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Recession in the US Economy in 2007 - Essay Example

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Summary

The paper "Recession in the US Economy in 2007" states that the US economic recession of 2007 was manifested in the form of a liquidity crisis caused by a plummet in real estate pricing and consequently the collapse of the US subprime mortgage industry…

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Subject: Macro & Microeconomics
Type: Essay
Level: Masters
Pages: 1 (250 words)
Downloads: 2
Author: gmurazik

Extract of sample "Recession in the US Economy in 2007"

While the 9/11 tragedy was unfavorable for many investors who had invested in treasury bills, it provided an opportunity for investment banks to borrow money at this low-interest rate and invest in the real estate industry where they would get good returns. In this case, the bank would turn the borrowed money into securities that it would sell to homeowners and get regular payments from all those mortgages. Initially, this turned out to be a highly profitable venture for both the lenders and the banks with up to 10% return on investment.

However, with time most people who could afford a mortgage had taken one and this caused a reduction in the number of new mortgage applicants. This compelled the banks to open up mortgages to other potential homeowners by removing all restrictions on securities. This encouraged many homeowners to take up mortgages. Unfortunately, many could not afford to repay the mortgages. This led to a high number of defaulters and higher-than-expected home foreclosure rates. Suddenly, there were too many homes up for sale in the market which exceeded the demand thereby resulting in a decline in the home value.

Role Played by the Financial Market
The financial market had a major role to play in the 2007 great recession. First, the low-interest rates offered by the central bank in response to the 9/11 tragedy fuelled the already rising housing bubble by the subprime mortgages and the related derivatives. In addition, the absence of regulation of the financial institutions involved in the sub-prime mortgage lending led to unprecedented growth of the real estate market and so did fraud. The bursting of the housing bubble led to the meltdown of the three principal derivative securities that had guarded the industry, namely Collateralized Debt Obligation (CDO), Mortgage Backed Securities (MBS), and Credit Default Swap (CDS) which eventually paralyzed the very supple and resilient financial market with its spill over into the entire economy. Read More

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