Macroeconomics - Term Paper Example

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The prevailing economic slowdown in US and the world has emanated from the subprime mortgage crisis in the US. In the US, the subprime crisis got started due to the imprudent lenders, mainly the subprime lenders disbursing loans to entities or individuals who were undeserving of loans and had low ratings in terms of credit worthiness…
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Macroeconomics Term Paper
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Download file to see previous pages The housing market like any other market follows the basic supply and demand laws. Demand means the amount of good consumers demand at a certain price. While supple means the amount of goods the suppliers/ produces are willing to supply at a certain price. Generally when there is a price rise, demand falls and where as supply increases when there is higher price (supply and demand, 2008). But incase of the US housing market there was almost abnormal rise in the prices and then a sudden fall ushered in from 2006 onwards. This was preceded by a stable housing price environment in most parts of the 1990s while an increasing trend was witnessed towards the end of the 1990s. Housing prices rose by a whopping 87% during the period January 2002 to June 2006. While the sudden decline started in 2006 and gathered enormous proportions in the years 2007, 2008 and is still continuing. Housing prices were down by roughly 25% in 2008 third financial quarter in comparison to the peak levels of 2006.
During the middle part of the 1990s governmental regulations in relation to lending norms were relaxed drastically and ensuing regulations followed which made it mandatory for housing loan institution like Fannie Mae and Freddie Mac to increase their share of US mortgages belonging to middle as well as low income families by significant levels. During the era 1999 US federal rules also made it sure that these two institutions which hold a major portion of the US mortgages accepted greater amount of loans but with minimal and in many cases, absolutely no down payment. Almost a similar kind of regulation was passed in the year 1995 in context f bank's landings through which they were made to lend heavily to minority sections of the population in the vicinity of the banks in the process prudent lending mechanisms and evaluation of credit worthiness were overlooked. This was the 'Community Reinvestment Act'. Testimony to the afore mentioned fact Fannie Mae and Freddie Mac's overall share of mortgages under their holding went up to 45% in the year 2001 from only 25% in the year 1990. This fact is shown in Fig.2. It is also evident from the figure that how these two institution's share of the outstanding mortgages went up continuously throughout the 1990s and also almost through the 2000s.
Fig.2. Outstanding Mortgages and Fannie Mae and Freddie Mac's share of them.

Source: Gwartney, et al.

Interest rate manipulation
During the period between 2002 and 2006 the US Fed ushered in an extended low interest rate phase. As a result of the ensuing low rate scenario there was a huge demand for the houses and consecutively the prices also soared in the sector.
Fig.3. 1-Year Treasury Bill Rate & Fed Fund Rate

Source: Gwartney, et al.
Fig.3. shows that how the fed had kept the interest rate for ...Download file to see next pagesRead More
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