Subprime Crisis and Oil Prices - Essay Example

First Part: Subprime Crisis The current problem in the global financial market has caused great trouble in the entire economic history of the world. And although there would be many reasons that could have financial disaster to the world market, the culprit being blamed today is the issue of subprime loans. The subprime mortgage loans or housing loans are not that secure. However, since the profit for such venture is high, many are sucked into it for big and fast money. According to Lahart (2007) the crisis began with the bursting of the U.S. housing bubble and high default rates on the subprime and adjustable rate mortgages in 2005. Conveniently at the same time, seemingly better loan incentives and lower standards made borrowers believe that they can refinance at a better standing. But since interest rates rose and the worth of houses dropped in the last two years in the crisis country, refinancing has become more difficult, leading to more instances of foreclosures and defaults. According to RealtyTrac (2008), about 1.3 million housing properties in the U.S. became subject to foreclosure in 2007, which is about 79 percent higher than in 2006. O Fineman, J & Keoun, B (2008) and Onaran (2008) said that about $435 billion was reportedly lost by several banks and financial institutions. A series of market interventions were attempted to bail out some firms, even presenting a $700-billion proposal to the U.S. Congress this month aimed at stimulating their economy and positively inspire the financial market. Just recently, the U.S. House of Representatives controversially rejected the bill, but leaders said they will revise the proposal. According the common interpretation, subprime lending is the practice of loaning to unqualified borrowers, mainly because of income, payments made, credit history, and employment. The Associated Press (2007) said the value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007. Moreover, about 16 percent of subrpime loans with adjustable rate mortgages were 3 months delinquent or currently in foreclosure proceedings as of October 2007, according to Bernanke (2007). As of January this year, the rate of delinquency has risen to 21 percent, said Bernanke (2008), while by May, it has jumped to 25 percent, said Bernanke (2008). According to Duhigg (2008), the U.S. mortgage market might just be estimated at $12 trillion, about ten percent of which is either delinquent or in the midst of foreclosure. Wilson (2007) and Shostak (2007) said there are three types of speculative borrowing that helped accumulate debt, specifically in the subprime mortgage crisis: first is the "hedge borrower" who intends to pay from other investments; second is the "speculative borrower" who believes that they can have service interest on the loan and even continually roll over the principal into new investments; and third, the "Ponzi borrower" who relies on the appreciation of their assets' values to pay-off their debt or loan. Of course the best way to discuss things is to put the listener or the reader in the shoes of the person experiencing the situation being discussed. Say your neighbor is facing a foreclosure, you'll probably think that it should not concern you. I'd say, think again. According to Greer (2008), if there is a foreclosure in your neighborhood, even if you are not struggling to pay the mortgage in your home, it might still cause trouble to you and your property. He said there is a number of reasons why a person should help his or her neighbor avoid foreclosure while you still can. To put it more bluntly, if you live in a neighborhood that has had many foreclosures, your own property value could be at a standstill or worse, dropped proportionally. Greer (2008) further said that "as foreclosures spike, gang activity and crime accompanies the problem hand in hand." According to studies, every 1 percent increase in foreclosures, there is an associated and accompanied 2.23 percent increase in violent crime and problems. Some examples of the impact of foreclosures are Cleveland, whose Slavic Village had troubles with foreclosures over a decade ago, Las Vegas, Jacksonville Florida, Miami Florida, Orlando Florida, Stockton California and many others. He said this means that nearly 40 million homeowners witness how their home values go down in the next two years beacuse to foreclosures. If you compute it for each home, it will come out as an estimated loss of $8,771, which is a significant loss and a negative effect on the economy And as homeowners lose the equity of their home, the neighborhood is more likely to experience more foreclosures, thus leading to another the financial depression, making the average loss drastically higher, no matter what is done. So what should be done It's actually very simple, if you really want to help, if not for the sake of your neighbor, then do it for yourself. Help your neighbor not by paying off their mortgage but by helping them find a buyer so that the house will not be vacant and your home's value will not be affected. If not, then you might refer a good real estate investor who buys houses to stop foreclosure. With such, your neighbor will be given a free offer on the house with no obligation whatsoever. On a greater scale, Eichengreen (2008) said the current credit crunch represents the first crisis of the age of mass securitization. He said that sometimes "the costs of securitization in the form of risks to financial stability, exceed the benefits." The implication of such is that the world such return to the "good-old-fashioned banking" wherein commercial banks grant loans to households and firms and hold them on their balance sheets, rather than distributing it. Reformers would say that financial regulators should "repave and re-grade," effectively changing the rules entirely. However, making such changes is not that easy. Eichegreen (2008) said policy makers should focus on the banking system since banks are in the center of the information-impacted segments of the financial system. Internal models and bond ratings should then be rethought. The crisis may be gigantic in scope, but the ways to further prevent any more damage are attainable. Bibliography Associated Press 2007, March 13, Will subprime mess ripple through economy MSNBC, viewed October 3, 2008 Bernanke, B 2007, October 15, The Recent Financial Turmoil and its Economic and Policy Consequences, Board of Governors of the Federal Reserve System, viewed October 3, 2008 Bernanke, B 2008, January 10, Financial Markets, the Economic Outlook, and Monetary Policy, Board of Governors of the Federal Reserve System, viewed October 3, 2008 Bernanke, B 2008, May 5, Mortgage Delinquencies and Foreclosures, Board of Governors of the Federal Reserve System, viewed October 3, 2008 Duhigg, C 2008, July 11, Loan-Agency Woes Swell From a Trickle to a Torrent, New York Times, viewed October 3, 2008 Eichengreen, B 2008, February, Ten questions about the subprime questions, University of California, Berkeley, viewed October 7, 2008 Fernandez, M 2007, October 15, Study Finds Disparities in Mortgages by Race, New York Times, viewed October 3, 2008 Fineman, J & Keoun, B 2008, July 17, Merrill Lynch Posts Fourth Straight Quarterly Loss, Bloomberg, viewed October 3, 2008 Greer 2008, How the Foreclosure Next Door Affects You, Street Dictionary, viewed October 3, 2008 Lahart, J 2007, December 24, Egg Cracks Differ In Housing, Finance Shells, Wall Street Journal, viewed October 3, 2008 Luhby, T 2008, June 5, Americans $1.7 trillion poorer, CNN Money, viewed October 3, 2008 Onaran, Y 2008, May 19, Subprime Losses Top $379 Billion on Balance-Sheet Marks: Table, Bloomberg, viewed October 3, 2008 RealtyTrac 2008, January 29 U.S. Foreclosure Activity Increases 75 Percent in 2007,RealtyTrac, viewed October 3, 2008 Shostak, F 2007, November 27, Does the Current Financial Crisis Vindicate the Economics of Hyman Minsky Ludwig von Mises Institute, viewed October 3, 2008 Wilson, S 2007, April 13, Hyman Minsky: Why Is The Economist Suddenly Popular Daily Reckoning, viewed October 3, 2008 Second Part: Oil Prices In the start of this decade, gasoline prices in the United States have roughly tripled, while its global price has risen even more. In the rates seen in January 2007 have quadrupled from its price three years ago. Such trend has caused many problems and has put consumers and petroleum-dependent industries in pinches. Oil-producing nations and companies have also felt the pressure of such instances. So why is it so high According to Cohen, A & Graham, O (2008), there is a clear significant change is happening in the global energy market, bumping with major challenges in the global economy and energy security. A Perfect Storm of Supply and Demand The theory of supply and demand could probably explain the phenomenon more effectively. This is the catalyst and the simplest economic driver for the great rise in oil prices. Cohen, A & Graham, O (2008) said that oil is no longer driven by developed countries like the United States. They said developing countries like China and India are transforming global energy markets through their size and pace of growth alone. According to BBC News, 2008, demand is "at an all-time high, fuelled by the continued breakneck economic expansion of the Indian and Chinese economies." And with both economies of population-driven countries growing fast, manufacturers and consumers are using up in energy at an ever-increasing rate. Paris-based International Energy Agency's (IEA) "World Energy Outlook: China and India Insights," said that from now and 2030, these two countries will account for 70 percent of the new global oil demand while their combined oil imports will jump from 5.4 million barrels per day in 2006 to 20 about 24 years after. And when such happens, the combined imports of Japan and the United States shall be overtaken. The BBC News report further said China overtook Japan as the world's second-largest consumer of oil in 2003 and is closing in on the US, with demand for oil growing at about 15% a year. Moreover, analysts worry that the global demand for oil is so big that supplies may not be able to keep up. IEA said that the demand might rise by an average of 2.2 million barrels a day next year, compared with the 1.5 million-barrel rise in 2007. Plus, the annual demand will rise 2% up to 2012. However, another trigger considered by BBC News is that since violence has allegedly delayed the elections in Pakistan and that the former Pakistani Prime Minister Benazir Bhutto was assassinated, oil prices increased because stability in Pakistan is important to US policy in the Middle East. Also, it said the threat to oil workers and facilities in Nigeria put a "long-term shadow" over oil supplies from the world's eight largest oil exporter. Even the weakening dollar that makes it cheaper for importers to buy dollar-denominated oil supply has become a great factor. Bowman, M (2008) said other factors contributed to the spike as well. He said that amid uncertainty and volatility in global stock markets, many investors have poured money into commodities such as oil. However, this combined with investor assumptions that oil prices will remain high, boosted oil prices further, effectively feeding more investor speculation in the market. Cohen, A & Graham, O (2008) said constricted supply is a big problem in the face of the oil price surge. The plans to increase oil supply through the exploration and production between 2008 and 2030 are being halted by heightened political risks and mismanagement of funds and government policies. One-third of Iraq's oil production capacity is not available, a big waste if one realizes that the country is capable of increasing its production from 2.4 million barrels per day to five if the situation in the said country eases. Even Nigeria is going through the same problem with one-quarter of its producing capacity down. The Effects On a wider scale, the effects of high oil prices are pretty general, with much of such passed on to the consumers. According to the Energy Information Administration (EIA 2008), when the prices of petroleum products increase, consumers are forced to use their money on oil-derived products, effectively lessening their money allotted to other goods and services which are also important in their daily lives. And since oil is used for transportation businesses of all types, the cost of input increases. If such cost increases cannot be passed to a company's consumers, it may cause worker layoffs and halting of the plant operations, thus reducing economic output in the end. EIA (2008) further stressed that since the U.S. is a net importer of oil, higher oil prices affects its purchasing power in terms of international trade. Moreover, the prices of imported oil would force the said country to devote its production to exports. It also said "changes in oil prices can also cause economic losses when macroeconomic frictions prevent rapid changes in nominal prices for final goods (due to the costs of changing "menu" prices) or for key inputs, such as wages." And even if there is great opposition on the part of the workers in terms of wage cuts, high oil prices still put pressure on the nominal wage levels. Lastly, high oil prices cause increase in other energy prices, depending on the substituting power of the product. Moreover, ff price increases are so big and sudden, its impact on short-term growth may be greater than if they are gradual. This is because sudden price hikes scare people and companies, preventing them from making proper decisions in the short time. What should be done In the face of such problems, there must first be a recognition that oil prices around the world are actually rising and that there is not enough being done to alter the existing production techniques and capacity. There must be an increased pressure on Organization of Petroleum Exporting Countries (OPEC) and non-PEC countries to level the playing field and open the international oil playing field to develop reserved effectively. Energy-saving technologies and unconventional sources of fuels worldwide must also be promoted. Also, one can consider to prepare for a possible transformation of automotive transportation if it is more practical since if oil prices never go down, a number of market-driven solutions are bound to replace internal combustion engine cars in the years to come. Bibliography BBC News 2008, January 2, What is driving oil prices so high, viewed October 7, 2008 Bowman, M 2008, April 23, 'Perfect Storm' of Factors Driving Up Oil Prices, Say Experts, Voice of America viewed October 7, 2008 Cohen, A & Graham, O, 2008, June 9, What Is Driving the High Oil Prices, The Heritage Foundation viewed October 7, 2008 < Energy Information Administration (EIA) 2006, Economic Effects of High Oil Prices, viewed October 7, 2008 Roberts, P 2008, June 12, Why Oil Prices Are So High, Global Research, viewed October 7, 2008 Read More