It was unexpected that the mortgage crisis that occurred in 2007 in the U.S. would have the effects it had on the European economy. The crisis was caused by the financial repercussions of an economy open to borrowing, and with good borrowing terms.
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This is to say that poor financial modelling, coupled with the misconception that real estate prices are always on the rise was the main cause of the mortgage crisis. Also among the significant causes was fraud and greed amongst investors (Youngblood 1). This paper is an exploration of the causes and effects of the mortgage crisis that occurred in the United States in the year 2007.
The causes of the mortgage crisis that occurred in the United States can be described as being indirect. After the 9/11 terrorist attack, investors started shying away from investing in the United States. Something had to be done to counteract this lack of interest among investor.
The Bush’s administration lowered the interest rates in a bid to encourage both investment and consumption. After the interest rates reached a record low of 1%, banks put conditions on loans to ensure that money is productively spent (Pritchard 1). Borrowers willing to take mortgages were however exempted from this condition and therefore the number of mortgages soared. People who had bad credit history also qualified for mortgages.
This, in conjunction with the prevailing high demand for houses at the time led to high prices of houses from 1999 to 2005. The result of this was that people soon realized that they were n9ot able to repay their loans. They either waited for banks to foreclose or they walked out. The prices had stopped going up, and thus the investors did not have many options. Most of them had to negotiate their loans for desperate options like workout programs.
As prices had fallen, banks incurred hefty losses as more defaulters failed to finance their loans. This led to very stringent conditions for loans and inter-bank lending which affected the activities of the banks seriously. Banks could therefore not operate normally after incurring serious losses, and this led to failure of a substantial number of banks (Youngblood 1).
The U.S. mortgage crisis had numerous effects on economies world over. One of the effects is the increase in the prices of prices of commodities, which had serious implications for businesses and consumers alike.
A number of parties who suffered serious losses due to the mortgage crisis sought interventions that could help decrease the effects of the mortgage crisis. More complex financial products were developed, and thus the solutions to the mortgage crisis were in the hands of the elite. Consumers and small scale businessmen continued to suffer. Also among the effects of the mortgage crisis is the fact that it became very difficult to sell a house due to the uncertainties in the real estate market.
Prices were low, and owners were reluctant to sell their houses while prospective buyers were aware of the crisis that had affected the real estate market. This saw the economy suffer a meltdown as the level of investment substantially reduced. It is still unclear whether the world has fully recovered from the mortgage crisis of the United States (Whalen1). However, the crisis was an eye opener for the people who are directly involved in financial modelling, especially in large financial institutions like the Central Bank.
Pritchard, Justin. “Mortgage Crisis Overview”. 2011 – March 11, 2011, <https://www.thebalance.com/mortgage-crisis-overview-315684>
Whalen, Christopher. “The Subprime Crisis – Cause Effect and Consequences”. At Indiana State University, March 2008.
Youngblood, S. “The U.S. Mortgage Crisis and Its Global Impact”. March 29, 2008 – March 11. Web.