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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number Causes and effects of the US Mortgage Crisis 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 began in 2006. The aim of the paper is to discuss causes and effects of the US mortgage crisis and to demonstrate how it led to the global economic crisis of 2007–2008.
The impact of the US mortgage crisis over property market and property investment market was really huge. There is no agreement of opinion concerning its reasons. 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 global financial and economic problems. Investments banks were the first to feel its impact – a number of them became bankrupt around the whole country. This meant a catastrophe for the largest world banks, such as Deutche Bank or JPMorgan. They suffered sufficient decrease of their share value and bore huge expenses.
All of this led to global financial crisis. A lot of banks around the whole world went bankrupt. Others had no other choice but to change their policy. Economy was influenced as well, especially oil and industrial market. Maximum price for oil was reached in 2008 – 147$ per barrel. Prices for gold were increasing as well. The whole situation was only expected to worsen.
Effects of the US mortgage crisis were also felt by ordinary people. The unemployment rate rose to 10% by late 2009 – almost 15 million people were out of work (for comparison, approximately 7 million were unemployed in 2008) (Fred, 2013). Housing prices fell approximately 30% on average from their mid-2006 peak to mid-2009 (Fred, 2013). In total, the US total national debt rose to over 103% by the end of 2012 (Fred, 2013).
Thus, the US mortgage crisis set off a negative chain-reaction of financial and economic challenges. Among its causes there are wrong direction of credit accommodation policy and instability of LIBOR index. As for its effects – it gave rise to the global financial and economic crisis. Its consequences may be felt even today. What is more, they are far from being eliminated.
Works cited
Fred Database. Federal Debt: Total Public Debt as Percent of Gross Domestic Product. Retrieved August, 2013.
Fred Database. S&P Case Shiller 20-City Home Price Index. Retrieved April 2013.
Fred Database. Unemployed. Retrieved April 2013.
Three top economists agree 2009 worst financial crisis since great depression; risks increase if right steps are not taken. Reuters. February 29, 2009. Retrieved September 30, 2009, from Business Wire News database.
Victoria Bischoff, Michelle McGagh. What is Libor and what did the banks do to it? CityWire, 29 June 2012. Web. Read More
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