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Cause and effect - Essay Example

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A lot of economists consider the crisis of 2007–2008, also known as the Global Financial Crisis, to be the worst financial crisis since the Great Depression of the 1930s (Reuters, 2009). Its roots, however, lie in a more local phenomenon – the US mortgage crisis which…
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Cause and effect
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Download file to see previous pages Some economists believe the crisis to be a result of economic cycles which are impossible to resist. There is, however, another theory, which considers the crisis to be a result of a new policy of credit accommodation. That is also the theory the paper focuses on.
Most banks and mortgage lenders offered 100 percent financing of a price for a house (or even more). As a comparison, most world banks currently finance approximately 85 percent of a price. This was a really advantageous credit for borrowers – they received an opportunity not only to buy a house, but also to renovate it. However, such a loan was quite risky for lenders. A house could have been sold only for lower price in case a borrower failed to pay the loan back. Thus, the investment becomes lossmaking. However, the number of such deals was constantly increasing. As a result, both banks and estate agencies were financed by investment banks.
Another factor was that mortgage rate was not stable. It was dependent on LIBOR, the average interest rate that the average leading bank would be charged if borrowing from other banks (Bischoff & McGagh, 2012). Benefits are obvious – borrowers expected their loan interest rate to decrease in case general situation is being improving. On the other hand, lenders expected it to grow together with the percentage.
Thus, mortgage-lending system of the US in 2006-2008 was dependent on LIBOR index. It was acceptable when the index was a little bit increasing or slightly decreasing, though both parties were interested in its stability. However, LIBOR index turned to be quite changeable and instable in practice. It was about 6 percent by the end of 2007. What is more, it was continuously growing. As a result, borrowers were unable to pay back their loans. Investment banks bore thumping damages.
That is how the US mortgage crisis appeared. Its effects may be felt even now. That is what set off chain reaction of ...Download file to see next pagesRead More
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