Mortgage Crisis in the United States - Essay Example

Finance and accounting mortgage crisis in the U.S.A. al Affiliation) Introduction The 2007 financial crisis set in as house prices began to fall and the number of foreclosures increased to extreme levels. In turn, it led to rating agencies to under grade their risk assessments of financial instruments. Since the level of risk became so high, ability of insurers of these financial products to cater for interest was restricted. There was a reflection that realization that bursts the United States housing and credit bubbles would contain unpredicted losses for asset based financial assets. In between the third quarter of 2007 and the second quarter of 2008, valuables of mortgage based security officers received difficulties to reflect the reassessment of their risk (Hagerty, 2012). This led to an immediate and intense disorientation of the financial markets. The International Monetary Fund Report (IMF) During its semiannual worldwide financial report released on 8th April 2008, the paramount statue of international finance analysis (that is IMR) stated that the collapsing house prices and rising queries in the residential mortgage market or arena losses of approximately five hundred and sixty five billion US dollars. When these factors are combined with other declines from other areas of loans originated and provision of security in the United States of America that relates to commercial real estate is indicated by the International Monetary Fund to gather a loss of about nine hundred and forty five billion US dollars. This was shocking as it was the first time that the International Monetary Fund was approximating the extreme losses incurred by banks and other financial institutions in the United States. As indicated earlier, this credit crunch started in the year 2007 and led to the increasing number of defects on the subprime home loans. The main mission of the International Monetary Fund is to facilitate and promote international financial stability. Factors that led to the mortgage crisis There are various examples of theories that led to the mortgage crisis. Numerous experts and economists concluded that it happened due to the combination of a number of factors that are listed below: Housing bubbles Since it had easy money policies, the Federal Reserve allowed the housing prices to increase up to unsustainable levels. The bubble bursting led to this unfavorable condition. The current mortgage crisis began with the bursting of the bubble house in 2001 and reached its optimal point in 2005. Housing bubble refers to an economic bubble that occurs in local and international real estate markets. Occurs when there is a rapid rise in the valuation of real property to levels that are unsustainable in relation to income and other sources of affordability. When there are such rapid increases there is a subsequent decline in home prices and mortgage debt that is greater than the actual value of the property. Housing bubbles are identified easily after there is a market correction done, and this occurred in the United States of America in the year 2006 (Hagerty, 2012). The chief executive officer of Federal Reserve once stated that it was unfortunate for the late realization of the problem of bubble in housing. The value of a house should not be raised to standards that are unaffordable to potential clients. Securitization Definition of this term is, a structured finance process where receivables, assets (fixed and current) or monetary instruments are acquired, grouped into pools and there after offered as security or collateral for third party investment. This concept substituted an economical concept, which reduced lenders’ probability to be prudent where there is heavy investment. Ownership of mortgage- backed securities and the tendency of rating investment grade was widely dispersed. This caused difficulties throughout the global system when the subprime loans extremely reduced in the year 2007. The issue of global imbalances The concept of global financial flows has been identified in the current years by unsustainable formations. Some countries such as Japan, Germany, and China operate large surpluses in each fiscal year while other countries such as United Kingdom and United States operate in deficits. Unfortunately, the United States deficits are reflected by the internal deficits in the household premises and government sectors. The resulting complications underlie the recent financial problems since the United State will be unable to borrow indefinitely (Hagerty, 2012). The low interest rates Several prominent economists are convinced that the United States housing bubble was due to essential issues such as reducing the short-term interest rate from about 6.5 percent to 1 percent. The Federal Reserve Board agreed that the housing bubble was at one point facilitated by the ignorance in real long-term interest rates. The mortgage rates are always related to the Treasury bond yields, which are in turn affected by the federal funds rate. Acknowledgement is done through the connection between lower interest rates, increased liquidity, and higher home values that constitute the economy. Irresponsible mortgage lending As opposed to a backdrop of a lot of credit, increasing house prices and low interest rates made the lending standards to maintain at points where the result was that citizens bought houses that they could hardly afford. When it reached a time that the prices were falling and the loans were unfavorable, there was an extreme shock to the financial system. Inadequate transparency and accountability in mortgage finance Within the operations of the housing finance value chain, various participants do contribute to the making of bad mortgages and the selling of unfavorable securities. This happens when one has in mind that he or she will not be held accountable for the illegal activities they get involved in economical parameters. A lender could risk selling an exotic mortgage to homeowners without any guilt that the operation might fail. It is therefore vivid that the market participants such as brokers, lenders and individuals in rating agencies are always after gaining their own interests fully while passing problems down the line until it will reach a point that the system will collapse and shut down. Because of the lack of accountability from consumers the market arena becomes a place of self-interest thus survival for the fittest (Nguyen, 2011). Shadow banking system Risky financial activities once approved to regulated financial institutions and banks that use of advantage and borrowing to short-term to lend long-term led to the migration of explicit government safety that is provided by deposit insurance and safety and soundness regulation. In particular, mortgage lending moved out of banks into unregulated financial institutions. This illegal and inappropriate risk taking is added to bubble house crisis. The defect of off-balance sheet finance Several banks adopted the methodology of off-the-books special purpose accounting entities including well-structured investment vehicles to carry out illegal and risky forms of investments (Nguyen, 2011). This operation gave various banks an opportunity to make several loans during expansion that also created sensitive liabilities upon the onset of the crisis. Market confidence in the banks and financial institutions became creditworthiness. Since the banks were allowed to hold little capital against the potential losses, the investors therefore had little ability to understand the banks’ true financial position. The government provided some mandates that facilitated subprime lending. These federal mandates were put in place in order to help low-income borrowers to access some of the expensive houses. An example of the mandate was the community reinvestment act. Eventually, this forced financial institutions and banks to engage in irresponsible mortgage lending. The problem of irrational exuberance This concept played a major role in the housing bubble. It can simply be defined as an advanced or uncontrollable state of hypothetical commitment (Nguyen, 2011). All participants such a mortgage lenders, investment bankers and government regulators who took part in the housing bubble operated on the assumption that home prices would continue ascend. Since the house prices did not, fall people were still optimistic for stability led to the effect of house bubble. Complexity and bad computer models Some financial instruments were extremely complex and this led to some three effects namely; risks of market transactions were covered, some of the regulators were puzzled and investors were not able to make personal judgments on the success of investments. Since the financial structures were complex at some points the ineffective computer models were unable to carry out technical operations. Those affected by the crisis The financial crisis in the United States that led to the subprime mortgage mess was a big blow to the economic condition of the country. This therefore means that everybody was affected by the crisis, that is, the government and citizens who were involved in the transactions plus the ones who never played any role. Due to this disorientation, the government had to raise the level of levies on taxes in order to try to cater for some intensive losses. Financial institutions and great economists were therefore forced to put their brains together at least to save the economic situation of the United State at that particular time of crisis. Major companies that was responsible for the mortgage crisis in U.S When the housing bubble crisis in the year 2008 took place, it led to the mortgage security collapse. This led to several credit crises that developed to a global financial crisis. Many critics were revolving in the United States that Fannie Mae and Freddie Mac were responsible for the crisis. In the beginning of 1968 when the Fannie Mae was chartered by the government of the United States to be a Government Sponsored Enterprise, then two years later Freddie Mac was also chartered for the same docket, things abruptly turned as least expected. Fannie Mae and Freddie Mac came up with a liquid and secondary market for mortgages. This led to a principle that selling of mortgages was possible in secondary markets shortly after originality. Eventually that methodology swayed away their funds up to a point that they could not produce additional mortgages. Freddie Mac and Fannie Mae had a great influence on the mortgage market that made them to constantly increase home ownership rates in the United States of America. Firms with structures of monopoly developed and this led to a great decline in the benefits that were provided. The effects of the mortgage crisis to the United States economy Enhancement of security damage The mortgage mess or meltdown greatly facilitates security damage. The housing price fall and the range of victims continue to expand. Foreclosures make the number of families that lose their own homes and increasing the homeless rates. Therefore, both renters and property owners will face the effects of the crisis. When the properties owned are lost, the tenants will absolutely be homeless. The increase suburbs becoming slums Surprisingly, has also increased steadily in the regions that are always occupied by the fortunate in terms of finance and stability at economic levels. This situation was greatly observed in Michigan and Ohio (Wachter & Smith, 2011). This elaborates that poverty rates are extremely increasing in the suburbs as compared to the cities. An increased employment rate Labor is a major factor of production. If it is inadequate in an economy this means that, the production level will fall. At that point, of time the population of idlers increased making the gross domestic product to depreciate. A fall in the chance of acquiring loans or credit Fast home loan approvals an effective access to credit commodities declines. People were doing this easily before approval and provision of the knowledge. After the required step, it was a little bit tricky for approval. Most citizens or entrepreneurs would view the burrowing of loan as a great burden (Wachter & Smith, 2011). Difficulties in the living conditions The impact of the crisis was greatly felt by the middle class. This was indicated by the fact that six out of ten Americans live to paycheck. Making ends meet was a great challenge. Rise in crime rate Most of the unemployed youths were involved in robbery in order to earn a living. The level of security reduced and people feared for their lives. Effect of the regulations on mortgage industries The United States has greatly benefited from the regulations. The case of house bubble is done away with completely. The leading industries in this operation are the International Monetary Fund and the Home Loan Mortgage Corporation (Wachter & Smith, 2011). References Courtemanche, C., & Snowden, K. (2010). Repairing a mortgage crisis. Cambridge, Mass.: National Bureau of Economic Research. Hagerty, J. (2012). The fateful history of Fannie Mae. Charleston, SC: History Press Michaelson, A. (2009). The foreclosure of America. New York: Berkley Books. Nguyen, T. (2011). Fraud and the Subprime Mortgage Crisis. El Paso: LFB Scholarly Pub. LLC. Wachter, S., & Smith, M. (2011). The American mortgage system. Philadelphia: University of Pennsylvania Press. Read More