The Global Financial Crisis of 2007 - Essay Example

Housing Policy Table of Contents Introduction 3 The Effect of the Global Crisis 4 Recent Global Financial Crisis and the Housing Problems 5 The Implications for Housing Policy 9 Conclusion 17 References 18 Bibliography 20 Introduction The global financial crisis, that hit the word economy hard, actually started to demonstrate its consequence in the middle of 2007 and continued till late of 2008. The significant outcome of this crisis was the drop in the global stock market indices. A large number of financial institutions have warped or been bought out and government administration in the rich nations had to approach with release packages to bail out their fiscal systems. A fall down of the US sub-major mortgage market and the turnaround of the housing boom in further developed economies had an upset effect around the world. The Effect of the Global Crisis (Shah, “Global Financial Crisis”). From the graphical representation, it is noticed that US real estate business was highly affected due to the financial crisis. What originated as a crisis in the US housing and mortgage markets; had infected other sectors and spread globally. Recent Global Financial Crisis and the Housing Problems The financial troubles that the worldwide economies face today came on the heels of two bubbles, one in the housing market and the other one in the credit markets. A plethora of several dissimilar factors added to the housing market bubble and also those tangled with the credit market bubble. The inflating of the housing bubble can be considered by home sales and home prices. Housing sales and prices had been rising at a quick speed since the early-mid 1990s, until the recession began in 2006 - 2007. Several household transactions indices have turned down from 10 % to 30 % worldwide and by as much as 40% or further in certain markets. Still the additional reserved losses in household worth turn out to be more important when an individual believes how household procurement is financed. Since housing sector is extremely leveraged, a preliminary 20% equity stake in a household, acquired over the most recent years have been in all possibility wiped out. Therefore, the perception that household ownership is a better source of revenue of wealth gathering has been a thoroughly misleading thought (Bardhan & Et. Al., “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions”). The subprime crisis crashed household dwellers financially which included both owners as well as renters. Proprietors with no mortgage debt were probable to be in the slightest susceptible situation, although if they had designed to comprehend their asset gains, these had lost the worth. Of the 112 million household units in the US, there were 75.5 million landlords engaged in 2007. Of these, 23.9 million houses were mortgage free that tentamounted to lesser than 1/3 of the entire set of proprietors (Bardhan & Et. Al., “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions”). Out of the 51.6 million households among mortgage debts, approximately 38% were spent as a payment further than 30% of their revenue on housing expenses and 14% spent more than half of their earnings on housing costs. These households are especially vulnerable to mortgage default (Bardhan & Et. Al., “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions”). Collateralized Debt Obligations (CDOs): CDOs can be referred as a category of prearranged asset backed security whose worth and expenditure results from an assortment of fixed earnings essential assets. CDOs founded on sub-prime mortgages have been at the centre of the global financial crisis (Nanto, “The Global Financial Crisis: Analysis and Policy Implications”). As per the IMF (International Monetary Fund) report as on February 2010, the crisis had four characteristics in familiar with other crises: 1) “asset price increases that turned out to be unsustainable; 2) credit booms that led to excessive debt burdens; 3) build-up of marginal loans and systemic risk; and 4) the failure of regulation and supervision to keep up with and get ahead of the crisis when it erupted” (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). The banks began to tighten the standards in the housing sector and requirement of larger down payment was mentioned. With the lenders in these markets requiring 20% to 25% of down-payment, many probable homebuyers were debarred from the market. These entry policies not only prohibited first-time buyers, but also the existing homeowners. They faced the problem of large down-payment and as a consequence housing prices destroyed much of their equity (Baker, “The Housing Bubble and the Financial Crisis”). The current sharp rise in housing prices in most parts of Australia have seen affordability for first time buyers as well as other buyers turning down. House prices and the affordability of home ownership fluctuated extensively in long term trends. In the short term, the prices fall as well as rise quickly. Affordability improves as well as declines not only when the prices fall but also when the interest rate goes down or the house hold income rises (Australian Government, “First Home Ownership”). By the end of 2007, real house prices had dropped by an additional 15% from crest. House prices in many of the appreciated markets had dropped by additional 20%. In addition, the rate of price turning down had gathered speed with prices in those cities declined at further 30% yearly at the commencement of 2008 (Baker, “The Housing Bubble and the Financial Crisis”). The rate of price turn down in the Shiller indices implied that the real house prices were to be reduced by more than 30% from their 2007 peaks by the end of 2008. This would mean a loss of more than $7 trillion in housing bubble wealth (about $100,000 per homeowner). The misplaced wealth is approximately equivalent to 50 percent of GDP of Australia. There is no way that an economy is able to observe a loss of wealth of this scale without experiencing incredibly serious financial stress (Baker, “The Housing Bubble and the Financial Crisis”). The housing financial fizz had started showing its effect in the year 2007, as the building boom led to so much of over-supply of houses that prices failed to support. The evidence vacancy rate changed from the leasing side to ownership units in 2006. By the fourth section of 2006, the vacancy rate of ownership entity was almost 50% over its peak. By the midst of 2007 prices globally had raised and began to stop descending. This process quickened through the fall of 2007 and continued till 2008 (Baker, “The Housing Bubble and the Financial Crisis”). A quick boom and burst in the housing market were the major reasons that had an impact upon the financial market as the declining house prices guided to foreclosures and delinquencies. These effects were enlarged by various obscuring factors together with the use of sub-prime mortgages, particularly the adaptable rate differed which guided to extreme risk taking. In the US, this was encouraged by the administrative plan intended to endorse home ownership, which was a valuable objective, but was overdone in retrospect. The extreme risk taking and the low interest monetary policy decisions were connected. (Taylor, “The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong”). Delinquency rates and foreclosure rates were inversely associated to housing price inflation during the period of 2003-2006. During the years of the swiftly rising housing prices, delinquency and foreclosure rates turned down quickly. As stated by John B. Taylor, “The benefits of holding onto a house, perhaps working longer hours to make the payments, are higher when the price of the house is rising rapidly. When prices are falling, the incentives to do so are much less and turn negative if the price of the house falls below the value of the mortgage. Hence, delinquencies and foreclosures rise” (Taylor, “The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong”). The Implications for Housing Policy (Cardarelli & Et. Al., “The Changing Housing Cycle and Its Implications for Monetary Policy”). United States, Denmark, Netherlands, Australia and Sweden emerge to have developed mortgage markets that permit households better entrance to housing associated financing, whereas households in continental Europe is likely to comprise of more restricted access to such financing (Cardarelli & Et. Al., “The Changing Housing Cycle and Its Implications for Monetary Policy”). The Federal policy seeks out to decrease revenue obstacles to homeownership with lower market rate loan programs. Certain loan programs of the Federal Government of US were Mortgage Credit Certificate (MCC) and Mortgage Revenue Bond (MRB). Since numerous consumers call for credit improvement that include costs to monthly expenses, such as mortgage insurance, lots of first-time buyers require higher interest rate subsidies that normally can be obtained by mortgage revenue bonds (Collins, “Pursuing the American Dream: Homeownership and the Role of Federal Housing Policy”). Federal support implicit or explicit for government sponsored enterprises (GSEs), such as Fannie Mae, Freddie Mac, Ginnie Mae, and the Home Loan Banking System, furthermore assist in smoothening the progress of the proficient flow of mortgage credit to borrowers, increasing affordability and dropping interest costs (Collins, “Pursuing the American Dream: Homeownership and the Role of Federal Housing Policy”). The tax code set up by the Federal government permits the borrowers to deduct the real estate taxes and the mortgage interests. If a tax payer’s income is high enough to justify itemized deductions, it will help reducing tax liabilities and therefore the family may devote the revenue to the monthly expenditures. The lower income taxpayers do not have enough revenue or tax liability to use these deductions (Collins, “Pursuing the American Dream: Homeownership and the Role of Federal Housing Policy”). The Federal Housing Administration (FHA) had played a very important role in homeownership policy through the financial instrument of high debt-to-income ratio and in providing mortgage insurance on loans with low down payments. Rural Housing Service (RHS) and the Veterans Administration (VA) formed similar loan guarantee programs. Such mortgages naturally engross high interest rates and bigger mortgage balances, however, these programs are likely to raise monthly payments with below-market rate loans. Federal programs such as HOME funds, and in several cases, Community Development Block Grant (CDBG), might be used to offer funding or credit to competent borrowers for down-payments. These direct subsidiary programs help to reduce the revenue as well as wealth barriers, but they are limited in scale. Though smaller in scale, rotating loan funds managed and controlled by local governments as well as by nonprofit organizations financed by the federal Community Development Financial Institutions (CDFI) fund and further sources, also offer smaller cost loans to borrowers not entitled for financing in the private market. The federal tax policy also permits penalty free Individual Retirement Account withdrawal for first time consumer in order to remove the blockade of down-payments and closing costs (Collins, “Pursuing the American Dream: Homeownership and the Role of Federal Housing Policy”). (GSEs) Government Sponsored Enterprises provided a $111 billion worth bailout plan to date and accounted for another $1.3 trillion purchase of GSE debts and MBS (Mortgage-Backed Securities). High risk mortgage purchases by GSE and guarantees assist further the housing bubble and the financial crisis. The high risk loans are main share of all GSE assets. FHA (Federal Housing Administration), GSE and high risk share of total mortgage originations are presented below: (Jaffee, “The Role of the GSEs and Housing Policy in the Financial Crisis”). The FHIP (Fair Housing Initiative Program) Program Assistance There are few FHIP initiatives that provide funds and competitive grants to eligible organizations: FHOI (Fair Housing Organizations Initiative) offers finance that create the capability and efficiency of non profit fair housing organizations by offering financial assistance to control fair housing enforcement and education initiatives more effectively. As per U.S. Department of Housing and Urban Development, “FHOI also strengthen the fair housing movement nationally by encouraging the creation and growth of organizations that focus on the rights and needs of underserved groups, particularly persons with disabilities” (U.S. Department of Housing and Urban Development, “Fair Housing Initiatives Program”). PEI (The Private Enforcement Initiative) provides a range of aid to the global network of housing groups. This initiative provides financial assistance to the non-profit fair accommodation organizations to continue testing and enforcement activities to avoid discriminating housing practices (U.S. Department of Housing and Urban Development, “Fair Housing Initiatives Program”). EOI (The Education and Outreach Initiative) provides a complete variety of support for the fair housing. It activates and funds to local government agencies, to states and non-profit organizations (U.S. Department of Housing and Urban Development, “Fair Housing Initiatives Program”). AEI (The Administrative Enforcement Initiative) assists the local and the state government. As per U.S. Department of Housing and Urban Development, “who administer laws that include rights and remedies similar to those in the Fair Housing Act implement specialized projects that broaden an agencys range of enforcement and compliance activities” (U.S. Department of Housing and Urban Development, “Fair Housing Initiatives Program”). David Moloney and Alastair Bor have provided few suggestive approaches towards the government policies in Australia for providing a better housing accommodation. As per David Moloney and Alastair Bor, the regulatory changes that would reduce the load on consumers from excess cost of capital for housing are: Ensuring the mortgage brokers accountable for advocating loans that are best for the consumer Fully discovering the benefits to home borrowers from creating a “white credit utility in Australia” Ensuring that the regulations do not prevent lenders from offering the product and credit innovations (Moloney & Bor, “Improving Accessibility and Flexibility of Mortgage Lending for Australians”). The Housing Affordability Program intends to expand a deeper perceptive of housing pressure and requires to plan indicators of housing pressure that can balance the customary indicator. The plan aids to formulate rent-setting procedure for social housing that enhance correspondence to the desired requirement; enhance the competence and equity of housing financial assistance allotment; and improve assessment risks in home purchase (Moloney & Bor, “Improving Accessibility and Flexibility of Mortgage Lending for Australians”). While Australia’s rate of home ownership has declined recently, it remains high by international standards and the large majority of people shall own a home during their lifetime. This propose that there may be only limited scope for policy to increase the overall time spent in home ownership, as most people will prefer to rent at some stage in their lives (Moloney & Bor, “Improving Accessibility and Flexibility of Mortgage Lending for Australians”). Along with the direct assistance to the first-time home buyers, Australian government provides encouragement for home ownership over renting through the tax system (for example, the non-taxation of imputed rental income and exemptions from land tax and capital gains tax for the family home). The housing markets in EU countries are characterized by a wide variety of policy interventions, in particular tax exemptions on particular types of housing-related investment or subsidies for housing-related activities (Moloney & Bor, “Improving Accessibility and Flexibility of Mortgage Lending for Australians”). As the combined credit expansion in the US was little distinct than in the previous years, it reflected slower corporate credit extension and household debt increased sharply. Household indebtedness increased quickly after 2000, obsessed mostly by outstanding mortgages, through little interest rates and financial novelty contribution. In spite of low interest rates, debt service when compared to disposable income, reached at a distinct height (Moloney & Bor, “Improving Accessibility and Flexibility of Mortgage Lending for Australians”). As per the IMF report as on February 2010, “the increased leverage left households vulnerable to a decline in house prices, a tightening in credit conditions and a slowdown in economic activity. Similar patterns existed in several current crisis countries” (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). The boom in household credit was connected with the formation of marginal assets whose feasibility depended on persistent positive macroeconomic circumstances. In the U.S. and also in certain areas in the U.K., a great section of the mortgage extension that consisted of loans was rendered to subprime borrowers though with certain restrictions in terms of credit and employment. Repayment and debt servicing were consequently open to economic downturns and alteration in credit and monetary circumstances. This capitalized on failure to pay correlations across mortgages, producing portfolios extremely uncovered to turn down in house prices that established ‘ex-post’ for the large non-performing loans when house prices went down (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). On the flipside of optimistic housing and commercial investment markets, the derivative markets in various forms extended deeply. Encouraging circumstances stimulated the appearance to great extent of the derivative markets, such as collateralized debt commitments with payoffs and mortgage-backed securities that relied in compound behavior on underlying asset prices. The valuations of these financial instruments were frequently founded on a persistence of rising house prices smoothened the advancement of the refinancing of underlying mortgages. The corporate credit failure to pay exchange markets too extended radically on the support of positive spread and low volatility (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). Troubles in the household sector have played an additional role in the recent crisis than the previous crises. The earlier crises were due to financial distress curtailed from the barriers of official sectors or the corporate sectors. The origins of the current crisis however contain a great deal to do with overextended households, particularly in the course of non-traditional mortgage loans mainly in the U.S. market. This extended household leverage had inferences designed on how the crisis was being spread out, from financial to the real sector and set hurdles for the resolution instruments and guiding principle responses (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). The up turn of the excess of extension of the household segment, is interpreted into several high risk assets. The value of these assets depended upon directly or indirectly increasing housing values. The problem got degenerated by inadequate position to absorb losses. Through confidence, wealth and collateral effects the consumption patterns of them were sharply adjusted (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). Conclusion The IMF report as on February 2010 states that “The crisis was the first global financial crisis since the Great Depression. Through several phases, its spread was unprecedented in scope and ferocity, with many transmission channels. It called for large government interventions, which have left many legacies for the future” (Claessens & Et. Al., “Lessons and Policy Implications from the Global Financial Crisis”). From this economic situation, it is well understood how the government policy in the financial market and consumers’ behavior influence the market situation. It can also be said that the effect is not only felt in a particular market, but also in other markets, due to globalization. References Australian Government. “First Home Ownership”. October 29, 2010. Commonwealth of Australia, 2004. Bardhan, Ashok Deo & Et. Al. “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions”. October 29, 2010. Homer Hoyt Institute, 2009. Baker, Dean. “The Housing Bubble and the Financial Crisis”. October 29, 2010. University of Nevada, 2008. Claessens, Stijn. & Et. Al. “Lessons and Policy Implications from the Global Financial Crisis”. October 29, 2010. IMF, 2010. Collins, Michael. “Pursuing the American Dream: Homeownership and the Role of Federal Housing Policy”. October 29, 2010. Federal Housing Policy, 2002. Cardarelli, Roberto & Et. Al. “The changing housing cycle and its implications for monetary policy”. October 29, 2010. VOX, 2008. Jaffee, Dwight M. “The Role of the GSEs and Housing Policy in the Financial Crisis”. October 29, 2010. Financial Crisis Inquiry Commission, 2010. Moloney, David & Bor, Alastair. “Improving Accessibility and Flexibility of Mortgage Lending for Australians”. October 29, 2010. The Menzies Research Centre Ltd, 2003. Nanto, Dick K. “The Global Financial Crisis: Analysis and Policy Implications”. October 29, 2010. Congressional Research Service, 2009. Shah, Anup. “Global Financial Crisis”. October 29, 2010. Global Issues, 2010. Taylor, John B. “The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong”. October 29, 2010. Stanford University, 2008. U.S. Department of Housing and Urban Development. “Fair Housing Initiatives Program”. October 29, 2010. Homes & Communities, 2007. Bibliography Hughes, David & Lowe, Stuart. The Private Rented Housing Market: Regulation or Deregulation? Ashgate Publishing, Ltd., 2007. OSullivan, Tony & Et. Al. Housing Economics and Public Policy Wiley-Blackwell, 2003. Oxley, Michael. Social Housing in the Future: Learning from Europe Institute for Public Policy Research, 2000. Read More