutions. 20. Fannie Mae. Originally chartered as the National Mortgage Association of Washington in February 1938, the agency was renamed the Federal National Mortgage Association (FNMA). Over time, the FNMA would come to be known also as Fannie Mae. 21. The FNMA opened its doors with an initial capital of $10 million supplied by the Reconstruction Finance Corporation, its supervising agency. Its role was primarily buying, holding, and selling FHA-insured mortgage loans which had been originated by private lenders, thereby allowing the latter to remove the loans from their books and use the income to finance further mortgages 22. Federal Housing Administration (FHA). The FHA challenged this status quo. For a small premium (fee), it offered to insure the repayment of principal and interest on any mortgage held by any authorized lending institution, but only so long as the mortgage conformed to FHA standards. To be eligible for FHA insurance, properties needed to be examined by a local FHA agent. 23. Other government-sponsored enterprises (GSEs) The Federal Home Loan Mortgage Corporation (FHLMC), or Freddie Mac. The Government National Mortgage Association (GNMA), also known as Ginnie Mae 24. SUBPRIME MORTGAGE CRISIS VIKRAM SINGH SANKHALA 25. 2000-2001 Dot Com Burst and Sept 9/11 attacks US Govt. adopted a policy of Credit Driven Consumption led Growth. Interest Rates were slashed to ease liquidity from 2001 By 2003 the Fed Funds rate (Fed rate) had gone down to as low as 1%. Lower interest rates made Home loans cheaper High demand in Housing Markets lead to Real Estate Prices rallying. 26. Aggressive Lending Real Estate as an asset class became very attractive. Returns generated were very high. Banks were Flush with liquidity because of Low Fed rate. Prime rate went down to 4.25% in January, 2003 from 9.05% in January 2001. However Prime market did not give the banks the high credit growth they had targeted. Started lending to subprime borrowers. 27. Aggressive Lending Bankers assumed real estate rates were set to appreciate further. Aggressive Lenders went to the extent of Financing with more than 100% of the Asset Price. Subprime borrowers were offered Mortgage Loans as ARMs. Higher Risks Higher Premiums. 28. Mortgage Brokers Lending operations were carried out by Mortgage Brokers. Were paid Commission for underwriting Mortgages Were not responsible for recovering those Loans in case of a default. Often underwrote Mortgages even when there was no proper documentation. 29. SECURITIZATION ROUTE Banks took the Securitization route to transfer the Risk off their Balance Sheets. Sold the Mortgage Loans to GSEs and Investment Banks Funds generated from securitization were again extended as Mortgage Loans. 30. BORROWER BANK INVESTOR SECURITISATION MODEL LOAN TRANSACTION SALE OF LOAN BACKED SECURITIES BANK ORIGINATES AND ADMINISTERS THE LOAN. BANK SELLS LOAN TO SECURITISATION VEHICLE WHICH ISSUES LOAN ASSET BACKED SECURTIES. FUNDING AND CREDIT RISK OF BORROWER IS BORNE BY INVESTOR. SECURITISATION VEHICLE SALE OF LOAN TO SECURITISATION VEHICLE 31. MBS Banks created MBS A Bond. Were entitled to cash flows from the Mortgage payments. Bunched MBS into several Tranches Pooling and Tranching. Many Hedge Funds and Institutions invested in High Risk High Return MBS. 32. FROM MBS TO CDS An MBS Investor could buy a CDS issued by other FIs by paying a premium. In return the FI guaranteed the cash flows from the MBS. CDS market was unregulated. Till 2000 the Number of CDS players was limited. Early 2000 saw a number of players including Investment Banks, insurance companies and speculators entering the CDS Market. 33. What is Credit default swap? Credit default swaps allow one party to "buy" protection from another party for losses that might be incurred as a result of default by a specified reference credit (or credits). The "buyer" of protection pays a premium for the protection, and the "seller" of protection agrees to make a payment to compensate the buyer for losses incurred upon the occurrence of any one of several specified "credit events." 34. BORROWER BANK INVESTOR/ OTHER BANK RISK TRANSFER MODEL LOAN TRANSACTION CREDIT DEFAULT SWAP OR CREDIT LINKED NOTE BANK ORIGINATES, FUNDS AND ADMINISTERS THE LOAN. CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTORS OR OTHER BANKS. 35. Example Suppose Bank A buys a bond which issued by a Steel Company. To hedge the default of Steel Company: Bank A buys a credit default swap from Insurance Company C. Bank A pays a fixed periodic payments to C, in exchange for default protection. 36. Exhibit Credit Default Swap Bank A Buyer Insurance Company C Seller Steel company Reference Asset Contingent Payment On Credit Event Premium Fee Credit Risk 37. The Bubble Estimated size of CDS Market in 2000 was USD 900 Billion. Estimated size of CDS Market in 2007 ballooned to USD 45 Trillion. This was three times the size of the GDP of USA. 38. 2003 US Proposed Budget for the IRAQ war USD 60 Billion Actual expenditure had reached over USD 500 Billion. Heavily borrowed short term funds. Had to rely on the Money Market. Allan Greenspan US Federal Reserve Chairman increased interest rates. 39. 2003 - 2006 In 2003 the average short term borrowing rates on three month Treasury Bill was 1% when the average 10 year T-Bill rate was 4%. In 2006, the average three month Treasury Bill rate went up to 4.85% whereas the average 10 year T-Bill rate was 4.79%. Normally short term rates are less than long term rates. 40. IMPACT The cost of funds for lending institutions increased. They raised the rates on ARM. With increasing interest rates, the housing market started witnessing a decline in Demand. Liquid money started flowing into commodities. Led to a surge in commodity prices and therefore Inflation. To control Inflation, Interest rates were increased further. 41. IMPACT Borrowers started defaulting on their payments because of increasing interest rates. Losses for Investors and institutions dealing in MBS. Rating agencies downgraded several MBS. This made the MBS Market illiquid. 42. IMPACT Investment Banks had to face significant losses. Decline in share prices. Few of them which had invested heavily started defaulting on their obligations. FIs which had underwritten CDS faced the pressure of payments. This led to Bankruptcies of several FIs involved in the Trading of MBS and CDS. Led to a liquidity crunch and the subprime crisis. 43. TARP The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase assets and e


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