The Cause and Effect of the Subprime Mortgage Crisis
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- Length: 1310 words (3.7 double-spaced pages)
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The subprime mortgage crisis is an ongoing event that is affecting buyers who purchased homes in the early 2000s. The term subprime mortgage refers to the many home loans taken out during a housing bubble occurring on the US coast, from 2000-2005. The home loans were given at a subprime rate, and have now lead to extensive foreclosures on home loans, and people having to leave their homes because they can not afford the payments. (Chote) The cause and effect of this crisis can be broken down into five major reasons.
When subprime mortgages began to flourish, the term housing bubble came into existence. The term relates to the time in which houses sharply increased in value, and consumers often borrowed at less than the lowest rates. People believed that the price of their homes would rise and they could then refinance for lower payments. The problem with that mentality is many people didn’t just refinance for lower payments, they also refinanced for personal spending. Inflation of home prices meant homeowners suddenly had more equity and were able to spend the money as they chose.
All good things must come to and end. In late 2005, the housing bubble burst, and housing began to decline in price. People who refinanced, particularly those who financed with variable interest rates suddenly found their homes were valued at much less. The housing market became flooded with homes for sale, because the homeowners with variable rates and interest only loans could not continue to make their payments. (Greenspan) The rise in the number of homes for sale caused further lowering of home values.
Keeping in mind that the main reason for the mortgage crisis is the high number of defaulted home loans, which triggered foreclosures and sell offs. The other four contributing factors include high-risk loans, the bust in the housing market, mortgage fraud, and speculation. High-risk loans are loans that are over leveraged, where the financing is done more than the suggested values to be given. (Greenspan) This can result in immediate sell off when the property falls below that loan amount and to avoid further loss the banks start raising the installment. The housing market has seen pressure as a result of the over pressure on most homeowners by increasing rates. This affects people ability to make the payments, resulting in defaults. This is the problem with the burst in the housing market. The third major factor that is causing the mortgage crisis is, mortgage fraud.
The frauds in the mortgage market are leading to increasing crisis as the banks and government authorities are not able to find borrowers after over financing. Lastly, speculation was due to the fact the aim of the mortgage market changed, the main aim of purchases in mortgage market in the past years was investment and not for self living which marked early selling of the property even at discount.
Besides these factors, numerous other factors are also responsible for the mortgage crisis faced by the U.S. market. The result leads us to a depressing sight, as homeowners are not finding a way to recover their losses as their complete investment has gone down the drain and the banks are on a selling spree, which is unstoppable as the main market has been experiencing rate cuts and real estate price cuts. The government has tried to get this problem under control, and planned a $700 billion bail out plan, which was later increased to $849 billion as a result of the requirement by most state governments. The plan for the bailout package is intended to purchase loans from the banks and support homeowners for some period. The U.S. market will have to take a long time to recover from this because the planning was wrong by most analyst and industry experts.
The decline in the commercial real estate market was a major effect from the crisis. A combination of factors that stemmed from subprime mortgage crisis has lead to major problems in the commercial real estate market. According to the National Association of Realtors (NAR), “there is a slowing in commercial real estate due to the tightening credit and slowing growth, the former a direct result of the subprime mortgage crisis.” Chief economist of the NAR, Lawrence Yun, said, “Although capital remains available for residential loans, the credit crunch is pronounced in commercial landing,” adding “Combined with a slowing economy, the lack of credit is curtailing activity in the commercial real estate sectors. As a result, there’s been a slowdown in the net absorption of space, which is leading to higher vacancies and more modest rent growth.” Some experts disagree; Patricia Nooney chair of the realtors Commercial Alliance Committee portrayed the decline as unusual since “transactions are being curtailed not for lack of demand, but for serious challenges in obtaining financing.” (Chote)
Another result of the mortgage crisis, there has been a documented rise in home-related crimes. There is a new concern that some homeowners have gone to such drastic measures to avoid losing everything that they are turning to arson as a way to escape from mortgages they can’t or refuse to pay. In 2005 and 2006, the FBI reported that arson grew 4% in suburbs, and 2.2% in cities (Arena) The crisis has had devastating effects on the economy in other ways as well, effecting the municipal bonds and bond insurers.
A secondary cause and effect of the crisis relates to the role of municipal bond insurance corporations such as Ambac and MBIA. Some of these companies also insured subprime mortgage backed securities, and as default rates on this, the insurers have suffered significant losses. The downgrades further threatened the bond insurers because they became unable to underwrite new business going further. This really rocked the foundation of many financial institutions. As a result, it had an adverse effect on jobs in the financial sector. Many companies had to lay off nationwide some in excess of 9,000 employees from different branches.
Job loss was only the beginning for the individual pain this crises held. Many families were forced out of homes. Many took drastic measures to stay afloat and began squatting as a way to make it. Some were even forced to be considered a squatter in the home they used to own. As home process have declined following the rise of home prices caused by speculation and as financial standard have tightened, a number of homes continue to be forced into foreclosure and sit vacant. The vacant homes are often poorly maintained, and attract the leagues of squatters trying to find shelter. These homes can also attract criminal activity. Again the result of that makes the entire neighborhoods housing price decline.
The subprime mortgage crisis has created a domino effect of change in the U.S. With many homeowners suffering from homes that were too good to be true the whole country is forced to rebuild from rock bottom. No one saw what was lying ahead and no one was really prepared for what would come next. The effects of this crisis have touched not only homeowners in a personal sense, but also the nation in a financial standpoint. Many can find the crisis as one of the resulting factors that has sent our great nation into the depression we find ourselves faced with.
Work Cited Page
1. “Center for responsible lending (27 November 2007). “A Snap Shot of the Subprime Market”
2. “The Bubble Economy” 2008 http://www.prospect.org/cs/articles?article=the_bubble_economy.
3. Alan Greenspan (2007-12-12). "WSJ Greenspan-The Roots of the Mortgage Crisis". Opinionjournal.com.
4. Robert Chote. "Financial Crisis: Someone will have to dig us out of all this debt". Daily Telegraph.
5. "Criticism rains down on mortgage industry - USATODAY.com". 2008.
6. Kelli Arena CNN Justice Department correspondent (2008-07-16). "Source: FBI investigating Indymac for fraud". Cnn.com.