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Background of sub-prime

Sub-prime mortgages formed a major portion of the overall mortgage market being estimated at $1.3 trillion as of March 2007. These mortgages had little or no upfront payment was made and issued to low/minority income/assets groups with low credit profiles. In third quarter of 2007, sub-prime ARM’s amounting to 7% of overall mortgages outstanding in US accounted for 43% of foreclosures initiated during that quarter and by May 2008 delinquency had risen to 25%.

After a long bullish trend on real estates, declining house prices in 2006-07 and increasing interest rates resulted in increasing delinquencies and foreclosures. This triggered a drop in market value of all the securities/derivatives derived out of underlying sub-prime mortgage loans. This erosion in market value has adversely affected the capital of various banks and financial institutions dealing with such securities like Fannie Mae and Freddie Mac. American real estate prices are almost down by a fifth and expected to recede a further 10-15%.

According to the International Monetary Fund (IMF), losses related to mortgage based debt and derivatives originating from America would reach $1.4 trillion. Already approx $760 billion has been written off by banks, insurance companies, hedge funds etc., on account of these losses. Also, IMF expects American and European banks to shed $10 trillion of their assets, which would be equivalent to 14.5% of their stock of bank credit in 2009.

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