First is the economic environment because it affects the value of the bank’s financial instruments, securities and loans portfolios and market and credit risk exposure. For example, a decline in economic conditions could lead to increased regulatory scrutiny, increase loan delinquencies, reduce customer borrowing power and eventually lower demand for the bank’s products and services (Bancfirst 14).
The demand curve for houses shifted to the right because of the following factors. Firstly, they began with low interest rates that prevailed from 2001 to 2004. These low rates made borrowers increasingly opt for adjustable rate mortgages over fixed-rate mortgages. Then the subprime mortgage industry developed a number of innovative products, e.g. hybrids, to fuel their growth. Hybrids were loans that began with a low fixed rate for an initial period and were then reset to higher variable rates for the remainder of the term of the loan. With such products in the market, borrowers and lenders alike focused only on the borrower’s ability to carry the low initial payments. These factors heightened consumer optimism and confidence which encouraged more borrowing. The equilibrium price went up.
The falling prices made homeowners begin to owe more than their home’s value. Borrowers with adjustable rate mortgages were unable to refinance before their rates reset. As borrowers were unable to pay, foreclosures rose sharply and financial institutions that had invested heavily in subprime-related securities went into decline and some collapsed. With some firms collapsed, the supply curve shifted inward. Thus, the equilibrium price for houses went up.
The housing crisis began when the US economy was in recession. This is manifested by the fact that the low interest rates that prevailed from 2001 to the end of 2004 were measures implemented by the Federal Reserve to combat the 2001 recession and prevent deflation (Barth et al. 7). The Federal Reserve Chairman says the ...