Subprime mortgage crisis

The sub-prime crisis and housing bubble

Subprime mortgage crisis is an enduring real estate and financial crisis triggered by a dramatic rise in mortgage misconduct and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. In America, sub-prime means that the borrower is below being a “prime” candidate for a mortgage, in other words they are a poor credit risk [1]. What this means is that in the United States, borrowers with little or no income, little or no equity and a poor credit history have been given variable interest rate mortgages they could never have been able to afford. In simple terms these are high-risk loans, which could be paid and resulted in bad depth for bank and the banks couldn't cope with it. Real estate contributes 10% of the total U.S. economy's output [2]. If real estate declines, so do construction jobs, thus potentially increasing unemployment. A decline in real estate sales eventually leads to a decline in real estate prices. This then reduces the value of everyone's homes, whether they are actively selling it or not. This then reduces the amount of home equity loans the homeowner can get, further reduceing consumer spending. Over 70% of the U.S. economy is based on personal consumption [3]. A reduction in consumer spending will contribute to a downward spiral in the economy. This results in further unemployment, further reduction in income, and further reduction in consumer spending.

Housing market in the United States suffered greatly as many home owners who had taken out sub-prime loans found they were unable to meet their mortgage repayments. As the value of homes plummeted, the borrowers found themselves with negative equity. With a large number of borrowers defaulting on loans, banks were faced with a situation where the repossessed house and land was worth less on today's market than the bank had loaned out originally. The banks had a liquidity crisis on their hands, and giving and obtaining loans became increasingly difficult as the fallout from the sub-prime lending bubble burst. This is commonly referred to as the credit crunch. Although the housing collapse in the United States is commonly referred to as the trigger for the global financial crisis, many experts who have examined the events over the past few years, and indeed even politicians in the United States, now agree that the financial system was poorly regulated and to some extent even encouraged unscrupulous lending [4].

The immediate cause or trigger of the crisis was the bursting of the United States housing bubble, which peaked in approximately 2005–2006. High default rates on "subprime" and adjustable rate mortgages (ARM) began to increase quickly thereafter [5]. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the U.S [6]., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to be a key factor in the global economic crisis, because it drains wealth from consumers and erodes the financial strength of banking institutions.

The Global Effects

Failure of the financial intuitions, government initiatives and banks

About $750 billion in such losses had been recognized as of November 2008[7]. These losses have wiped out much of the capital of the world banking system. Thus the massive reduction in bank capital just described has reduced the credit available to businesses and households. When Lehman Brothers and other important financial institutions failed in September 2008, the crisis hit a key point. During a two day period in September 2008, $150 billion were withdrawn from USA money funds. The average two-day outflow had been $5 billion. In effect, the money market was subject to a bank run. The money market had been a key source of credit for banks and nonfinancial firms (commercial paper). This credit freeze brought the global financial system to the brink of collapse and thus triggered the global financial crisis.

The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and large reductions in the market value of equities and commodities. Moreover, the de-leveraging of financial institutions, as assets were sold to pay back obligations that could not be refinanced in frozen credit markets, further accelerated the liquidity crisis and caused a decrease in international trade. Insecurity among investor prevailed which decreased the confidence of investors to further invest in to business, stock markets, which brings me to my next point, that USA plays a pivotal role in the world stock market. According to Shirai,[8] “US investors held foreign stocks of about $5 trillion at the end of 2007, while foreign investors held US stocks of about $3.1 trillion at the end of June 2007” (Shirai. S, 2009)[8]. This indicates that the United States was a net investor in foreign stocks. That means that the United States contributed to the development of global stock markets to a significant degree by expanding the investor bases of other countries. Due to the sub-prime mortgage crisis, US investors no longer invested significantly in the global stock market that led to its collapse and had a major impact in triggering the global financial crisis.

The spread of financial crises throughout the world [dark most effected]

References

1. CARPE DIEM: The Rise and Fall of the Subprime Mortgage Market". Mjperry.blogspot.com. 2008-07-17. http://mjperry.blogspot.com/2008/07/rise-and-fall-of-subprime-mortgage.html. Retrieved 2009-02-27.

2. Justin Lahart (2007-12-24). "Egg Cracks Differ In Housing, Finance Shells". WSJ.com (Wall Street Journal). http://online.wsj.com/article/SB119845906460548071.html?mod=googlenews_wsj. Retrieved 2008-07-13.

3. Mortgage Bankers Association (2007-06-12). "Delinquencies and Foreclosures Increase in Latest MBA National Delinquency Survey". Press release. http://www.mbaa.org/NewsandMedia/PressCenter/58758.htm. Retrieved 2008-07-13.

4. Ben S. Bernanke. "The Recent Financial Turmoil and its Economic and Policy Consequences" [[New York, New York|]], New York (2007-10-17). Retrieved on 2008-07-13.

5. Ben S. Bernanke. "Financial Markets, the Economic Outlook, and Monetary Policy" Washington, D.C. (2008-01-10). Retrieved on 2008-06-05.

6. Bernanke, Ben S. "Mortgage Delinquencies and Foreclosures" Columbia Business School's 32nd Annual Dinner, New York, New York (2008-05-05). Retrieved on 2008-05-19.

7. Board of Governors of the U.S. Federal Reserve System, Release Z.1, 9/18/08. Table L.218, line 2. Note that $1.1 trillion (line 22) of the $10.6 trillion total consisted of home equity loans.

8. U.S. FORECLOSURE ACTIVITY INCREASES 75 PERCENT IN 2007". RealtyTrac. 2008-01-29. http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=3988&accnt=64847. Retrieved 2008-06-06.

9. RealtyTrac Press Release 2008FY". Realtytrac.com. 2009-01-15. http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=5681&accnt=64847. Retrieved 2009-02-27.

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