Applied Economic Theory

1086 Words5 Pages
Applied Economic Theory United States Mortgage Crisis After rising at an annual rate of nearly 9 percent from 2000 through 2005, house prices have decelerated, even falling in some markets. At the same time, interest rates on both fixed- and adjustable-rate mortgage loans moved upward, reaching multi-year highs in mid-2006. Some subprime borrowers with ARMs, who may have counted on refinancing before their payments rose, may not have had enough home equity to qualify for a new loan given the sluggishness in house prices. In addition, some owners with little equity may have walked away from their properties, especially owner-investors who do not occupy the home and thus have little attachment to it beyond purely financial…show more content…
The central banks were present at the creation, as asset prices inflated and credit markets hypertrophied. Between 1997 and 2006, according to the S&P/Case-Shiller national home-price index, American house prices rose by 124%. America's was not the frothiest housing market: in the same period prices in Britain went up by 194%, those in Spain by 180% and those in Ireland by 253%. What was peculiar to America was the ability of large numbers of subprime borrowers—those with poor credit records—to take out mortgages and buy homes, lured by cheap credit and the belief that house prices could only rise. By 2006 a fifth of all new mortgages were subprime. The interest rates on many of these were adjustable, unlike those on most American mortgages. Low “teaser” rates were charged for a while before higher, market-based rates kicked in. The Fed's basic policy tool for influencing economic activity and inflation is its ability to control very short-term interest rates--specifically, the federal funds rate, which is the rate that banks pay each other for overnight loans. Lower interest rates can be used to stimulate private-sector borrowing and spending at times like the present when the economy is suffering from a lack of demand. In September 2007, shortly after the turbulence in financial markets began and signs of economic weakness started to appear, the Federal Open Market Committee (FOMC), the body that determines the Federal Reserve's monetary
Open Document