The Subprime Meltdown: A Primer

21 June 2007
By Dr. Faten Sabry, et al.

The Subprime Meltdown: A Primer won a "5-star" award for being the most-read US article on Mondaq during July 2007. Mondaq is a comprehensive electronic resource of thousands of articles offering legal, regulatory, and financial commentary and information. All content is supplied directly by hundreds of the world's leading professional advisors, in more than 80 countries.

The subprime mortgage market consists of loans to borrowers with high credit risk, and the mechanisms that have evolved to originate, service, and finance those loans. While this market has existed since the early 1980s, it was not until the mid-1990s that the growth of the subprime industry gained significant momentum. However, several structural and economic factors have recently slowed subprime growth and increased delinquencies and foreclosures. Some of these factors include the rise in short-term interest rates and the decrease in the rate of home price appreciation (with actual price declines taking place in many locations).

As a result of mounting defaults and delinquencies, one of the largest subprime lenders, New Century Financial Corporation, filed for bankruptcy on 2 April 2007. With the industry rapidly contracting, many other lenders have since followed suit, or simply exited the subprime market altogether. Consequently, many lenders, borrowers, and investors have filed lawsuits.

To address these matters from an economic perspective, NERA's Securities and Finance Practice has created NERA Insights: Subprime Lending Series, a series of papers dedicated to the analysis of the subprime lending crisis. In Part I of the series, "The Subprime Meltdown: A Primer," NERA Senior Vice President Dr. Faten Sabry and former Senior Consultant Dr. Thomas Schopflocher provide a brief overview of the subprime mortgage industry and the process of securitization. The authors examine the economic factors leading to the deterioration of the US subprime mortgage industry; identify factors that differ between the current crisis and the 1998 crisis; and discuss pending and potential litigation issues arising from the current industry difficulties.

This paper has been published in the American Bankruptcy Institute Journal, September 2007, Vol. XXVI, No. 7.

This paper was also published as a chapter in US Subprime Market: Evolution, Growth and Crisis, Icfai University Press, July 2008.