Subprime Crisis - Essay Example

In layman's terms, they use the supposed income from these mortgages as their collateral in their other investments. The banks were hoping that with the prime rate on the upward trend, they could make considerable gains on the basis of that hypothetical margin of profit. The problem began when the bubble burst and the prime rate skyrocketed so much to the point that the people were no longer capable of paying their mortgages. The financial institutions who were counting their immense profit lines on paper were suddenly left holding the bag, left saddled with numerous foreclosed properties that were both unloadable and prone to depreciation.

Haunted by serious liquidity issues arising from this maelstrom, a lot of these lending institutions have been rocked to the very core. Some have even declared bankruptcy, the most notable being former investment powerhouse Bear Stearns, the 5th largest investment house in the nation. In the IMF's recent report, it is illustrated that the global level of aversion from an emerging market, macroeconomic, and credit risk standpoint has increased exponentially from the previous year. This is highly indicative of the ripple effect emanating from the U.S. housing crisis.

In addition, the prices of U.S. mortgage-related securities have plummeted from a high of roughly $100 a share in 2006 to less than $20 in 2008, causing billions of dollars in equity losses. With no liquid equity, these institutions are hard pressed to back individual mortgages, which in turn perpetuates the crisis. The cold, hard facts do not paint a rosy picture on the global scale. Average housing market prices have tumbled accordingly, with the United States and United Kingdom embroiled in a rapid downward spiral.

The rest of the Europe is holding, but even there the downward trend has already started over the past two years. Just when did the housing boom originate Fueled by a favorable prime rate and the advent of poorly underwritten, predatory loans, commercial mortgage borrowing reached historically high levels in the 2nd quarter of 2005. Over $400 billion worth of loans were underwritten, a good percentage of which has fell into default as of 2008. The effects of these massive defaults are momentous; during the 1st quarter of 2008 estimated losses from defaulted loans have already reached the $130 billion plateau for banks, and roughly $500 billion overall with no relief in sight.

Over the next few years losses are expected to reach the $900 billion mark, and banks and financial institutions everywhere are scrambling just to keep their head above their water. While recent Federal Reserve initiatives to bail out financial institutions reeling from the crisis are admirable, its lukewarm reception can be attributed to a prevailing notion that it is just too little, too late. With mounting losses expected in the coming months, we can only hope that the country would survive this catastrophic downturn which has rendered even more losses than the infamous Asian financial crisis of the 90's.

With capital markets running dry and a high propensity towards risk aversion, one can only hope that the government and the Federal Reserve will put forth dynamic stimulus programs to bail out this badly