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The Current U.S. Economic Crisis and Potential Fixes - Essay Example

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This paper carries out an analysis of how and why the crisis occurs and it evaluates the effectiveness of current measures used by the government to solve this crisis. Major Banks in the United States and Europe have recently suffered significant losses as a result of the recent credit crisis. …
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The Current U.S. Economic Crisis and Potential Fixes
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Download file to see previous pages The outbreak of the recent sub-prime crises came after warning signals of write-downs in the value of mortgages late last year6. House prices in the U.S witnessed an unusual growth between 1997 and 2005. For example, prices increased by approximately 85% during this period. The period 2001 and 2005 witnessed the highest rates of appreciation7. Sub-prime delinquencies and foreclosures were therefore mitigated by house price appreciations during these years. This is so because borrowers facing difficulties to make regular mortgage payments could depend on the appreciation of the value of their property to solve their financial problems by refinancing the mortgage and withdrawing cash from the increased equity in the house thereby sustaining the new mortgage for a while. Borrowers could repay the principal by selling off the property8. Appreciation in property prices therefore significantly improved the performance of sub-prime loans9.
However, Ellis (2007) argues that house prices began to decline in 2006, and as at October 2007, prices were down by approximately 3.2% of their peak in the second quarter of 2006. Banks and financial institutions were expected to face an uphill earnings battle early this year. "certainly, we will not be at the levels of profits we saw within the last 12 months". This is a quote by Mark Batty, a financial services analyst at PNC wealth Management Philadelphia, which manages about $77billion of assets10. According Ellis (2007) investment banks and brokerages in the S&P 500 such as Goladman Sach a member of the Fortune 500 and Merrill Lynch a fortune 500 member as well were expecting to experience a 10% decrease in earnings growth in the fourth quarter of 2006. Diversified Financial firms like Citigroup...
From the report it is clear that sub-prime delinquencies and foreclosures were therefore mitigated by house price appreciations during these years. This is so because borrowers facing difficulties to make regular mortgage payments could depend on the appreciation of the value of their property to solve their financial problems by refinancing the mortgage and withdrawing cash from the increased equity in the house thereby sustaining the new mortgage for a while. Borrowers could repay the principal by selling off the property.
This essay stresses that banks are currently facing declining demand for mortgages and home equity loans as well as rising illiquidity and foreclosures among home owners. Bank of America recently announced its intention to get out of the wholesale mortgage market and it is planning to retrench 700 workers following a huge drop in earnings. The demand for asset-backed loans such as commercial paper has witnessed a drop. Financial services firms depended a lot on real estates as a means of backing their loans to debtors. Companies and financial institutions rely on these loans to raise short-term loans and a fall in demand implies that earnings to financial institutions will remain under pressure. The evidence suggests a significant relationship between “policy-induced” driving up of U.S silver and Chinese exchange rate appreciation and price deflation. The reversal of the silver flow into Shangai led to a credit crunch in the city.


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