Financial Crisis in the United States - Case Study Example

Topic: presentation: Introduction Financial crisis in the United s began back in 2007. Early in the year, there happened to be an excess of residential houses for rental purposes in the United States. This led to a drop in their prices. The time for loan repayment by the loaned to the respective banks was due and they had to start submitting their monthly installments. This came at a time when rental prices had come down, with many customers unable to reinstate their mortgage. This caused banks to face a difficult time after customers failed to repay their loans. The expectations of house owners dwindled, and many of them had to turn to other means of earning income as the houses were unable to fetch anything substantial as anticipated. There was a rise in the number of discarded mortgages which were viewed by customers as an additional burden, for the fact that they cost monthly payments that were higher than the net worth of the houses. Before this phenomenon, came in to being, lenders enjoyed the honorable responsibility of customers repaying loans effectively. During this time, promises made by the customers to the lenders were never realized, with the customers opting to leave elsewhere, far away from their houses. Repayment of the loans would have had a negative impact on house owners, who would submit monthly installments towards payment of unprofitable ventures. The customers never minded maintenance of their credit worthiness to their lenders. It was viewed as a venture that could lead to insolvency. Insurance companies plunged in to high debt levels amounting to billions of dollars. There is no guarantee that shareholders will get the anticipated payments for their bonds and no more bonds are being offered by banks in the market since there is no one to buy them for fear of never getting paid for the ones they buy. This has led to a decrease in the working capital of banks since bonds are a major source of their capital. All this has led to the prevailing economic crisis in America. Reasons that caused financial crisis in the United States The existence of a simple lending system caused an extravagant purchase of property by citizens. They could buy costly houses with loans, regardless of whether under the normal circumstances; they belonged to a class of such spending. The rules that existed then concerning land use made the owners of the land to hike the prices due to the high demand that was prevailing in the market during this time. These two aspects really contributed to the financial crises in America. High mortgage was mainly due to restrictions in land use in a number of urban markets as well as boundaries of metropolitan growth. They caused a rise in the price of houses to unexpected levels. A small rise in prices of homes was only experienced in the areas where the land regulation was not strict (Wendell Cox, page 16-21, 2008). The major cause of the financial crisis was the issue of housing. Reckless lending was being practiced all over the United States. Accessibility to loans and mortgage was the major driving force for the rising need for homes. Earlier on, the lenders were employing stringent measures for one to qualify for a loan. During this time, people who were until that time not qualified for a loan were allowed to apply. To qualify for a loan, a person was supposed to have minimum monthly earnings of $5,000 that satisfied the underwriting procedures. Many mortgage lenders contributed to the crisis. They would give loans regardless of whether the customers could afford to secure. Most of the loaned people were unable to pay for their mortgage which led to a rise in the number of defaulters creating a situation whereby the lenders could not afford to cover in their provisions. Many lending firms failed because of this occurrence. Bear Stearns and Lehman Brothers were examples of companies that failed because of this extent of defaulters (Wendell Cox, page18, 2008). Appraisals coming from incompetent house appraisers were a common phenomenon, whereby the appraisers never made real house comparison to existing house values. They are said to have been passing by the house instead of making appraisals through the standard ways of valuation (Denis Bider, page 31-36, 2008). Excessive land use regulations were a major cause of the high prices of mortgage. According to, Wendell Cox (page 26, 2008), “The immense share of the additional rise of house prices in the United States and mortgage coverage depending on income has took place in the limiting land use markets”. These restrictions in land use accounted for major rise in house prices as high as 80 percent. The mortgages became over inflated. The interest rates were low on the mortgages during lending but later stabilized at the normal rates after two years. The new rates became a burden to the customers, especially the ones with insufficient income to pay for the mortgage. Due to this, foreclosures arose in the housing market, causing a fall in the housing prices. The problem was further amplified by the fact that mortgage insurers hardly ever kept them. They instead they sold them to entrepreneurs who may be interested in investing in the mortgages. This led to further borrowing since the mortgage owners would sell them at a profit, and then borrow some more loans. Excessive land use regulations restricted the supply markets resulting in severe financial crisis. If this restriction would have been moderate, the losses attributed to mortgage could have been much less. Wendell Cox (page30, 2008) further states that, “As an alternative of a more than $5 Trillion housing bubble, a more possible situation would have been at most $0.5 Trillion housing bubble”. This was a loss that could have been handled by the investors and the financial markets. The process of applying for mortgage was characterized by a lot of dishonesty amongst mortgage brokers and the customers. Deceitful information was largely offered to the mortgage brokers by fervent customers in order to acquire mortgages. This led to a distorted representation of the customers by the mortgage brokers to banks which most of the time never took trouble to authenticate the information provided to them. This was a problem that was initiated by the banks which aimed at lending as much as possible to willing borrowers in order to acquire maximum interest. The banks viewed this as a golden opportunity to expand their markets. This was counteracted by unnecessary and fraudulent borrowing. The citizens borrowed loans devoid of a second thought to purchase homes, motor vehicles, appliances and shares in the stock market with encouragement from banks. These sectors turned out to be so overblown that they could no longer meet the desires of the owners. Almost every body is affected by this crisis. It is not only banks that faced this crisis, but even other financial establishments. The repercussion was felt in insurance companies, pension schemes as well as other communal funds. The financial crisis in America have also been largely brought about by the existence of conducive environment for investment, making investors from all over the word to bring so much money in the United States of America to invest. Starting a business in America is easy compared to many other developed nations. Taxes and bureaucratic processes discourage people from investing in countries other than the United States thereby saturating the market. Security risks, corruption and political instability that are absent in the United States makes it a haven for investment. Other issues such as barriers in the language of communication, lack of skilled labor force and lack of rule of law are not problematic in the United States. All these factors have contributed to the financial crisis in the United States due to the financial overabundance (Denis Bider, page 36-41, 2008) In 2002, the low short term rates encouraged borrowing by the citizens for investment. This led to so many investors within the same market. With supply rising above the demand, investors could not make much out of their investments. This led to the inability to repay their loan. The short term rates have largely contributed to the financial crisis. There lacked a state regulation system that could check on the mortgage finance establishments that are non-depository. Due to this, lending of money by banks was not done under any serious investigations in order to confirm the legibility of the borrowers. There was a clear absence of checks and balances within the banking system, which could be attributed to ravenousness by the banks in order to get the maximum interest possible from the mortgage borrowers. The Credit Default Swap (CDS) market lacked regulation that has played a role in the current financial crisis in the United States. The un-regulated Credit Default Swaps were providing uncertain mortgage bonds with insurance. This promoted irresponsible behavior during the time when mortgage was being offered by banks (Jorge Costales, Fox, pars. 6-7, 2008). Without the CDS readily available to offer insurance on these uncertain mortgages, companies could not have risked insuring such property; hence the mortgages could have been stopped before it had gone too far. There were no existing leverage control on savings banks and hedge funds and therefore they were operating at a considerably soaring economic leverage proportion. Leverage control could have assisted in ensuring that they do not lend to an extent of risky levels or fall in to the prevailing financial crisis that was caused by a general and considerable undervaluation of the imminent jeopardy. There was reckless buying and selling of loans. Since the lending principles were predetermined in the loan policy and system manuals, they were assumed to be the same all through the mortgage industry. Buying and selling of mortgages by lenders was done with the assumption that the regular underwriting procedures had been completed from the initial lender. These negligent lending actions has caused commercial banks, mortgage companies, investment banks and insurance companies to incur heavy losses that rose to the tune of billions of shillings because of negligence of underwriting principles (Denis Bider, page 56-58, 2008). Conclusion The financial crisis in the United States has caused a situation whereby banks have been compelled to encourage other nations to bring in capital. The Middle Eastern and Asian sources have been noted to have recently introduced substantial capital to buy shares in the largest American banks. The Euro is currently being accepted in several shops in the United States for payments. This is a sign of the effects of the financial crisis facing the United States. It is an indication of a weakening economy. Banks have been compelled to cut back on credit. Exports have greatly been affected by the weak dollar, and exporters are loosing confidence due to their thinning income on exports. The public has reduced consumption and spending and this has hurt the market. There exists a notable balance of payments with an insignificant budget deficit. Banks are incurring billions of losses, and this is really proved to bring a calamity in the banking system since there are still further forecasts on losses. Bibliography 1. Denis B. Financial Crisis Attributed to Mortgage. New York: Knopf, 2008. 2. Jorge C. “Deregulation vs. a Lack of Regulation.” 2thinkgood.com, 11. Oct. 2008 23.Nov.2008 3. Wendell, C. “Root Causes of the Financial Crisis.” Primer Magazine, Oct. 2008. Read More