Why The United States Mortgage Crisis

The mortgage crisis of 2007 marked catastrophe for millions of homeowners who suffered from foreclosure and short sales. Most of the problems involving the foreclosing of families’ homes could boil down to risky borrowing and lending. Lenders were pushed to ensure families would be eligible for a loan, when in previous years the same families would have been deemed too high-risk to obtain any kind of loan. With the increase in high-risk families obtaining loans, there was a huge increase in home buyers and subsequently a rapid increase in home prices. As a result, prices peaked and then began falling just as fast as they rose. Soon after families began to default on their mortgages forcing them either into foreclosure or short sales. Who was to blame for the risky lending and borrowing that caused the mortgage meltdown? Many might blame the company Fannie Mae and Freddie Mac, but in reality the entire system of buying and selling and free market failed home owners and the housing economy.

During the early 2000 's, the United States housing market experienced growth at an unprecedented rate, leading to historical highs in home ownership. This surge in home buying was the result of multiple illusory financial circumstances which reduced the apparent risk of both lending and receiving loans. However, in 2007, when the upward trend in home values could no longer continue and began to reverse itself, homeowners found themselves owing more than the value of their properties, a trend which lent itself to increased defaults and foreclosures, further reducing the value of homes in a vicious, self-perpetuating cycle. The 2008 crash of the near-$7-billion housing industry dragged down the entire U.S. economy, and by extension, the global economy, with it, therefore having a large part in triggering the global recession of 2008-2012.

The FOMC, Federal Open Market Committee, is a group made up of the 7 Board of Governors, the President of the New York Reserve Bank, and 4 other Reserve bank presidents who switch with other Reserve Bank’s on one year terms. Together these members meet and vote on the policies in which they believe they should enact given the current and predicted future state of the economy.

By law, the Federal Reserve conducts monetary policy to achieve its macroeconomic objectives of stable prices and maximum employment. The Federal Open Market Committee usually conducts policy by adjusting the level of short-term interest rates in response to changes in the outlook of the economy. Since 2008, the FOMC has also used large-scale purchases of Treasury securities and securities that were guaranteed or issued by federal agencies as a policy tool in an effort to lower longer-term interest rates and thereby improve financial conditions and so support the economic recovery (What).

The Federal Reserve exercises its power to stimulate stable employment economies and economic prices. The pursuit of the required employment rate and the creation of price stability, the Federal Reserve can increase or decrease the interest rate.

The Federal Reserve website explains the theory of monetary policy in more detail. As the website says, “the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks, and in this way, alters the federal funds rate…the rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight” (www.federalreserve.gov/monetary policy/fomc).

The federal reserve system creates economic growth and stability. Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, stated in a speech at the World Affairs Council of Philadelphia saying, “[The] Federal Reserve's goal [is] of maximum employment and price stability, and, as I will explain, there are good reasons to expect that we will advance further toward those goals.” This being said, fluctuations in the interest rate causes adverse condition. When the interest rate goes down, it increases the money supply by making money less expensive, which allows member banks to borrow more money. When the interest rate goes up it decreases the money supply by making money more expensive, which in turn discourages borrowing and spending, slowing down the economy. Continual rate changes affect the entire economy. High interest rates causes the government to be limited in creating programs without the aid of the federal reserve. During the financial crisis, the Federal Reserve established several facilities to provide liquidity directly to borrowers and investors in key credit markets. As the production of financial markets enhanced, the Federal Reserve eased down these programs. In the attempt to dispense entrance to short-term debt funding, the Federal Reserve System effectuate a variety of crisis management

The Federal Funds Rate is the interest rate that Federal Reserve uses to trade funds with banks. Changes in this rate can trigger a chain of events that can be beneficial or devastating to the economy. If a bank is charged a higher interest rate to trade money or take out a loan, then the increase will be passed on to their customers, causing them to pay higher transaction fees or more interest. Each month, the Federal Open Market Committee meets to determine the federal funds rate. This in turn affects other short term interest rates. The determining rate immediately impacts the rates at which banks borrow money and the interest rates the banks use to charge their customers on loans. If the rate raise is too high, then money flow drops

In the year 2008, the United States experienced the most serious financial and economic crisis since the Great Depression of 1929. The economy, after peaking in 2006, began to express warning signs of a dooming financial and economic recession. The primary cause of the entire recession was a credit crisis resulting from the burst of the housing bubble. This analysis will be devoted to the study of the housing bubble and its burst. The housing bubble was primarily caused by the low, short-term and variable interest rates, subprime loans given to less than qualified borrowers, and the collapse of big time lenders

The problem was everyone who qualified for a mortgage already had one. Lenders knew if they sold a mortgage to a person that defaults the lender gets the house, and houses were always increasing in value in that market, that would be a valuable asset to sell. To keep up with the demand from investors, lenders started selling mortgages to borrowers who wouldn’t have qualified before because of the risk for default. These mortgages are called sub-prime mortgages and lenders started creating tons of them. In the unregulated market, lenders employed predatory tactics to get more borrowers with attractive offers such as no money down, no credit history required, even no proof of income. People never would have qualified before were now buying large houses, and the lenders sold their mortgages to Investment bankers. The investors packed subprime mortgages in with prime mortgages so credit agencies would still give a AAA rating. The rating Agencies who had a conflict of interest by receiving payments from the investment banks, had no liability if their credit ratings were correct or not. They turned a blind eye to the risky CDOs and kept giving AAA ratings. This worked for a while and everyone was happy including the new homeowners. The housing market became hyper inflated with more homeowners than ever. Wall Street continued to sell their CDO’s which were ticking time bombs. The subprime mortgages began

      Monetary policy is under the control of the Federal Reserve System and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. The Federal Reserve System’s control over the money supply is the key Mechanism of monetary policy. They use 3 monetary policy tools- Reserve Requirements, Discount Rates/Interest Rates, and Open Market Operations. The reserve requirement is the percentage of bank deposits a bank must hold in reserves and cannot loan out. By raising or lowering the reserve requirements, the Fed controls the amount of loanable funds. The interest rate is the amount the FED charges private banks, so they can meet the reserve requirements. The prime rate is currently set at 5%. If the Interest rate is low, the banks will borrow more money from the FED and the money supply will increase. Interest rates have been above average for the past 20 years, but are currently considered low. Open Market Operations is the most effective and most used

One of the first indications of the late 2000 financial crisis that led to downward spiral known as the “Recession” was the subprime mortgages; known as the “mortgage mess”. A few years earlier the substantial boom of the housing market led to the uprising of mortgage loans. Because interest rates were low, investors took advantage of the low rates to buy homes that they could in return ‘flip’ (reselling) and homeowners bought homes that they typically wouldn’t have been able to afford. High interest rates usually keep people from borrowing money because it limits the amount available to use for an investment. But the creation of the subprime mortgage

During house price “bubbles”, subprime loans were introduced to people with low ability to pay off their mortgage, especially to households with low income. Unfortunately, these loans were distributed unevenly across the country (Silje Pileberg, 2014). His article pointed out that this loan was specifically for borrowers with low credit scores (FICO scores less than 640, for example). However, the system seemed not to work fairly just as Pileberg (2014) described. A recent research by Barth (2009) demonstrated that 31 out of 32 types of available mortgage products were chosen by prime borrowers from January 1999 through July 2007. This is because the difference between prime and subprime lending becomes artificial due to the fact that lender can define on its own which borrowers are subprime. The subprime lending eventually grew rapidly. Barth (2009) showed that subprime home mortgage originations went up

An increase in loan packaging, marketing and incentives encouraged borrowers to undertake difficult mortgages so they believed that they would be able to refinance quickly at more favourable terms. People borrowed money to buy the house and then expected the price to rise and sold so that they could pay off the debt which owed to the bank and demanded a new loan to buy another house. However, once the interest rate began to rise and house’s price dropped in 2007, refinancing became more difficult and banks could not collect their mortgages.

In 2007 investment banks acquired more than one trillion dollars in investments filled with these suffering subprime mortgages. During the first quarter alone in 2007, twenty five subprime mortgage lenders were forced into bankruptcy. Towards the end of 2007, it became clear that our financial market would was not able to solve this subprime mortgage crisis on their own. With failed attempts entering the international banking market, the Fed responded by significantly decreasing the federal funds rate again. The Fed decreased the rate like they had in response to the DotCom Bust and 9/11 in an effort to stimulate the economy once again. By 2008, the federal funds rate had been lowered to 1%, but the reduction of this rate was not enough to prevent the financial crisis.