What Were The Main Cause Of The Crisis?

The financial crisis emerged because of an excessive deregulation of business operation of financial institutions and of abusing the securitization mechanism in the absence of clearly defined rules to regulate this area in the American mortgage market (Krstić, Jemović, & Radojičić, 2013). Deregulation gives larger banks the opportunity to loosen underwriting lender guidelines and generate increase opportunity for homeownership (Kroszner & Strahan, 2013). After deregulation, banks utilized many versions of mortgage loans. Mortgage loans such as subprime and Alternative-A paper loans became available for borrowers challenged to find mortgage lenders before deregulation (Elbarouki, 2016; Palmer, 2015). The housing market has been severely affected by fluctuating interest rates and the requirement of large down payment (Follain, & Giertz, 2013). The subprime lending crisis has taken a toll on the nation’s economy since 2007. Individuals who lacked sufficient credit ratings or down payments resorted to subprime mortgages to finance their homes Defaults on subprime and other mortgages precipitated the foreclosure crisis, which contributed to the recent recession and national financial crisis (Odetunde, 2015). Subprime mortgages were appropriate for borrowers with substandard credit and Alternate-A paper loans were

In the years of 2007-2008, the world economy faced the most severe global financial crisis. The collapse of the sub-prime mortgage market was considered to be the trigger for the Global Financial Crisis. In the United States, low interest rates and financial deregulation created credit conditions where it was easier for the American people to buy homes with subprime loans. It increased the housing demand and raised the house prices in the market, which resulted in a housing bubble. Fannie Mae and Freddie Mac are two private corporations that are referred to as government-sponsored enterprises. They offered a mass of mortgage-backed securities (MBS) to the high-risk borrowers. Rising house prices created home equity for the borrowers, allowing

effectively encouraged frivolous spending and heavy borrowing allowing people to live beyond their means. Low interest rates also increased the discount value of assets and therefore increased their value. This created a house price boom in the UK and US. It was in the US that this twined with high levels of borrowing created the subprime lending market, whereby individuals with poor or no credit history borrowed vast subs of money to buy

Investors relished in these mortgage backed securities. They paid a higher rate of return than investors could get in other places, and appeared to be safe bets. Home prices increased; Leading lenders to believe the worst case scenario, homeowners would default on their mortgage, and they could sell the house for an additional amount of money. 1 At the same time, credit rating agencies continued to inform investors that mortgage backed-securities were safe investments. Investors were desperate to gain more securities. Promoting lenders to help create more of them. However, to create more, lenders needed more mortgages. This caused lenders to loosen their standards and provided loans to individuals with low income and poor credit. These are referred to as subprime mortgages.2 Eventually, some institutions begin using what is referred to as predatory ending practices to generate mortgages. They made loans without verifying income and offered absurd, adjustable rate mortgages with payments individuals could afford, at first, it became disorderly quickly. Subprime leading was a new practice at the time. These investments were becoming increasingly less safe. However, investors trusted rating, and continued to

The worst of the mortgages were packaged and tranche into bonds and got rated AAA by these credit rating agencies. By erroneously rating these bundles of mortgage-backed security payments too highly, the credit rating agencies substantially contributed to the creation of toxic financial assets. The problem was each agency were competing for the banks revenue, to keep the banks business the agencies would always rate their bonds the highest possible grade of AAA.

This almost brought down the world’s financial system, and threatened the collapse some of the large financial institutions. Which luckily was prevented by the bailout of banks by national governments, but left the stock markets to fend for themselves, thus causing global drop. It took huge taxpayer-financed bailouts to shore up the industry. Even so, the ensuing credit crunch turned what was already a bad turn out into the worst recession in 80 years. In 2008 the world economy faced its most dangerous crisis since the Great Depression of the 1930s. The contagion, which began in 2007 when sky-high home prices in the United States finally turned decisively downward, spread quickly, first to the entire U.S. financial sector and then to financial markets overseas. The American economy is built on credit, and because of this credit went unchecked and got out of control. Many people were taking out loans, mortgages became simple. Many people got rich and wanted more. Banks made a cut on the sale, then packaged the mortgage with a group of other mortgages and erased all personal responsibility of the loans. The housing market eventually declined, causing massive losses in mortgage backed securities. Many banks and investment firms began losing money. This also caused a massive amount of homes on the market which lowered housing prices and slowed

There are a number of notions as to what led to the mortgage crisis. Many professionals and economists believe it came about through which subprime lending played a major part. (Bianco, 2008) An increase in loan enticements such as easy initial terms and a long-term trend of climbing housing prices had encouraged borrowers to undertake problematic mortgages in the belief they would be able to refinance at more advantageous terms in a diminutive amount of time. Furthermore, the increased market power of originators of subprime mortgages, as well as the lessening role of Government Sponsored Enterprises (GSE’s) as concierges, amplified the number of subprime mortgages provided to consumers who would have otherwise qualified for compatible loans. The inferior performing loans were safeguarded by private investment banks, who, for the most part, lacked the GSE's power and influence over mortgage originators. As soon as the interest rates began to escalate and housing prices started to descend reasonably in 2006–2007, refinancing became more challenging. As easy preliminary terms expired, ARM interest rates reset higher, and home prices failed to increase as expected, defaults and foreclosure activity amplified dramatically.

Between 2007 and 2008, the impending mortgage crisis met its peak, and subsequent “burst”. In simple terms, over the years leading up to the housing bubble, banks loaned out large amounts of money to the people in an effort to stimulate the economy. Those who originally did not qualify for such large loans, now did. However, these subprime borrowers (borrowers with a poor credit history) often could not actually afford their payments, leading them to file for bankruptcy, and pushing the country closer toward the recession and the collapse of the housing market. The rise in subprime mortgage delinquencies and foreclosures meant a severe decline in securities. As the recession escalated, the wellbeing of financial institutions and citizens alike

Essentially, a subprime loan is one in which “the borrower has blemished credit, usually measured by a FICO credit score” (Wallison, 2010). Moving forward from 2001, the United States saw an increase in subprime borrowing. This resulted in an increase in homeownership rates and demand for housing in the years leading up to 2008. In 2004, the United States peaked when homeownership reached 69.2% (Bianco, 2008). In addition, the rise in demand also fueled an increase in the values of homes (Bianco, 2008). Since interest rates were so low, homeowners also adopted other measures such as refinancing their homes and taking out second mortgages (Bianco, 2008). According to Forbes, subprime mortgages increased to represent approximately one-fifth of the U.S. home loan market in 2006 (Jacobs, 2009). That year, approximately 84% of all subprime loans were from private financial institutions to middle and low-income persons (Denning, 2011).

As home prices continued to rise, lenders thought the borrowers would just default on the mortgage and then the lenders would just be able to sell the house for more cash. While prices and risks were rising, investors were notified by credit rating agencies that mortgage backed securities were safe investments by giving them AAA rating (Naude 3). These investors were told one thing and market investments were not showing high returns. Lenders started to create more and more investments because investors wanted to buy more securities, but in order to create more investments, lenders needed more mortgages (Erkens, Hung, & Matos 392). A way to create more mortgages was to widen their customer market. Lenders created less strict rules and regulations

First, the subprime mortgage was a major reason for the financial meltdown. Initially, subprime mortgages were designed to assist borrowers with a low credit score and fall into the low-income bracket. However, lenders starting utilizing this loan type for all borrowers regardless of economic status. The ethical issue observed was a lack of trustworthiness. Lenders did not disclose all of the risk involved with this loan type. They only promoted the benefits of profits and lower monthly payments. The slow down of the housing market quickly identified the pitfalls of

The housing market crash, which broke out in the United States in 2007, was caused by high risk subprime mortgages. The subprime mortgage crisis resulted in a sudden reduction in money and credit availability from banks and other lending institutions, which was referred to as a “credit crunch.” The “credit crunch” and its effect spread across the United States and further on to other countries across the world. The “credit crunch” caused a collapse in the housing markets, stock markets and major financial institutions across the globe.

There were a lot of factors which brought about the crisis. Due to limited space, this essay will look at the U.S. housing market and the U.S. financial system, and discuss the increasing demand of the subprime market as the most important factor bringing about this crisis.

Another reason which can be associated with the emergence of housing bubble has been the lowering down of lending standards by the financial institutions, which led to mortgage lending being offered to less credit worthy customers. Further, another significant factor which contributed to the U.S housing bubble were the affordable lending policies adopted by the government in the early 1990s which encouraged or rather forced the lending institutions to offer credit exposure to the communities and neighbourhoods with low and moderate incomes.

Many Americans embraced the use of credit cards for their daily transactions as a result of the stability in the financial markets and could spend money in excess of their incomes due the excellent performance in the stock markets as well as other investments. They majorly relied on their investments to bridge or finance the cash gap and the financial infrastructure was perfect. Millions of investors in the US had borrowed money against their homes and the effects of the financial downturn severely hit the housing market. The ever rising value of the houses in the early years and the perceived stability in the mortgage backed securities led the banks and other lenders to believe that the risks in the prime loans could be contained and that the trend