Mortgage Inflation in the United States - Research Paper Example

Mortgage Inflation in the United States Introduction The world economy is still suffering from the repercussions of the economic crisis of 2008 which started as a result of housing crisis in United States of America. At the start of the millennium economic prosperity of United States was admired by everyone in the world and the housing sector was growing with prices increasing every day. But this prosperity was short lived as mortgage companies started given out loan to people against houses. Prices were expected to rise so loans were given even to people who could not afford those loans. The term mortgage inflation refers to the increase in installments of mortgage payments. The increasing inflation caused the housing prices to increase and along with the rise of interest rates mortgage rates also increased. The mortgage rates increased so much that at a point most borrowers were not able to repay their loans and they defaulted. This started the mortgage crisis in United States. The bursting housing bubble then led to the recession of 2008. The side effects of the recession were global and common people were affected as the result as prices increased and employment decreased. The solution lies in the tighter regulations regarding mortgage and investment companies. Mortgage Inflation in United States The housing crisis of 2008 was actually the starting point of a global recession with which the world is still fighting today. In this essay we will attempt to explain housing crisis and economic recession of 2008. Also the side effects of recession and possible solutions will be discussed. Causes of United States Housing Bubble During early 2000 US economy was doing very well and the housing sector was growing significantly. Housing prices increased by around 124 percent between 1997 and 2006 (The Economist, 2007, par. 2). The demand of house in United States was driving the prices higher and higher. The increasing demand of houses was due to the subprime mortgages. Mortgage companies were given out loans to people who couldn’t afford the loans. These were riskier loans that were made to people who had bad credit history. Subprime loans were actually increasing the demand of houses in United States and this was in turn increasing prices of houses. This is how a housing bubble was created that was based on the weak foundations of subprime lending. In these ‘good’ economic times inflation was also increasing and therefore interest rate were also higher. In order to entice people to buy homes mortgage companies started given out mortgages that initially required the borrower to pay less than the market interest rate and more at a later stage. This also added to the housing bubble. The bubble eventually burst when people were not able to pay back their loans and their houses were foreclosed. When the foreclosures increased the prices started to fell because demand was less than the supply of houses due to high mortgage rates. People were not willing to buy houses at higher rates. The value of houses decreased further and foreclosures increased because more people were not able to give back their loans. This led to the burst of housing bubble in United States. The states that were most affected by the mortgage crisis were Florida, Michigan, California and Arizona. These states saw a great increase in prices in houses and they suffered the most when the housing bubble burst. Causes of Recession The economic recession of 2008 is closely linked to the housing bubble in United States. Mortgage companies partnered with investment banks and created mortgage backed securities and other instruments. Through these instruments they sold the mortgages to investors of the whole world. The payments that were expected to come from the mortgages were sold to the investors. In this way mortgage companies and investment bank passed their risks to the investors. In 2007 around $986 billion of CDOs were floated in markets all over the world (Capone, 2007, pp. 7). Stock markets today are integrated and online trading allows investors from all over the world to take part in trading activities. This made CDOs end up in the hands of MNCs and other large investors. Again these CDOs were dependent on the money that was coming from the mortgage owners. When these people defaulted on their loans, it created a worldwide panic because everyone who invested in CDOs lost money. These CDOs were also considered safe investment because they were given excellent ratings by rating companies (Buttonwood, 2007, par. 3) therefore people had invested heavily in them. This made the recession global as companies all over the world lost money. Then mortgage companies started defaulting because they were not getting mortgage payments and investment bank also suffered heavily. This started a panic that swept the world and investors lost confidence in the markets. When stock markets went down everyone lost their money and companies who had investment in stocks started laying off employees. In this way a worldwide recession started. Side Effects of Recession Stock markets today are integrated and not only companies but also countries hold stocks in different geographical regions in order to diversify their risks. When CDOs defaulted people lost money and they became watchful in investing their money. The investment banks like Lehman Brothers announced bankruptcy investors lost all confidence in stock markets and stocks markets plummeted. United States government was forced to bail out AIG and some other investment banks in order to avoid mayhem (Norris, F. 2008). This pained everyone as today large companies, bank, and countries hold stocks as investments. When they were hurt they started to cut costs by increasing prices and laying off employees. This increased inflation and people now find it difficult to buy things of necessity. After the crisis there was a surge in food prices. People who became unemployed started to consume less and this decreased demand more. In this way the world was caught in a vicious cycle where unemployment was increasing alongside with increase in inflation. Growth rates of the developed world steeped and economies came on the verge of shrinking. These are the side effects of the economic recession of 2008 with which the world is still fighting today. Solutions It is high time that countries start to think how we can avoid such crisis in future. We can only avoid such crisis by increasing regulations in the investment banking sector and the mortgage industry. In the housing crisis of United States people were given out homes without even a down payment. This allowed them to easily walk away from the houses when prices decreased. This can easily be avoided by introducing tighter regulations with regards to mortgages. Investment banks should also be regulated and they should not be allowed to sell toxic securities to investors. A proper check and balance system should exist and only then we can curb such crisis in future. Lending companies should not be allowed to lend beyond a point and high cash reserve ratios should be maintained by the banks. Economies all over the world should attempt to generate employment by encouraging people to start up small and medium enterprises. Employment generation can only solve the economic crisis the world is facing today. Growth should be the main focus of economies. Investors should be motivated to investment through tax cuts and other incentives. This can hopefully solve the crisis. Conclusion The housing bubble eventually led to a global recession that was caused by the subprime lending and selling of toxic investments like CDOs. People were made to buy mortgages even when they couldn’t afford one. This was the precursor of the housing bubble. The housing bubble was nothing but an artificial increase of prices of houses. The bursting of the bubble led to the financial catastrophe of 2008. The side effects of the crisis include higher inflation and lower employment rates. The crisis has actually made life of common people all over the world miserable. The solutions of the crisis lie in tighter regulations with regards to mortgage and investment companies. Economies should concentrate on growth and increasing employment as these two things can solve the current crisis. The future of Miami is not hopeful as Florida was one of the states that were hurt badly after the crisis. Miami has to see higher inflation and lower employment in future as well. Better regulations can help Miami avert another such mortgage crisis. Works Cited Page Buttonwood. Credit and Blame. The Economist, 2007. Web. http://www.economist.com/node/9769471?story_id=9769471 CSI: Credit Crunch. The Economist, 2007. Web. http://www.economist.com/node/9972489?story_id=9972489 Norris, Floyd. Another Crisis, another Guarantee. The New York Times, 2008. Web. http://www.nytimes.com/2008/11/25/business/25assess.html?hp Parisi-Capone, Elisa. Collateralized Debt Obligations (CDOs): An Introduction. RGE Monitor, 2007. Web. http://media.rgemonitor.com/papers/0/template_CDO_brief_0307-links.pdf Read More