Sub-Prime Mortgage Crisis - What Caused It ? How Can Us Recover from It?

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Sub-Prime Mortgage Crisis - What Caused It ? How Can US Recover From It?

The recent financial crisis in the U.S. that spread to other countries and caused massive turndown in the global economy had its roots in the recent waves of globalisation. Since the developed countries’ production had shifted dramatically towards services, specially to financial services, and this in turn led to financial liberalizations, developed countries experienced massive capital inflows, lending booms, housing and / or stock market bubbles. Financial crises are usually followed by hard and sharp contraction in economic activities, which requires government intervention to bail out banks and restore banking stability. However, government intervention
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Besides, the AAA ratings of most structured securities also lured foreign investors to the security market, raising the demand for the structured products (E,Benemlelich.J,Dlugosz.2008). The volume of trade in securities increased, which further strengthened a bubble in housing prices by creating cheap credit. According to S&P/Case-Shiller Home Price Indices, in 2005 the price of the house where gone up about 100 % compare to 2000.

At the same time, the rise in the demand for securitized products changed the function of the banks; their key activity became to originate loans, package them, and sell them to investors. As a result, lending standards fell dramatically and banks relaxed regulatory standards, which increased loan approvals. Also, mortgage brokers began providing discounted mortgages, no-documentation mortgages and NINJA (No income, No job, No assets) loans. The background checking became unnecessary because the price of the houses were just increasing, and the originating banks were able to pass the loans to less risk-averse investors (E,Benemlelich. J,Dlugosz.2008).

The credit bubble started to create such an environment. This bubble refers to trading an assets above the real value of the assets. So, the underlying assets for those securities were the houses.

Each house has two types of value. The first value is the market value which the current value of the
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