Mortgage Crisis in the USA - Report Example

Mortgage Crisis in USA Result of deregulation of the credit system Part Introduction The global financial crisis was preceded by the sub prime mortgage crisis, which marked huge number of defaulters and reflected the impact of the deregulation of the credit market by U.S. government. The national economy collapsed mainly due to the fact that the cost of supporting such a high-risk mortgage market backed by private-level securitization of assets was becoming too much to bear, which ultimately resulted in the downfall. At the end of August 2008, the write-downs and the overall losses of those securities backed by sub prime mortgages piled up to $500 billion and beyond (Immergluck, n.d.). This financial turmoil became such an acute problem in the derivative market that many premier financial firms like Lehman Brothers, Washington Mutual, and AIG eventually surrendered to the situation by incurring huge losses and few among them collapsed. The downfall of such stalwarts of the financial market pressurized the entire economy of the world to go down with them. If we analyze the issue we would find that it is the de-regulation of the US government, which ultimately resulted in the Subprime crisis. De-regulation of the US credit system is the main cause behind the mortgage crisis and the only way of restoring the normal situation is by tightening the degree regulation in the credit market. With loosening of the credit market regulations, those creditors eagerly gave loans to the set of people who did not fall in the set of potential borrowers before and credibility assessment was loosened. The crisis affected the inter-bank lending, ultimately slowing down the entire credit process of the nation. Most of the assets on which financial market worked at that time were not real as at that point of time there were an increasing number of home buyers in United States who defaulted during their loan payments. Many Americans were forced to leave their home, though the issue was not solved at that point (Gale, 2005). As mentioned above, their (home-owners’) failure to meet the debt created havoc within the American as well the Global Economy (“Mortgage crisis robbing seniors of golden years”, 2009). In the first three months of the year 2007, only 0.58 percent of the default mortgages were in foreclosure (Gale, 2005). This percentage was higher in the case of the sub-prime buyers where about 2.43 percent of the mortgage properties were evacuated. This could lead to further rise in banks’ losses (Wei and Grant, 2009). The financial institutes, the government, as well as the public were stressed out (Katz, 2009, p.23), when America saw vacant and abandoned neighborhoods, almost across all the cities of the nation. By taking possession of those properties the financial institutes were also not benefited much as the price of real estate eventually went down to a considerable extent. According to a study in a journal “Emerging Infectious Disease” the mortgage crisis has actually made some people of United State sick. The report the worst hit was the city of Bakersfield, located in the central part of California. About 300 percent of homeowners in that city failed to pay back their mortgages. This rapid increase in the number of defaulters also saw the emergence of a typical disease in that part of the country called the “West Nile Fever” (“Mortgage crisis is sickening”, 2009). From this fact we can see that with an open credit market, the general mass failed to make their risk assumption, which ultimately brought this fate for them. The government should have made controlling regulations and proper assessments about the credit takers before allowing the mortgage loans. The Mortgage crisis devastated the people and the financial institutes of America, but the analysts at times blame the adjustable-rate of mortgage. This concept became more acceptable and popular due to the fact that people belonging to low income group with bad credit rates ventured to take huge mortgage loans. The adjustable rate of interest was apparently very lucrative, as the borrower has to pay less interest rate for the first few years. This prompted the people of lower income group to grasp the opportunity to take loans of huge amounts, which they would not have taken otherwise (Gale, 2005). During the early 1960s the cost of consumer debt was very high in United Sates of America. Low cost credits were available for only those consumers who had a steady income and also had a considerable amount of asset that he or she could pledge as collateral. Till the end of 1970s the borrower needed to have a face-to-face meeting with the lender in order to purchase any item on credit. But everything changed since the year 1970, when the rate of consumer credit increased by a huge amount. This period can be marked as the beginning of the era of over-consumption of credit in United States of America (Dickerson, n.d.). The main reason pointed out for this over consumption is the deregulation of the credit market (consumer credit market specially) and that resulted in “democratization” of the available credit. This caused the higher-risk borrowers to take more credits as the ceiling for the interested rates were considerably lower. Adjustable credit rates were the direct result of such modifications. Here we can see that the government was initially following strict policy for controlling the credit market. Due to that there were lesser incidents of defaulters and such negligible amount of bad debts did not hurt the financial markets to a great extent. The introduction of adjustable rates of interest indicated a lack of balance between the short term self interest and the benefits of the common people. The loans provided at adjustable rate of interest became a bottleneck when the few initial months of low interest payments were over. As the income levels of most of the borrowers were low, they could not afford the higher side of the interest payments, which was applicable after few months of initial payments. According to the report of Mortgage Bankers Association National Delinquency survey, the number of sub-prime borrowers who were delinquent during the first three months of 2007 was up to 15.75 percent, which was higher than that of sub prime borrowers for fixed loan mortgages. These figures gave enough evidence about the vulnerability of such credit composition. Finally on 29th June of the year 2007 the government took some serious steps for cutting down the number of sub-prime borrowers who are being given loans on the basis of these risky, adjustable rates of interest. Under this guideline the borrowers must be able to afford the future payments for repaying the loan, after the increased interest rate is being imposed (Gale, 2005). This imposition from the government may seem to be a late one as the sub prime crisis has already affected the global economy. The deregulation measures introduced by the government had brought about short-term boom owing to the profitability of the real estate business initially, but it gradually showed that the economy was ultimately meant to suffer in the long run. The study of the root cause behind this crisis therefore urges for corrective measures to be taken immediately by the government. According to Peter Kolesar a researcher of Columbia University there are certain qualitative measures that can be taken to control the mortgage crisis that is hampering the entire global economy. The analysis of mortgage crisis categorized the solution into five major categories. Firstly the study states that the United States government should impose more control and monitor over the credit rating process of the country. Secondly, the government should realign incentive policies of the financial institutes who are providing the mortgage loans. Thirdly, the government and the government sponsored financial institutes must educate the common mass about the risks involved in taking credits. Fourthly, the government should reform the agencies that rate the credibility of the borrowers. Finally, the government should improve the total risk management of the entire economy. (Kolesar, 2009) Conclusion In conclusion we may say that the deregulation of the credit market led to lack of proper assessment of credibility of the borrowers. Thus, we can see that the government should not only apply control measures on the credit policies but also they should monitor the borrowers and the lenders separately. The steps recommended by Kolesar might be very helpful in this regard because the decision of the common mass and the credibility judgment of rating bodies are the two key elements of this crisis. Both these aspects should be dealt with utmost concern and systematically. The government should also keep a vigilant eye on the rating agencies, which rates the borrowers according to different categories. The entire transactions relating to credit should lie in the hands of the Government. Part 2 Discussions As we have pointed out in our main argument that the deregulation policy of the American Government ultimately lead to the downfall, these qualitative recommendation directly or indirectly indicates that the Government should play a major role in monitoring each and every activity of the credit market. In brief the Federal bodies should get more involved in monitoring the activities of the financial institutes as well as they should provide certain amount of relevant knowledge to the consumers so that they can asses their own risk taking ability. Gale (2005, p.1) states, “Many consumer advocates applauded these new guidelines, but not everyone agreed that the new guidelines are a good thing. While the new guidelines should prevent some borrowers from getting loans that they cannot handle, they will also prevent many people from buying homes who never would have fallen behind on their payments or had any other problems. After all, even under the looser standards the vast majority of subprime borrowers with adjustable-rate mortgages were not behind on their payments and were in no danger of having their homes foreclosed upon” The steps by Federal government might dishearten some borrowers but this will finally ensure that only those loans are denied where it is evident that borrowers cannot handle the repayment. This would certain prevent defaulting. This is also assured from the fact that even under the deregulated regime the borrowers who were not under risky adjustable-rate mortgages were not defaulting. Wei and Grant (2009, p.A2) states, “The commercial-real-estate market could yet be salvaged by an improving economy and bailout programs coming out of Washington. In addition, capital markets are starting to ease for publicly traded real-estate investment trusts. Since March, more than two dozen REITs have managed to raise more than $13 billion by selling shares.” The call for government intervention is highly emphasized here. The commercial market for real estate could be bailed out of the crisis only via some help from Washington. The publicly traded real estate firms were already out of the crisis as they have managed to compensate the loss by selling shares worth $13 billion. References: 1. Gale T. (2005). ‘The Subprime Mortgage Crisis: Opposing Viewpoints’, Detroit: Opposing Viewpoints Resource Center. 2. Kolesar P. (2009). ‘A Quality Perspective on the Mortgage Crisis’, The Quality Management Journal, 16 (3) ABI/INFORM Global, 30 3. Immergluck D. (n.d.). ‘Private Risk, Public Risk: Public policy, market development and the mortgage crisis’. FORDHUM URB LJ, XXXVI, 448-488 4. ‘MORTGAGE CRISIS IS SICKENING’. (Feb 27, 2009). Current Science, ProQuest Education Journals, 12. 5. ‘Mortgage crisis-robbing seniors of golden years’, USA Today. (JUN 05, 2009). Academic Search Premier 6. Katz A. (September 2009). ‘There Goes the Neighborhood’. The American Prospect, 20-24 7. Dickerson A.M. (N.d.). ‘Over-Indebtedness, the Subprime mortgage crisis, and the effect on U.S cities’, FORDHUM URB LJ, XXXVI, 390-425 8. Wei, L. and Grant, P. ‘U.S. News: --- THE OUTLOOK: Commercial Real Estate Lurks as Next Potential Mortgage Crisis’, Wall Street Journal. (Eastern edition). New York,: Dow Jones & Company, Aug 31, 2009. A.2 Read More