Subprime Mortgage Crisis was a crisis that majorly affected the sectors of finance and real estate in the United States. It lasted from 2007 to 2010 with its climax being in 2008. It is the drastic rise in delinquencies of mortgages together with foreclosures that engineered the crisis. Debt saturation, the default of credit swaps and reverse trading are also among the major factors that elicited the crisis (Fengbo, 2008). Due to these factors, most financial markets, as well as banks throughout the world, became affected.
To expand a little on several events that caused the crisis, the whole saga emerged when the peak of the housing bubble in the US was attained. That was in the year 2006. By then, adjustable-rate mortgages recorded a drastic increase in the default rates. This was a motivation for borrowers who became encouraged given the presence of increased incentives on loans as well as terms of borrowing (Fengbo, 2008).
Borrowers were also drawn forward by the ancient trends which always saw prices of houses rise. This did not last for long before the rates of interest on borrowed loans began to increase. Subsequently, it became a challenge for the borrowers to re-finance the loans thus leading to numerous defaults and a rise in foreclosures. The prices for the houses (real estate) did not rise as was initially anticipated. There was no other option than to reset the adjustable-rate mortgages to a much higher level (Fengbo, 2008).
This in turn led to a drastic decrease in the prices of houses at that particular time to an extent of being lower than the borrowed loan amount. Individuals were forced to run for foreclosures, which led to the big crisis of escalated foreclosures. According to Hellwig (2009), it is this huge foreclosure that went on to play a role in the economic global crisis. When there is an escalated foreclosure, customers tend to lose any money they hold and banks on the same note suffer great financial instability.
During the period that later turned out to drive the US into the crisis, various countries from Asia and parts of the Middle East brought a lot of cash into the economy. These countries were believed to be enjoying a faster-growing economy due to oil availability. At the time money was being injected, the interest rates were extremely low and this led to rapid growth in real estate markets. It is this rapid growth and popularity in real estate markets that engineered the creation of credit as well as housing bubbles (Foote & Willen, 2011).
The easily available loans tempted many customers to apply and have the cash thus leading to huge accumulated loads of loans and debts. Securities that were mortgage-backed increased drastically due to bubbles arising from credits and real estate. At the time, later on, when the market for houses in the United States collapsed, almost all individuals who had intensely invested in real estate recorded intense losses with others being declared bankrupt. The losses were worldly estimated to approach a few trillions of dollars (Whalen, 2008).
At the time the housing bubbles escalated, a susceptible economy emerged due to various factors. To start with, the creators of policies did not take into consideration the significance of various financial institutions like hedge funds and banks of investments. It is these banks that participated in the provision of credits to the government of the United States. Eventually, the banks lost their lending potential as the burden of huge loan recovery overpowered them. Banks did not have the necessary financial cushion needed to overcome the impact of loan defaults and losses in mortgage-backed securities (Hellwig, 2009).
The policies set by the government were also partly to blame for the subprime mortgage crisis that occurred. The implementation of various policies and regulations by the government also had a large role to play in the development of the crisis. For instance, the act of home mortgage disclosure enabled lenders to keep track, maintain and disclose their loan data. This is where the issue of racism in subprime mortgages arose. Several lawsuits were filed for systematic institutionalised racism against the leading lenders (Fengbo, 2008).
To wind up the causes of the crisis, it was evident that the rate of unemployment at that particular time was also a factor that led to the crisis. The western states, especially those located in the middle of the United States, had been hit hard by layoffs from auto industries which had been initially ranked to possess high foreclosures. By then, many individuals were already sure that they would be able to re-finance and subsequently make their loans affordable (Foote & Willen, 2011). This was not the case as the housing market continued to record reducing rates of appreciation. This made it impossible for individuals to service their loans. At the time the subprime load introductory period came to an end, the new rates were so high that many individuals could not manage and this is how it contributed to the crisis.
Looking at the impact of the crisis, the IMF (International Monetary Fund) estimated the losses to about three trillion USD for banks in both the United States and Europe (Blackburn, 2008). The United States alone lost close to sixty per cent of the estimation with Europe losing about the remaining forty per cent.
To expand on the impact of the crisis, vital measures of wealth were affected as follows. Looking at the real GDP of the United States, more than one-quarter of the American’s net worth was unaccounted for. The stock exchange index recorded a 45% decrease by the end of the crisis period. The price of houses was also affected negatively (Blackburn, 2008). It was estimated that house prices fell by almost 20% at the end of the crisis (Blackburn, 2008).
In fact, it was expected that the prices for the same houses were to be affected by a further 35 % potential decrease (Whalen, 2008). Looking at the home equity, the US which had recorded 13 trillion USD found itself to record about 8 trillion USD after the crisis (Blackburn, 2008). In addition, it was speculated that this drop was to continue after the year 2008. The United States’ retirement assets were also affected by the crisis.
America saw a 22% decline in its total retirement assets which was translated to be a decrease from 10 trillion USD to about 8 trillion USD (Blackburn, 2008). Other investment and savings assets were also affected negatively. The GDP level of the United States has since fallen short of its potential by almost 6% and this was projected to take several years before regaining its initial strength (Foote & Willen, 2011).
Another sector that was affected was employment. The crisis caused the rate of unemployment to rise by almost 10%. In addition, it was again projected that the rates would continue to decline by a further 8% in subsequent 4-5 years (Blackburn, 2008). This translated to about eight million more unemployed individuals as compared to the period before the crisis occurred.
Looking at Europe, the banking systems in Europe were largely affected by the crisis escalating to sovereign debt. Many countries used money from their taxpayers to save their banking systems (Fengbo, 2008). Some other European countries opted to look for measures that would see their deficits in budgetary allocations reduced. Such measures included involvement in austerity programs. For instance, Greece, Italy and Iceland are among the European countries that engaged in austerity programs to reduce their budget deficits by almost 20% (Blackburn, 2008). Europe as a region also faced a drastic rise in unemployment rates with Iceland, Greece, UK and Portugal being the most affected.
At the time of the crisis which coincided with the ensuing recession, the consumers in the US were able to increase their savings as they were deleveraged. On the other edge, corporations significantly reduced their investments (Hellwig, 2009).
Since the crisis, various economic entities have benefited from the lessons learnt. For instance, awareness and attention have been increased in financial markets and institutions following the instability that occurred (Fengbo, 2008). Government policymakers, political groups, agencies and regulators became more sensitive by putting in place additional comprehensive measures to contain the crisis.
References
Blackburn, R. (2008). The Subprime Mortgage Crisis. New Left Review, 1(60), 11-16.
Hellwig, M. F. (2009). Systemic risk in the financial sector: an analysis of subprime-mortgage financial crisis. De Economist, 9(157), 129–207.
Fengbo Z. (2008). Perspective on the United States Sub-prime Mortgage Crisis. NY: John Wiley & Sons.
Foote, C. L. & Willen, P. S. (2011). Subprime mortgage crisis. Palgrave Macmillan.
Whalen, R. C. (2008). The Subprime Crisis: Cause, Effect and Consequences. CA: Institutional Risk Analytics.