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The Subprime Loans Case Study

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What accounts for the subprime financial turmoil which burst onto the scene in the summer of 2007? Who is most to blame for this mess?

The mortgage industry was very attractive to many investors because of the high return and the reduced risk that was associated with it. This did not miss the attention of unscrupulous business people. These people got the wind that they could make a lot of money by selling mortgages to various financial institutions that were eager to make quick money. As a result, the mortgage brokers went out to get as many people as possible to give loans. However, when the people qualifying for the loans became scarce, mortgage brokers loosened the regulations and gave mortgages to unqualified people. In the end, there were many loans that were being defaulted leading to the financial crisis. The people who have the highest blame for these are the financial institutions that went against the laid down rules in giving credit. Financial institutions were so much obsessed with the urge to make more money than they invested a huge amount of money in high-risk ventures. Moreover, the financial institutions failed to consider the credit worthiness of a client before issuing loans.

Overall, would you say that the U.S. / global financial system has functioned well or poorly through this episode? Is this sort of instability likely to strike again?

In general, the global financial system and particularly that of the U.S. did well in tackling the financial crisis. Inflation rates have more or less remained unresponsive though fluctuations have been reported mostly due to fluctuating oil and energy prices. The inflation rate was at 3.9% in October 2011 but had been reducing though slightly and it stood at 1.7% in January 2013. However, the Federal Open Market Committee (FOMC) expects the inflation rate for the next two years to be around 0.5% above the committee’s long term goal of two percent. Similarly, the Gross Domestic Product (GDP) growth rate has been slow since 2009 when the GDP deepened to -3.5%. The GDP growth rate improved a bit to 3.0% in 2010 but reduced again to 1.7% in 2011 and further drifted to 1.5% in 2012. Nevertheless, economists have projected the economy to grow by 2.4% this year. However, if financial institutions are not regulated the same can happen again.

What is your assessment of how Ben Bernanke, the Chairman of the Federal Reserve, has handled the situation?

During a financial crisis, expenditure both public and private is very crucial. People need money to spend so as to keep the economy going. This is what Ben ensured is done. In a move to inject money into the credit market, the government purchased preferred stocks that were introduced as well as creating currency. The banks were also taken into consideration when the government bought their private assets increasing the banks’ liquidity. Expansionary fiscal and monetary policies were also applied to boost consumer spending which in turn would spur economic growth. It was also proposed that shadow banking should be highly regulated while at the same time measures to cushion the banks financially were taken which included strict capital requirements. To this extent, Ben Bernanke handled the situation in the best way possible.

If you were advising top lawmakers in Washington about potential policy responses to the subprime turmoil, what sort of advice would you offer? Please consider both short-term remedies and long-term reforms.

In the short term, I would advise policymakers to implement expansionary monetary policy. However, noting that in scenarios like these ones, monetary policy might not be sufficient hence implementing expansionary fiscal policy could also be prudent. The measures that were implemented were tackling the problem head-on. However, this will not prevent future recurrence of the same thus the government should put in place measures to counter the crisis before it happens. Banks were the largest contributors to the housing bubble. Therefore, I would suggest that in the long term regulations be introduced to check the involvement of banks in property trading. The financial sector should be strictly regulated.

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"The Subprime Loans." IvyPanda, 22 Feb. 2021, ivypanda.com/essays/the-subprime-loans/.

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IvyPanda. 2021. "The Subprime Loans." February 22, 2021. https://ivypanda.com/essays/the-subprime-loans/.

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IvyPanda. (2021) 'The Subprime Loans'. 22 February.

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