Lawrence Humes
4/28/15
Mr. Donnellan
Period 1
How Banks Went Broke: A Look into the Financial Crisis of 2007-2008
Nobody foresaw what was about to happen to the economy. In the beginning of the 21st Century the economy was at a state of peace and unity. People were taking loans and purchasing houses that they normally couldn’t afford while these houses were increasing in value. The banks were giving out loans to the people to purchase the houses and earning money on the interest of those loans and the commission of the loan. That is when people began to notice the advantages of what could be taken from this economic situation. With a new method of earning money quickly and easily, it is no surprise that everybody began to try
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Banks were intelligent enough to realize that the people who were taking and asking for loans were unlikely candidates to pay them back. The banks knew that by giving out these loans that the people would result in two ways. One being to actually pay back the loan with interest to the bank, or two, be forced to foreclose their house. Either way the bank didn’t care because they were making money and getting rich either way. If the people actually paid back their loans, the bank is guaranteed profit through the interest incorporated in the loan and the commission made by the sale. If the people couldn’t pay, there still is a great opportunity for the bank to make profit through selling them to investors. Right before the depression the value of homes was steadily increasing. With a person’s foreclosed house, a bank was able to resell that house and potentially make even more money than if the person has paid back his entire loan with interest. For banks, it was a win-win situation. They saw dollar signs in every possible direction and went for it. They did not care how they were making their money, just as long as there was profit within reach. Money is all that mattered to these banks. (Casil)
People also began to buy houses
The public was uneducated in how the process worked but seemed not to be bothered because it got them into the house. They don’t want a mortgage, they want a home. A home they can raise a family, build equity, build a life, have a sense of freedom. That “boom” market gave it to them. The lenders probably told them to just sign here for now and we’ll get your mortgage down to where you really want it and in a couple of years and we’ll figure out the rest. When you have no idea that the market would crash as it did, are you prepared? No, because who is thinking that your home is losing value, that people are going to lose their jobs or that the economy would turn into a recession. Not the banks or the public thought that. The perception was that the market was going to go up or stay steady, so the homeowners were going to be able to refinance and get rid of their current payment. People were going to make more money, they were going to get a raise in a couple years at their jobs and everything would be better. So when the homeowners refinanced their loan they would get a fixed rate mortgage for 30 years. But that never happened.
The Great Recession of 2007-2009 was one of the most economically disastrous events in American history. The housing market took a significant downturn during this period. People were not cautious when it came to their money and loans. Larger loans were given out to people, even to those with bad credit and low incomes. These large loans caused many homes to go through foreclosure since people were unable to pay off their mortgage debts. These debts were created by banks increasing the interest rates on the loans significantly in a short period. In 2008, foreclosures were up by eighty-two percent. This increase is significant because the previous percentage of foreclosures was at fifty-one percent from 2007. Unemployment skyrocketed, and people
After the optimistic forecast from the realstate that the houses value were going to increase, many institutions started to make adjustments to take profit from this trend. In some cases, prime mortgages were allowed for subprime borrowers to take. This might look like a great idea to financial institutions because the house values were rising: if a people (who in the first place couldn’t afford a house) stop paying their mortgages then the bank could sell the house for a value greater than the one at the moment of default. Everything was going well, so how is it that the crisis unfolded? Well, these institutions wanted to make more profit
Simply put, it all commenced within the United States housing market. In the years leading up to 2008, buying and selling mortgages became a very popular way for lenders to make money. While housing prices continued to increase, lenders found themselves in a win-win situation. If homeowners paid their mortgages, the lenders made money. If homeowners could not pay their mortgages, they would
A few years later the market took a turn for the worse, where interest rates were on the rise, and homes were losing their value quickly. Now borrowers that were in these interest only ARM’s needed to refinance these loans because the rates were going up, to a point where the homeowner was not be able to afford the payment. The Federal Reserve tried to stimulate the economy by lowering interest rates during the recession in early 2001, from over 6% in 2000, to a rate just above 1.25% in 2002. These low rates encouraged many Americans to apply for loans for homes that a few years ago they would have not been able to. To encourage the homeownership boom, the Bush administration urged Fannie Mae and Freddie Mac to allot more money for low-income borrowers so they could buy their own homes. This resulted in the subprime mortgage
The U.S. economy experienced a deep recession in years of 2008 through 2009. A huge factor in this was the number of large financial institutions that failed. Also, the stock market declined significantly which can be contributed to the bailout plan that was passed by our government. Third, spreads on many different types of loans over comparable U.S. Treasury securities has expanded significantly (Chari, Christiano, & Kehoe, 2008). The financial crisis is the result of the collapse of the housing bubble in the U.S., which can be seen as the starting point of a crisis in the global economy afterward.
The financial crisis of 2007-2009 resulted from a variety of external factors and market incentives, in combination with the housing price bubble in the United States. When high levels of bank and consumer leverage appeared, rising consumption caused increasingly risky lending, shown in the laxity in the standard of securities ' screening and riskier mortgages. As a consequence, the high default rate of these risky subprime mortgages incurred the burst of the housing bubble and increased defaults. Finally, liquidity rapidly shrank in the United States, giving rise to the financial crisis which later spread worldwide (Thakor, 2015). However, in the beginning of the era in which this chain of events took place, deregulation was widely practiced, as the regulations and restrictions of the economic and business markets were regarded as barriers to further development (Orhangazi, 2014). Expanded deregulation primarily influenced the factors leading to the crisis. The aim of this paper is to discuss whether or not deregulation was the main underlying reason for the 2007/08 financial crisis. I will argue that deregulation was the underlying cause due to the fact that the most important origins of the crisis — the explosion of financial innovation, leverage, securitisation, shadow banking and human greed — were based on deregulation. My argument is presented in three stages. The first section examines deregulation policies which resulted in the expansion of financial innovation and
They thought that if the bank loaned them the money, they must be able to afford it. When their mortgage payment increased, they could not afford to pay the higher amount and the foreclosure process began yet again.
The financial crisis that happened during 2007-09 was considered the worst financial crisis in the world since the great depression in the 1930s. It leads to a series of banking failures and also prolonged recession, which have affected millions of Americans and paralyzed the whole financial system. Although it was happened a long time ago, the side effects are still having implications for the economy now. This has become an enormously common topic among economists, hence it plays an extremely important role in the economy. There are many questions that were asked about the financial crisis, one of the most common question that dragged attention was ’’How did the government (Federal Reserve) contributed to the financial crisis?’’
Throughout history there has always been some sort of a class struggle. The rich always seemed to get richer while the poor barely managed to get by. One of the main things that contributed to the ever-expanding gap between the rich and the poor was greed. Whether it was the greed for money or for power, greed was certainly a driving force. More recently, the greed of several, rich and powerful individuals helped to cause one of the largest financial collapses of modern times. The purpose of this paper is to establish some of the key players in the economic crash of 2008, and to show some common
Before the 1970s the banking was not a business that you went into to make money. That was until Louis Ranieri came around. Louis Ranieri had one idea that changed the housing market forever. His plan was to have a mortgage back security. A mortgage back security is an assist based security backed by a mortgage. For example, if you use your mortgage to start a business, your business is backed by that mortgage. The average mortgage loan has a fixed rate loan and takes thirty years to pay off, but then he thought to bundle them all together. They thought these would still be less risky because who would not pay their mortgage. They were doing hundreds of million dollars in mortgage bonds a year, but that all changed when they ran out of mortgages to put into the bonds. If there were no bonds then there was nothing left to make money, and the banking world was going to back to the way it was. Rather than letting that happen, the banks made a loan called a subprime loan.
This book also makes people aware of what kind of people work on Wall Street and why they could let something like this happen. Greed was one of the big motives because everyone was making money during this time. Everyone though home prices would keep rising so brokers and banks wanted more and more people to own homes. The problem was that people who could afford a home already had one and to make more loans banks had to lower their standards. A common acronym is “NINJA” which stands for no income, no jobs or assets, no problem. Banks would entice these types of borrowers with adjustable rate mortgages to book the sale. Then the banks would turn around and sell these mortgages so it was someone else’s problem. Eventually when the borrower
Savings and Loan Associations (S&Ls) already offered mortgages with constant payments before the Great Depression, though they were typically less than 12 years long. At the time, other lenders mostly offered short-term mortgages that needed to be refinanced because they had “balloon” payments at the end. During the Great Depression, many households went into default in part because this refinancing became difficult. One government response was to create the Home Owners Loan Corporation
The first way that the lenders and bankers saw an opportunity to make money at the expense of those who could not afford it in the first place, was to levy large handling fees for lending in addition to larger than normal interest rates. This presented the borrower with more problems on top of the already too expensive house they were buying. The greedy lenders took advantage of the poor credit borrowers but with the expectation that they could not pay. This leads us to the second way that the greedy preyed on the needy using real estate as bait. Lenders expected that borrowers would eventually fall on hard times and would not be able to pay the mortgage on the property they had purchased. This allowed the lender to swoop in and seize the property at a lower rate than the borrower paid for the property. The lender could then re-sell the property to another “prospect”. Instead of passing on
This chapter is about the background of 2007-2008 financial crisis. The 2007-2008 financial crisis has a huge impact on US banking system and how the banks operate and how they are regulated after the financial turmoil. This financial crisis started with difficulty of rolling over asset backed commercial papers in the summer of 2007 due to uncertainty on the liquidity of mortgage backed securities and questions about the soundness of banks and non-bank financial institutes when interest rate continued to go up at a faster pace since 2004. In March 2008 the second wave of liquidity loss occurred after US government decided to bailout Bear Stearns and some commercial banks, then other financial institutions took it as a warning of financial difficulty of their peers. In the meantime banks started hoarding cash and reserve instead of lending out to fellow banks and corporations. The third wave of credit crunch which eventually brought down US financial system and spread over the globe was Lehman Brother’s bankruptcy in August 2008. Many major commercial banks in US held structured products and commercial papers of Lehman Brother, as a result, they suffered a great loss as Lehman Brother went into insolvency. This panic of bank insolvency caused loss of liquidity in both commercial paper market and inter-bank market. Still banks were reluctant to turn to US government or Federal Reserve as this kind of action might indicate delicacy of