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U.S. Mortgage Crisis Term Paper

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Updated: May 30th, 2019

United States Mortgage Crisis began in the year 2007 and it affected the entire world. It brought financial crisis in all the parts of the world and this was as a result of bad financial modeling. An increase in the rate of borrowing also caused mortgage crisis in United States.

The United States government had ignored rise in home prices not knowing that it might cost the entire world. Severe impacts were felt all over the world as a result of mortgage crisis some of which include rise in mortgage foreclosures and delinquencies and decline of mortgage securities (Caprio 212; Dornbusch 311).

This paper describes the United States mortgage crisis problem explaining its significance/importance. It also compares what political leaders have done to help alleviate the problem.

As the adjustable-rate mortgage values increased over time, many more home owners defaulted leading to high number of mortgage delinquents (Shiller 45). This is because many home owners found it difficult refinance their mortgages due increasing rates of monthly repayments.

This was compounded by the lost of value by the assets used as collaterals for the mortgages and held by the lenders. The lending process also suffered as the mortgage-backed debt purchases and securities by global investors also plunged.

These investors also showed a decline in their willingness and capacity to support the lending process as a whole. This trend sent across all the global financial markets which responded tightening of their credit lending capabilities. This worldwide panic slowed down the economic growth of Europe and United States and the global economies in general (Kaminsky &Reinhart 473 – 500).

United States housing bubble peaked up in between 2005-2006 which led to immediate trigger or cause of mortgage crisis. Around 2004 to 2007, lenders began to originate high risk mortgages in large numbers. With the loan incentives, the loans soon followed the trend exhibited by the adjustable and subprime rate mortgages (ARM).

Buoyed by initial increasing home values, more Americans took mortgages with the hope of repaying at favorable rates leading to the housing bubble (Krugman 96). In addition, lack of water tight loan acquisition policies and regulations from the government side also gave the lenders a leeway to give mortgages without proper vetting.

Such poor monitoring policies and regulations by the government allowed private investment banks to scrutinize loan applications even though they lacked to do so in a neutral manner. After housing prices began to drop and interest rates rose in many parts of United State, it became more difficult to refinance.

The housing bubble finally deflated as the home owners failed to repay their loans due to high interest rates and a slump in the home values contrary to what was predicted initially. These defaults led to high number of foreclosures.

Such cases where witnessed in many states including Texas and New York where the home values dropped by a whopping 45%. This provided the borrowers with financial incentive which made them to enter into foreclosure.

The housing bubble and its deflation by 2006 was the major contributor to the global economic recession. This is because it drained consumer’s wealth and eroded banking institutions financial strength (Sutton 46 – 55).

It has to be noted here that the housing bubble was caused primarily by foreign investors who pumped finances in the property sector. The main culprits in this case are the oil-producing countries and fast-growing economies in Asia such as China.

These foreign investors took advantage of the low interest rates and easy credit conditions in the U.S and invested heavily in the housing and property sector leading to the credit and housing bubbles. The consumers, investment companies and financial institutions had easy access to loans for investment of any form.

The consumers however assumed the unprecedented debt load that accrued as a result of impulse buying. Mortgage-backed securities (MBS) consequently increased to unprecedented rates never witnessed before in the history of U.S.

Over a short period of time, the U.S housing sector became a buzz with investors and financial institutions from all corners of the world landed with cash to have a piece of the booming housing sector. When the credit and housing bubbles finally deflated, many big financial institutions from all over the world were counting losses running into millions of dollars.

This was as a result of decline in house prices in major cities in the U.S such as New York and Texas. However, the losses were not recorded only in the U.S alone as many other countries had also followed, to some extent, the trend set by the U.S housing and credit sectors. Trillions of U.S. dollars were estimated to have been lost as a result of mortgage crisis (Wolf 7; White 11).

Whereas the credit and housing bubbles were growing, the U.S financial system became weaker as a combination of factors such as lack of the hedge funds and actions of investment banks worked hand in with the bubbles.

These investment banks engaged in underhand activities such as giving out mortgages without proper scrutiny and using complex off balance sheet derivatives. The policymakers were unable to recognize the laming financial status of financial institutions.

They therefore called out for government help to bailout the institutions. Operating without sufficient financial cushions also led bankruptcy in financial institutions; the cushions could have helped in absorbing loan defaults and all the losses felt by MBS.

Financial institutions could not therefore loan money due to high losses that they experienced and slowed down the economic activities in the institutions. The central banks took the initiative to provide funds after people lost trust in financial institutions in U. S.

The main aim of central bank was to help restore faith in commercial markets and to also encourage the process of lending to help reduce the poor economic status of the country. The government also took the initiative of bailing out key financial institutions (Levitt 4).

U.S. mortgage crisis also led to decline in wealth and business investment and consumption. Household wealth is part of the trillions of losses that America faced as a result of the crisis. Those who owned homes in United States were not able to earn much from their homes after the collapse of housing prices.

This is because the free cash that was used by consumers doubled in 2001 from $627 billion to %$ 1,428 billion in 2005. During the same period, housing bubble managed to build nearly $5 trillion. An average increase of 46% was recorded on U.S home mortgage that were debts relative to GDP.

The total amount reached $ 10.5 trillion. The rich people did not loss so much as a result of U.S mortgage crisis. The gap between the rich and the poor was widened as a result of U.S mortgage crisis. Those who owned 34.6% of United States wealth in the year 2007 managed to get higher share in 2009 of over 37.1% of wealth.

However, typical American families and wealthy but not wealthiest people felt the punch of economic recession as a result of U.S mortgage crisis. Nevertheless, half of those considered poor in Houston and New York were not affected by the crisis; their economic status remained the same (Jackson 3).

Consumers were forced to spend as a result of low value of houses and the high cost of goods in the markets. This forced leaders all over the world both from large nations and emerging countries to meet and formulate ways in which the economic crisis could be dealt with.

Central banks leaders, business executives, economists and government officials were among those people who met to make proposals on how to deal with the crisis faced in United States.

The central banks and Federal Reserve in United States both in Houston and New York have taken steps to increase supplies in order to avoid deflationary spiral risks in which high unemployment and low wages lead to self-reinforcing thus a decline in global consumption.

The government in United States encouraged borrowing as away to offset demands from private companies which caused the crisis. Fiscal stimulus was also encouraged by the government.

The total stimulus packaging from 2008 to 2009 was $ 1 trillion. In the last quarter of 2008, a total of $ 2.5 trillion was purchased by central banks which were the total amount of troubled private assets and government debts (Reinhart &Rogoff 124; Talbott 103).

The governments of the two cities purchased preferred stock in major banks with an aim of raising the capital of their major banks. The U.S also implemented creating currency policy in 2010 as a method to fight liquidity trap. The government created a total amount of $6 trillion which was then banked in Federal Reserve banks.

They hoped that this would help stimulate the banks to be able to fund mortgages and also offer loans to various companies in United States. The banks also began to invest in foreign currencies to create currency wars.

The government has also taken the initiative of bailing out firms as stated above offsetting huge financial obligations. They also began to spend whereby they donated trillions of dollars to help in asset purchases, offered loans and guarantees and also promoted direct spending.

In 2009, United States key advisers and its President Barack Obama introduced a number of regulatory proposals which addressed consumer protection, capital requirements, executive pay, or bank financial cushions.

These proposals were meant to expand regulation of derivatives and shadow banking systems and also to enhance Federal Reserve authority to safely and systematically recuperate important financial institutions.

In 2010, the banks were given limited power by U.S president; they were therefore not in a position to conduct proprietary trading.

A regulatory reform bill was passed by U.S Senate in 2010 following 2009 House. One of the bills passed by U.S Senate was Volcker Rule. The bill was not part of United Sates legislation though it managed to prevent proprietary trading in the nation (Mankiw 9).

In Houston, the Congress men took the initiative of pressurizing mortgage industry to give loans to those who were unjustly denied loans in the past years. The Congress ensured that the loans were of lower standards as compared to those issued in the past.

Lowering the loan standards would provide unlimited funds making funds available from Fannie Mae to Freddie Mac. After The White House made several proposals, Congress efforts were rebuffed. Those companies who started mortgages sold them to Wall Street firms since they wanted to obtain higher yields on their trading portfolios. These companies are successful and profitable today (Fletcher 215).

Houston City Council members asked for a presentation from their staff on national economic troubles and how they can affect the city. The staff mainly focused on property tax revenue, ability to maintain city services and staffing and future sales.

Houston has felt higher pinch on the interest rates since they are being issued on short term debt. The interest rates however increased from 2% to 8% which costs the city an interest rate of $85,000 and about $ 70 million total debts in a week.

However, Houston city is still expecting asset bubbles to occur while the prices for household might adjust down and eventually the city might get out of financial crisis.

In conclusion, flawed financial modeling and too much borrowing is what caused mortgage crisis in United States. However, there are many factors that led to the crisis which include housing bubble peaking up, policymakers being unaware of the important role that financial institutes such as hedge funds and investment banks played among many other factors.

There are many effects of U.S. mortgage; led to bankrupt of major financial institutions in America, led to poverty, decline in house prices in major cities in the U.S, In 2008, housing value and stock markets declined.

The American government made proposals to deal with mortgage crisis and some of the proposals made were the U.S implemented creating currency policy in 2010 and the government has also taken the initiative of bailing out firms.

Works Cited

Caprio, Gerard. Banking Crisis Database: Systemic Financial Crises. Cambridge: Cambridge University Press, 2005. Print.

Dornbusch, Rudiger. Dollars, Debts, and Deficits. Cambridge, MA: MIT Press, 1986. Print.

Fletcher, June. House Poor: Pumped Up Prices, Rising Rates, and Mortgages on Steroid – How to Survive the Coming Housing Crisis, New York: Collins, 2005. Print.

Jackson, James. The Financial Crisis: Impact on and Response by The European Union. Specialist in International Trade and Finance, 2009. Print

Kaminsky, Graciela & Reinhart, Carmen. “The Twin Crises: The Causes of Banking and Balance of Payments Problems.” American Economic Review 1999, 89: 473-500. Print.

Krugman, Paul. The Return of Depression Economics and the Crisis of 2008. New York: W.W. Norton, 2008. Print.

Levitt, Steven. (2008), “The Financial Crisis and the ‘Chicago School’,” Freakonomics, 26 December 2008. Web.

Mankiw, James. “How to Avoid Recession? Let the Fed Work.” New York Times, 23 December 2007. Web.

Reinhart, Carmen & Rogoff, Kenneth. Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison. New York: University of Maryland and the NBER. Print.

Shiller, Robert. Irrational Exuberance. Princeton, NJ: Princeton University Press, 2005. Print.

Sutton, Gregory. “Explaining Changes in House Prices.” BIS Quarterly Review 2002, 46-55. Print.

Talbott, John. Sell Now! The End of the Housing Bubble, New York: St. Martin’s Griffin, 2006. Print.

Wolf, Martin. “Keynes Offers Us the Best Way to Think About the Financial Crisis,” Financial Times, 23 December, 2008. Web.

White, Lawrence, “What Really Happened?” Cato Unbound, 2 December 2008. Web.

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