The Economic Crisis in the United States - Term Paper Example

The United s is going some of the harshest economic times it has seen in decades. During the 2nd half of 2008 economy experienced a complete crash of the credit markets which affected small businesses, individuals, and homeowners. The topic was the hottest issue during the presidential debate race that ended in November with the selection of Barrack Obama. This bursting of the credit bubble was an expected outcome of a problem that had been building up for a couple of years. The root of the economic crisis in the United States is based on the crash of the real estate market. This paper examines the collapse of the real estate market and the mortgage crisis in order to find roots of the problems and alternative solution to deal with the situation. Americans homeowners were enjoying some of the greatest home equity valuation increments they had experienced in their lifetime during the late 1990’s into the 21st century. During the 10 year span starting in 1996 and ending in 2006 the rise in house prices significantly exceeded the consumer price index which measures price inflation of general goods. Appendix A shows a graphical illustration of this phenomenon. In financial terms what Americans were seen was a strong bull market that provided great financial returns for investor in short period of time. As more equity was being build the banking were the first that wanted to capitalize on this trend to increase their lending business. Many banks started to aggressively market loans backed by the new mortgage equity American had just acquired out of practically thin air. Many consumers fell into this trap, and both clients the banks paid dearly. As prices rose new homeowners became victims of the acquisition of homes whose values were inflated and ended up paying a lot more than what many of these homes were worth. The vicious cycle affected the entire supply chain of the home industry, as contractors were eager to build new complexes since there many buyers eager to get into this booming home market which seemed like a good idea due to the great appreciation home investments were achieving. Florida is an example of a state whose governmental officials contributed to the problems Americans are facing today. In 2004 Florida issued 228,000 residential building permits, more than any other state (Caudield). This type of irresponsible behavior does not follow sound economic judgment. The laws of supply and demand state that if the supply for a good or service exceeds the demand the inevitable result is a lower price in order to achieve sales because there is too much of a product out there in the market. The contractors over flooded the market with new home and apartment offerings which negatively impacted the price of all homeowners in the United States. The banking industry was an influential player whose business practices led to the mortgage crisis the American people are facing today. Their practices led to the proliferation of thousands of mortgages given out to people that in reality had no business being a homeowner at this time due to the fact they could not afford them. The banking industry got caught up in the investor frenzy which clouded their judgment. A mechanism banks utilized to push mortgage sales to unqualified customer was adjustable rate mortgages (ARM). Adjustable rate mortgages are loans with interest rates that change over the lifetime of the loan (Federalreserve). The flexibility of this financial device was utilized by banks to lower the interest rate of mortgages which lower the payment initially and allowed many people to get a home loan they would otherwise not get based on fixed-mortgage payment logic. The practice led to an increase in the default rate of mortgage loans. In 2008 the credit crisis led to banks asking the federal government of a $700 billion bailout to remedy the situation caused by the losses banks would incur from the huge amount of mortgage loan defaults. The overproduction of homes through the nation due to the speculation of capital gains from the creation and subsequent sale of this tangible product increase the supply of homes and led to an excess inventory scenario. The best way to visualize the extent of the problem is to analyze the numbers. In 2005 there were 2.07 million new homes built, which is 43% more than the average amount of homes that were built per year than during the 1990’s (Ronald). The end result of the housing bubble has been huge losses of equity for home owners. In 2008 American homes depreciated nearly $2 trillion dollars (Harrington). The nation needs to find alternative solution to deal with the problem and stabilize the markets in the long term. The information about the excess home production serves as a basis for an alternative solution to remedy the situation. I would encourage Congress to pass an Act to limit the home production for the next 10 years. My proposal is that during the 10 year period from 2009 to 2018 home production in the United States of America be limited to 1,000,000 new homes per year. There would be a clause after the 5th year which could increment the amount of homes to up to 1.5 million homes per year if a market study justified the decision based on the need for new homes. By lowering the supply of new homes the market would limit itself to the people that actually need the homes for shelter, not speculators purchasing homes for their investment agendas. A constraint in the supply equation will help increase the home values once the demand rises. The economic bailout plan was a good initiative that helped stabilize the market in the short term. There was an immediate need to unfreeze the credit markets since our entire economy was at serious risk if this was not done immediately. The limited home production proposal is an alternative solution that helps in the medium and long term. American need more long term solution to the problems. The declines of the prices is bad, but the problem worsens went can not pay for their mortgages. One of two things has to happen for the purchasing power of American to increase so they can pay mortgages. Either their income increases or if their expenses decrease. A major expense in every family budget is transportation costs. Every American family budget has a gasoline allocation costs. As the price of gasoline decreased by 60% during the last few months Americans had more money in their pockets to spend in other necessities. If the private and public sector found a viable solution that eliminated our dependency on crude oil by 100% for transportation purposes as well as for household consumption the cost of living of American families would go down a lot and more money would be available to make mortgage payments. The United States survived after social and financial tragedies such as the civil war and the Great Depression. The economic crisis that surged in 2008 as a recession is in full motion needs the attention of everyone. The underlying problem that started this economic cycle was the burst on the housing and mortgage markets. A home is the foundation of family life and it is the biggest financial commitment a typical American. The home marketplace began to expand and attracted new institutionalized investor which converted the home marketplace into a speculative marketplace. This along with other problems such as excess inventory, mortgages being given to unqualified candidates, and high inflation in home values led to the housing bubble burst which started in 2006. The country needs long term solution to deal with this crisis. Alternative solutions such as the banking industry bailout, restricting home construction, and reducing the cost of living of Americans will help towards stabilizing the housing market in the United States. Works Cited Page Caulfield, J. November 2005. “Sunny side up: As home construction to climb skywards, consolidation is heating up and dealers are jockeying to find ways to stay in the game.” 28 December 2008 Federalreserve.gov. 17 May 2007. “The Federal Reserve Board. 28 December 2008 Harrington, C. 12 December 2008. “Home Values Have Depreciated by $2 Trillion.” 27 December 2008. Mauldin, J. 17 November 2008. “The Coming Collapse in Housing.” 27 December 2008. Ronald, D. 22 April 2008. “The Subprime Mortgage Collapse: A Primer on the Causes and Possible Solutions.” The Heritage Foundation. 27 December 2008 Appendix A: Home Prices vs. Consumer Prices (1990-2006) (Mauldin). Read More