Question

what motivated to investment bankers to get involved in the subprime market? did they behave appropriately? why or why not?

Answer 1

Anytime something bad happens, it doesn't take long before blame starts to be assigned. In the instance of subprime mortgage woes, there was no single entity or individual to point the finger at. Instead, this mess was the collective creation of the world's central banks, homeowners, lenders, credit rating agencies, underwriters and investors.

When the central banks flooded the markets with capital liquidity, it not only lowered interest rates, it also broadly depressed risk premiums as investors sought riskier opportunities to bolster their investment returns. At the same time, lenders found themselves with ample capital to lend and, like investors, an increased willingness to undertake additional risk to increase their investment returns.

In defense of the lenders, there was an increased demand for mortgages, and housing prices were increasing because interest rates had dropped substantially. At the time, lenders probably saw subprime mortgages as less of a risk than they really were: rates were low, the economy was healthy and people were making their payments.

Lenders took on greater risks too, and approved subprime mortgage loans to borrowers with poor credit. Consumer demand drove the housing bubble to all-time highs in the summer of 2005, which ultimately collapsed the following summer.

The end result was increased foreclosureactivity, large lenders and hedge funds declaring bankruptcy, and fears regarding further decreases in economic growth and consumer spending.

The Investment bankers worsen the situation:The increased use of the secondary mortgage market by lenders added to the number of subprime loans lenders could originate. Instead of holding the originated mortgages on their books, lenders were able to simply sell off the mortgages in the secondary market and collect the originating fees. This freed up more capital for even more lending, which increased liquidity even more, and the snowball began to build. A lot of the demand for these mortgages came from the creation of assets pooling mortgages together into a security, such as a collateralized debt obligation (CDO). In this process, investment banks would buy the mortgages from lenders and securitizethem into bonds, which were sold to investors through CDOs.Thus these kind of scenarios motivated investment bankers to get involved in the subprime market.