GLOBAL FINANCIAL CRISIS - Essay Example

It started when the US sub-prime mortgage market collapsed due to the default on payments. A sub-Prime mortgage is a loan made for homes to borrowers who are not eligible for prime home loans because they either do not have sound credit history or have non at all. For example, people with low incomes, low bank transactions, history of defaults or unemployment, can use these mortgage loans to purchase homes. These loans are generally given out by lenders on higher interest rates, additional fees, penalties for early satisfaction of the loan and other additional costs such as adjustable interest rates (ARM).

With such instruments where the borrowers do not have a credit history for the borrowers to base heir decisions on, there is a high risk of default. What was once known as the leader and a strong entity of the economy in 2007, the real estate business took a complete nosedive, which was not expected as the values of houses had not declined since World War 2 and were on a continuous rise after the great depression, and thus, lead to the liquidity crunch in the US market. The mortgage taken by investors had real estate as collateral which eventually lost all its value and hence defaults on payments occurred.

The demand for houses increased also during 2001 because the federal government reduced the interest rates, it was the lowest in 2001. This allowed people to invest in more houses and people started buying vacation houses and second homes. The builders continued building more and more houses even after the demand for property started to decrease after a while. The property market became so overvalued that finally the market collapsed, resulting in a rapid decrease in the rates properties and property demands.

(University of Iowa, 2008) Many Credit Rating agencies also played a major role in the event. The Mortgage backed securities which were in great demand in the early 2002, continued with the increasing demand and although