Consumer Credit and Mortgage Finance - Coursework Example

The Mortgage Markets The Mortgage Markets Theory An individual family unit has financial commitments. Of all the financial responsibilities met by the individual family unit, mortgage is arguably the largest in most cases. It is also evident that the dominant method of financing housing today is through mortgage. To most of those who engage with a mortgage, they realize that this is one of the most complex securities in the financial markets world. This perception, though, varies from those who understand the process and those who don’t. For instance, for someone who sees the transaction accomplished speedily without the knowledge of the very involving critical decisions which have to be made during the transaction, it is a simple transaction. On the contrary, this consumer purchase is one which consists of a complex structure emanating from then combination of consumption, investments as well as a number of risks. The level of financial complexity and risks is profoundly contributed to by the utilization of a mortgage to finance a purchase of a home. Despite adding to the level of financial complexity and risks, when mortgage is used to finance a purchase of a home, it is substantially important in ensuring that the capital invested in in the provision of the housing services is paid. Regulation and Policies According to Organisation for Economic Co-operation and Development (2011), housing policies have a significantly important role to play in the improving the living standards of citizens, ensuring adequate housing of citizens as well as in strengthening economic stability. Access to housing opportunities are catered for by the housing policies making sure that everyone has equitable access to housing (Organisation for Economic Co-operation and Development, 2011). As innovations continue to be seen in the mortgage markets, the regulatory oversight should be appropriately provided by the as well as prudent banking services (Organisation for Economic Co-operation and Development, 2011). This has consequently resulted into increased access to credit as well as the lowering of the housing finance cost. Regulatory oversight is important in the mortgage market in order to make sure that the desired stability in the financial world is achieved (Organisation for Economic Co-operation and Development, 2011). Otherwise without its influence in the lending standards which ultimately regulates the rate at which the subsequent non-performing loans increase with, economic stability would be at risk (Organisation for Economic Co-operation and Development, 2011). Organisation for Economic Co-operation and Development (2011), observe that regulation is very important for preventing the volatility of mortgage investments. This is, however, dependent on the behaviour of the responsiveness to demand (Organisation for Economic Co-operation and Development, 2011). When demand is high, so should the housing supply. Whenever there is ineffective construction licensing procedures, this translates into incurring more cost on the procedures which are transferred to the prices of the houses passed to the consumer in the mortgage market (Organisation for Economic Co-operation and Development, 2011). The same effect is experienced when the country in which the developers of real estate are situated face land shortage challenge. Regulations with regard to the above mentioned factors play an important role therefore in making sure that mortgage markets remain in the desired operations achieving the desired results. Housing policies are important in the role they play in the facilitation of residential mobility (Organisation for Economic Co-operation and Development, 2011). In addition, it enhances the matching of workers with jobs. It has also profound contribution to the recovery process from a crisis. When housing supply increases when there is a high demand of housing, households mobility is affected positively. Following the eased access to credit, there is consequently a higher household mobility. This is chiefly because of the provision of housing options which are relatively easier to finance to the consumer. Another major determinant of residential mobility is the tenant-landlord regulations which go along with rent controls (Organisation for Economic Co-operation and Development, 2011). Easing the policies which are concerned with these would improve the supply of rental houses. Consequently, there is the increase in the residential mobility. Regulations aimed at limiting the competition that exists among intermediaries in housing transactions such as the real estate agencies plays a substantially important role in the in enhancing residential mobility (Organisation for Economic Co-operation and Development, 2011). This impact is also achieved through the restructuring of taxes involved in housing transactions. These two formerly mentioned determinants reduce high costs associated with the purchase of a home thus increasing residential mobility. Efficiency and equitability are the two chief achievements aimed at by housing policies. In this pursuit, taxing on housing is designed in such a way that it is the same as alternative investments (Organisation for Economic Co-operation and Development, 2011). This surely reflects equity achievement. In addition, policies guiding the relationship between the tenant and the landlord are designed to eliminate disproportional relationships between the two. In terms of achieving efficiency, low-income households have access to housing courtesy of housing policies. Organisation for Economic Co-operation and Development (2011) observe that this is made possible by the availability of portable rent allowances and social housing systems which enhance its achievement. Correlation Correlation is a relationships between two variables in such a way that their direction of movement either moves towards the same direction or the opposite directions (Valadez & Pepperdine University, 2010). When the direction of the movement of the two variable is the same, the correlation is considered direct or to be positive (Valadez & Pepperdine University, 2010). On the other hand, when the direction of the movement of the two variables is in the opposite directions, then the correlation is considered negative or inverse. In the mortgage markets, there can be correlation between diverse pairs of variables (Valadez & Pepperdine University, 2010). For instance, one can assess the correlation between Housing Price Index and the Gross Domestic Product. One can do this by examining the relationship between the two variables over a certain period of time in order to establish the nature of the relationship that the two variable exhibit. Also, one can assess the correlation between mortgaged backed securities and default rates. The above mentioned are just examples of numerous other variables which can be assessed for depending on the significance of the assessment. The significance of conducting correlation assessments is the to take lessons from the existing situations in the mortgage markets and using this gained knowledge in making critical decisions involving risks (Valadez & Pepperdine University, 2010). For instance, once one established the relationship between, for example, Gross Domestic Product and housing prices, his or her decisions in financial transactions will be significantly influenced by this background information that he or she have regarding the economic status in the situation. If there are any problems established through the assessment of the correlation between certain variable, there can be efforts of fixing the situation in order to prevent financial recession. Causality Causality is essentially the cause and effect relationship; that for everything to be there must be a cause to it (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). In the situation in the mortgage markets, it is important to evaluate the cause and effect relationship on certain variables. Causality forms the base for correlation assessments. One would also endeavor to establish the existence of causality between certain variables in the mortgage markets. For instances, one can assess the existence of causality between developments in the housing and mortgage markets and house price developments. The direction of the causality is also very important in determining the actions to take regarding financial decisions. When the direction of causality is towards causing a positive impact in the mortgage markets, it results into a positive correlation between the variable which were being assessed for the causality (Valadez & Pepperdine University, 2010). In addition, when the positive is towards negative results, the result of the causality is inverse correlation of the variables under evaluation. As the mortgage financial structure involves significantly varied risks which may as well confuse the consumers as well as the investors, understanding the causality between certain critical variables in a certain financial situation is profoundly important (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). Moreover, whenever one is committed in making an investment in which risks of suffering from losses due to lack of knowledge regarding the variables involved is high; criticality is of great essence (Valadez & Pepperdine University, 2010). One can only be critical if he or she possesses the knowledge of the causality between the most critical factors to be considered while making the financial decision. Major Event and Crisis There have been defining moments in the mortgage market. Highlighting some of the major ones in a chronological order will help to create a vivid trend of the mortgage markets in the last one century. To begin with, in 1920, almost a century ago, the world experienced a financial crisis which is known as the great crash (Retsinas & Belsky, 2011). Following this was in the 1987 financial crisis (Retsinas & Belsky, 2011). This shook the world’s financial structures within a horrifying 72-hours period of time. Its name Black Monday emanates from the day of its onset, which was a Monday ‘black’ to the financial world. It is reported that trillions of dollars were counted as losses which were associated with this financial crisis (Retsinas & Belsky, 2011). Consequently, this short period was followed by many years of a destroyed real economy. The Asian financial crisis of 1998 affected the whole world (Retsinas & Belsky, 2011). It started in 1997 when there was a fall in the demand for raw materials worldwide. Worst hit by this crisis was Russia which was then one of the leading commodities exporters in the world. Thus, the relationship of why Russia was particularly more affected than other exporters here is very clear. This also made the crisis to also be referred to as the Russian crisis of 1998 (Retsinas & Belsky, 2011). According to Retsinas & Belsky (2011), having substantial amounts of investments invested in Russia, several countries across the globe suffered the losses with Russia. Ultimately, the shock was felt in a significant part of the world when there was a decline in Russian economy. There is also the uncertainty crisis that affected almost all the financial structure in the whole world in September, 11, 2001 (Retsinas & Belsky, 2011). This followed what has been considered to be the worst terrorist attack in human history which was in the United States. The two building consisting of the world trade center, the twin towers were hit by hijacked airplanes. There was a simultaneous attack to the pentagon. This terror attack had profound financial impacts globally as investors as well as consumers were uncertain of the direction the response of the attack would take or whether subsequent impending attacks would have occurred. This, crisis, however, did not last long before financial structure adjusted to the aftermath of the attack and continued the financial cycle. In the same year, 2001, there was yet another bubble. This is the bubble which is referred to as the dot-com bubble (Retsinas & Belsky, 2011). Internet based companies along with other markets were profoundly affected by the crash and thus affecting the global financial structures. In 2007, a substantially large number of mortgages in the United States triggered a crisis (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). It reached its peak in the year 2008. This crisis was referred to as the subprime crisis. The loans which are issued to borrowers with low credit scores are the subprimes. These loans attracted many borrowers who went for mortgages making the consumption increase. Investors on the other hand worked to meet the demand of the consumer marker at the same time increasing the home values. Consequently, there was a house bubble which ultimately led to the popping up of defaults from the inflation created. There were huge losses as a result of the crisis and trillions of dollars were lost by major investors. According to Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009), bankruptcy and liquidating of bankrupt financial institutions followed this subprime mortgage crisis. The 2007-2008 Crisis The 2007-2008 crisis is popularly referred to in three terms. These terms are; ‘the subprime’, ‘the mortgage mess’ as well as ‘the mortgage meltdown’ (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). Earlier in the year 2006, steep foreclosures occurred which was the onset of the crisis. Key parties which could have prevented the escalation of the foreclosure were unable to control them which consequently lead to the mortgage market worsening in the year 2007. This resulted into a nightmarish financial crisis globally. As a result consumer spending was generally low. In addition, the role played by each party, the consumers, the lenders as well as the legislatures was profoundly important to decipher the causes in the pursuit to fix the crisis (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). According to the International Monetary Fund Report, in the year 2008 only, it had been estimated that approximately $1 trillion would be accounted as losses in the United States market alone (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). This figure would be a cumulative total of the losses suffered by loans originated and securities categories, which included the mortgage market. The mortgage market, as reported in the previously mentioned report, could lead to more than 50% of these losses suffered by loans originated and securities categories. This was estimated to be $565 billion, in the United States. Other loans originated and securities categories, mortgage markets excluded, could suffer losses which could see the cumulative losses to $1 trillion in the United States loans originated and securities markets. Consequently, every person who lived on earth could suffer approximately $142 (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). In addition, heavier losses could be experienced by banks which had been estimated to potentially carry more than half of all these losses. The International Monetary Fund Report continued and cautioned that these were merely estimates otherwise the actual numbers could have been higher (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). The 2007-2008 crisis is said to have been caused by a house bubble burst (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). The house bubble under spotlight here had started in the year 2011 and it reached its peak in the year 2005. Following the characteristics of this house bubble, after the burst there were loses of trillions of dollars which were valued in homes. This occurred in correspondence to the correction of the bubble. Subprime lending also has been observed to have played a significant role in the creation of the 2007-2008 crisis. As borrowing in order to own homes increased so did the demand for housing. Consequently, ownership rates increased to the peak in the year 2004. This is reported to be 69.2 percent from 64 percent in the year 1994 (Nadauld, Sherlund, & Board of Governors of the Federal Reserve System (U.S.), 2009). With high demand of owning homes, there was substantial fueling of the house prices increment as well as consumer spending. Consequently, there was the creation of ‘abnormal’ home value increments which had profound impacts to the mortgage markets. In addition, there was a huge increase in the United States household debt. Financial Analysis to the Mortgage Markets The financial analysis to mortgage markets in this paper will be on the first quarterly of the year 2013 in the United States context. According to the trend in the mortgage market in this first quarterly of 2013, there was shift of the markets in the seller’s favour (Delloite Center for Financial Services, 2014). There had been a weak buyer demand which is the major contributor of this shift favoring the seller. Demand for housing being weak interpreted to decreased responsiveness by real estate developers (Delloite Center for Financial Services, 2014). Consequently, having in their minds that the homes which were available for sale in the inventory of homes were few, consumers got competitive over the potential homes of purchase. Therefore, homes were observed to sell at a higher price and faster than the previous years. 86% of real estate developers experienced either constant or higher prices, which were observed to be the highest share which had been reported in the previous few years (Delloite Center for Financial Services, 2014). There were higher material costs which were as a result of limited supply of the materials when the increased housing started to respond to the increasing demand. However, sales were generally slow due to low inventory. This time seemed to change the normal trend in the mortgage markets in the United States. This is the same time when a one million mark was surpassed by annualized housing starts since the year 2008 (Delloite Center for Financial Services, 2014). In the first quarterly of 2013, there was also the improvement on credit conditions on prime mortgage which was higher (Delloite Center for Financial Services, 2014). Thus there was a continued households’ balance sheets improvement which was observed as a result of the influence by increased demand for subprime mortgages (Delloite Center for Financial Services, 2014). They continued performing towards the positive direction, with the employment of refinancing thus lowering their mortgage balance and improving in their financial footing. There was also a 25 percent increase in homeowner’s equity. Nontraditional mortgages demand was observed to make no improvement while demand for subprime loans by borrowers was observed to indicate an increase (Delloite Center for Financial Services, 2014). In addition, the increase indicated in the demand for subprime loans by borrowers was for the seventeenth consecutive quarterly (Delloite Center for Financial Services, 2014). A slow improvement was indicated in the asset performance in the first quarterly of 2013 (Delloite Center for Financial Services, 2014). According to Delloite Center for Financial Services (2014), with a 4.3 percent above average indication in the first quarterly of 2013 as compared to the earlier years since 1995-2005, mortgages which were delinquent had declined with a 6.8 percent. There was also an indication of a 3.7 percent decrease in the modifications of mortgages since the beginning of the year 2013 till the end of its first quarterly (Delloite Center for Financial Services, 2014). This was contributed to by the two hundred and thirty eight thousand and nineteen mortgages which were modified within that period (Delloite Center for Financial Services, 2014). There was a 10.7 percent decline in foreclosure starts indicated from the data provide from January to February. However, few days in the second month of the year was observed to have contributed to a significant extent in the decline from January to February. The Future of Mortgage Loans The future of mortgage loans is a profoundly important issue which needs to be assessed from a critical point of view. Scrutinizing loans is essential to make sure that people don’t suffer from bad loans as has been experienced in the past. It is however estimated that buyers will most probably have to pay more for loans compared to the period before the crisis (Retsinas & Belsky, 2011). This is partially contributed to by high value loans which are probable. Despite possessing high risks, the loans backing securities are likely to increase also in the future. Lending of loans is also more inclined to the nation rather than the private sector (Retsinas & Belsky, 2011). This is also the situation that is predicted in future and even more. Thus, the role that will be played by the private sector in lending loans is going to be relatively smaller compared to that played by the nation (Retsinas & Belsky, 2011). There is also the proposition of monogamous loans rather than those which have quality and time that vary (Retsinas & Belsky, 2011). References Delloite Center for Financial Services. (2014). U.S. Residential Mortgage Update. Netherlands: Author. Nadauld, T. D., Sherlund, S. M., & Board of Governors of the Federal Reserve System (U.S.). (2009). The role of the securitization process in the expansion of subprime credit. Washington, DC: Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board. Organisation for Economic Co-operation and Development. (2011). Housing and the economy: Policies for renovation. Paris: OECD. Retsinas, N. P., & Belsky, E. S. (2011). Moving forward: The future of consumer credit and mortgage finance. Cambridge, MA: Joint Center for Housing Studies, Harvard University. Valadez, R. M., & Pepperdine University. (2010). The housing bubble and the GDP: a correlation perspective. Journal of Case Research in Business and Economics, 3(1), 1-18. 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