Impact of Subprime Mortgage Crisis on the UK Economy - Literature review Example

?Running Head: Impact of Subprime Mortgage Crisis on the UK Economy Impact of Subprime Mortgage Crisis on the UK Economy [Institute’sName] Impact of Subprime Mortgage Crisis on the UK Economy The UK sub-prime mortgage crisis initiated rigorous fiscal market upsets. These upsets, together with the extensively reported credit crisis, have deepened what otherwise might have been a placid financial slump. The UK financial system is now in the middle stages of a financial slump. A number of regions of the country will undergo excessively harsh financial situations. The huge amount of non-conventional mortgages has deepened the existing housing market slump. The subprime mortgage crisis has already influenced the overall economy. The fall in home demand as well as the subsequent increase in home inventories has places the housing construction business into a decline (Taylor, 2009, p. 78). Housing began to drop 45 percent during the past 2 years, in accordance with the Commerce division, and fresh home sales plunged 36 percent, driving fresh home inventories to more than 450,000. This drop in fresh residential construction cut 2 percent GDP growth during the fourth quarter of 2011, and it is doing the same in the first half of 2012. However, the housing market influences more than simply the housing construction division of the financial system. Rising and falling home costs in the past couple of years generated huge capital benefits for households, which produced a sturdy wealth outcome for consumer expenditure and facilitated in decreasing the national investments rate (Morgenson and Rosner, 2011, p. 103). From 2008, the standard annual growth rate of actual buyer expenditure was a sturdy 4 percent, with buyer durable expenditure going up to 6 percent per annum. In view of the fact that personal spending costs creates over 80 percent of the entire economy, increasing home costs were a main medium for general financial development. Increasing home costs were as well a contributing aspect to the almost negative UK household investments rate during the last two years. If countrywide home costs drop by 6 percent during 2012, a negative capital effect will reduce utilization costs, boost the national investments rate and lessen economic movement. Policies have stepped in to try to mitigate the economic blow of the subprime mortgage crisis and the weakening housing division. A wide range of suggestions have been established and / or implemented. Some of these are particularly significant (McLean and Nocera, 2011, p. 132). Recently, government help thousands of individuals by refinancing their mortgages. With this initiative, more or less 75,000 borrowers will be directly affected. Whereas this will facilitate to hold back the existing sub-prime mortgage market crisis, a large majority believe that a much more extensive reaction is required and that this is an insufficient effort at facilitating the people. This issue is important to global political economy, as the management’s treatment of the crisis will begin to come under better inspection because of uncertain sub-prime loans that have been prepared during the past two years rearranging to their higher interest rates. This will carry on to be a concern because supported by the data from the credit union, there are more or less 4 million citizens with outstanding sub-prime mortgages along with about 1.5 million borrowers are following their loans, with more than 2 million maybe dealing with foreclosure within the subsequent two years. Because of the existing situation of the subprime mortgage crisis, the UK pound has declined against other currencies during the last few months (Forrest and Yip, 2011, p. 193). This is important because, now, the outcomes of this crisis are gradually being felt overseas. For instance, in the US, the Euro has naturally appreciated against the dollar because of the dollar’s decline. “At first glance, this would not typically send up any type of red flag for investors in the UK, but when examined more closely it becomes apparent that this mortgage crisis is going to directly affect the UK’s balance of payments; because of the pound’s decline, a competitive advantage has arisen for the UK” (Duthel, 2009, p. 201). This depreciation of the pound has caused a likely competitive disadvantage for the UK, in view of the fact that this now makes their commodities more costly in comparison. Housing market in the UK has been showing major signs of slowing down. After housing price rise reached to maximum in June 2010, the marketplace has constantly had a drop in the inflation rate. In addition, the number of mortgage endorsements for home acquisitions dropped by 31 percent in September 2010 in comparison with September 2009, progressing a four-month long slump. Both of these drifts have been considered to be in reaction to higher interest rates - a direct outcome of the credit crisis linked with the subprime mortgage crisis. Causes of the Subprime Mortgage Crisis The subprime mortgage crisis was the preliminary cause of the 2008 economic disaster, which then led to the most unpleasant slump since the Great Depression. During the past couple of years, several homebuyers acquired highly priced residences with non-conventional mortgage products, which were financed by overly enthusiastic mortgage lenders. The current slump in housing sales, lesser residence costs and the reorganizing of adjustable rate mortgages have formed a meltdown within the mortgage market. The problems are mainly prominent within the sub-prime segment and are revealed in swiftly increasing negligence, failure to pay and foreclosure rates (Gulati, 2009, p. 238). The slump in home demand as well as increase in inventories has place downward force on residence costs. The nationwide average current house cost was $ 200,000 during the November of 2011, 4.1 percent drop from the similar period during 2006, in accordance with the recent research. The existing huge housing record will compel additional cost improvements. In addition, the current huge existence of real estate sponsors, entrepreneurs, as well as flippers will make the value drop more rigorously since prospects of declining home costs considerably decrease acquisitions by this group of consumers. Banks as well as other lenders recorded 1.5 million foreclosure filings in 2010, indicating 2 percent of all UK households, up from 0.9 percent in 2008. Foreclosure movement is likely to go up during 2012 because of a record amount of adjustable rate mortgages rearranging during the first half of the year. The remarkable raise within the amount of unoccupied residences on sale is single aspect pushing up the amount of home foreclosures (Financial Crisis Inquiry Commission, 2011, p. 451). The recent market research reported 2.1 million unoccupied residences available for sale in the fourth quarter of 2010, up from 1.3 million four years back. The huge inventory of unsold, unoccupied houses makes it complicated for economically broken property holders to sell when their adjustable rate mortgages resets to higher unreasonable interest rates. During the 2005-2009 time frame, oddly low interest rates in addition to consumers prospect of double-digit home cost increases helped a record increase of $ 3.2 trillion “in home mortgages being written by UK lenders” (Shiller, 2008, p. 203), with more or lessa5 percent of this amount considered subprime. The subprime mortgage division provides borrowers with bad credit histories, higher interest rates. The quick rate of mortgage beginnings was bigger as compared to enduring mortgage demand levels. Consequently, there will be much lesser housing demand during the next couple of years. One of the key improvements causing the huge increase in subprime lending during the past few years was the implementation of innovative credit scoring methods. This let lenders to arrange candidates by creditworthiness as well as set risk-based loan interest rates. A huge fraction of these loans were initiated by mortgage dealers who subsequently sold the loans to investment banks. The investment banks, consecutively, enclosed the loans into “collateralized debt obligations and sold these to investors” (Shiller, 2008, p. 222) around the globe. Credit Rating Agencies and Crisis Credit rating agencies have an extremely significant role on different phases during the subprime crisis. They have been greatly condemned for devaluing the risk in new, “complex securities that fuelled the UK housing bubble” (Bitner, 2008, p. 123), for instance, mortgage supported securities as well as collateralized debt obligations. The three credit rating agencies were main “enablers of the financial slump” (Bitner, 2008, p. 141). The mortgage-linked securities on the brink of the crisis could not have been traded without their endorsement so sponsors depended on them. In some instances, they were compelled to utilize them, or “regulatory capital standards were hinged on them” (Bitner, 2008, p. 142). This crisis could not have started without the rating agencies. Their ratings facilitated the market to ascend and their downgrades from 2008 to 2010 caused mess across markets as well as firms. Credit rating agencies are currently under inspection for providing investment level, ‘capital secure’ ratings to securitization operations supported by subprime mortgage loans. These high ratings promoted a stream of international financier funds interested in these securities, backing the housing bubble within the UK. An approximate $ 2.5 trillion in loans were given to property holders with poor credit as well as undocumented earnings during 2004 and 2009. These mortgages could be packaged into mortgage-backed securities and collateralized debt obligations securities that got high ratings and consequently could be traded to international shareholders. Higher ratings were considered necessary by a number of credit improvements together with over-collateralization - such as guaranteeing collateral more than the debt issued, credit default indemnity, and equity sponsors ready to tolerate the initial losses. Rating agencies are one of the major culprits for this crisis. They wrongly and illegally changed the securities from F-rated to A-rated. The banks as well as other financial institutions could not have done what they did devoid of the involvement of the rating agencies; “without the AAA ratings, demand for these securities would have been considerably less” (Bitner, 2008, p. 201). Bank write-downs in addition to losses on these investments summed up to $ 450 billion on September 2010. Global Credit Crunch Lehman Brothers, blocked by the credit crisis as well as declining real estate prices, filed for Chapter 11 protection in the biggest bankruptcy filing in 2008. “Lehman fell under the weight of $ 60 billion in soured real estate holdings” (Robinson and McDonald, 2010, p. 263), and the credit market’s upset eventually pushed it to ask for court security. Lehman borrowed large quantities to finance its investing leading to its economic failure in 2008. A major fraction of this investing was in housing construction sector, making it susceptible to a slump in that market. While making remarkable profits throughout the boom, this susceptible spot implied that only a 4 percent to five percent drop in the value of its assets would completely eradicate its book value or equity. Investment institutions, such as Lehman, were not put through the similar directives imposed to depository banks to put a ceiling on their risk taking. During August 2007, Lehman shut down its subprime lender and took a “$ 25 million after-tax charge and a $ 27 million reduction in goodwill” (Robinson and McDonald, 2010, p. 271). The firm declared that bad market situation within the mortgage space demanded a considerable cutback in its capital as well as aptitude within the subprime space. “Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. JPMorgan Chase and Co. provided Lehman Brothers with a total of $138 billion in Federal Reserve-backed advances” (Robinson and McDonald, 2010, p. 301); the Federal Reserve Bank of New York repaid these cash advances by JPMorgan Chase. References Bitner, R. 2008. Confessions of a Subprime Lender: An Insider's Tale of Greed, Fraud, and Ignorance. Wiley. Duthel, H. 2009. The Financial Crash. Lulu.com. Financial Crisis Inquiry Commission. 2011. The Financial Crisis Inquiry Report. PublicAffairs. Forrest, R., and Yip, N. 2011. Housing Markets and the Global Financial Crisis: The Uneven Impact on Households. Edward Elgar Pub. Gulati, R. 2009. Managing in a Downturn. Financial Times Prentice Hall. McLean, B. Nocera, J. 2011. All the Devils Are Here: The Hidden History of the Financial Crisis. Portfolio Trade. Morgenson, G., and Rosner, J. 2011. Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon. Times Books. Robinson, P. and McDonald, L. G. 2010. A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers. Crown Business. Shiller, R. J. 2008. The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It. Princeton University Press. Taylor, J. B. 2009. Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis. Hoover Institution Press. Read More