Write a professional report about Financial Crisis that occurred 2007-2008.
The financial crisis happened in year 2007 and the previous scenario of this situation was lucrative for the financial institutions. The Financial institutions developed a mortgage loan scheme that was very lucrative for the people in USA as well as the lenders near 2001. After the scheme was announced, without calculating the credit risk the companies started to lend money using the scheme. The Credit crunching in the banking sector was the main reason for the economic downtown in the year 2007. The “Housing bubble” was also the main reason for the companies to enter into the unstable valuation of the real estate market (Dzikowska & Jankowska, 2012). The rapid increase in the real estate property valuation and unsustainable indicators income of the US citizen also one of the reason that led to this crisis.
Reasons that led to crisis – The mortgage debts increased beyond compare. The debt increased beyond the property valuation. The low interest rates of the US economy were also a reason that led to the higher valuation of the properties. The main criteria for the company were to check the relation between the long-term lower interest rates, which was the reason for higher valuation of the company. The imperfect data regarding the inflation rate and interest rates also came out to be costly in the matter. The Federal reserve board increased the interest rates from 1% to 5.25 % during 2006 but it was too late and they did not increased it further out of fear of downturn of the real estate market and housing property valuation (Masera, 2011). The subprime borrowers’ played a role in this by increasing the loan amount and leisure spending on the debts. The prime lenders are the most important contributors in this crisis by faulting on the large amount of loans. Decline in the risk premiums and emergence of the new kind of lender in that time (Masera, 2011). The lax lending standards such as no documentation of the stated income and higher risk loans were also formulated during that time. The securitization of the real estate property is one of the most important parts of this crisis. The Mortgage backed securities are favorite debt instruments for the lenders and the credit rating agencies helps in formulating loans with higher rate of default were originated. This securitization enabled the investors to grade the higher risk default and it was easy by the lenders for this instrument to transfer the risk to others (Korngold, 2012).
Beginning of the collapse – The beginning of the collapse began in 2005 when the housing bubble has burst and the foreclosure rates increased during that time. The collateralized debt obligation (CDO) of the homeowners, credit risk and decline in the risk premium, mortgage and hedge funds dysfunction all led to the crisis. During the late 2006 and early 2007, the number of subprime borrowers has risen drastically (Fratianni & Marchionne, 2010). In spite of the lending terms and warning signals the numbers of lenders and borrowers kept rising. In 2000, the state of Massachusetts had the subprime loans fueled by refinance instruments were 1.6% (Friedman & Posner, 2011). However, subprime loans in Mortgage Backed Securities rose above 12.3 % in 2006 in the state only (Fratianni & Marchionne, 2010). The higher than expected foreclosure rates of the mortgage backed securities started to change the scenario of US. Ameriquest was the first lender that got hit because of the down turn of the economy and laid off 3800 employees to recover the money lended. Ameriquest also made a settlement of $ 325 million. More than 25 lenders in US has reported bankruptcy (Friedman & Posner, 2011). The stock of the country’s largest subprime lender New Country Financials reported around $ 100 million of liabilities as well as bad debts (Masera, 2011). By 2007 June, the bigger investment companies predicted that the mortgage backed securities trade would get hit because of the crisis especially, Bear Stearns, Goldman Sachs, Merrill Lynch, Lehman Brothers and Morgan Stanley. Once the subprime crisis broke out in the market, the predicted $100 billion of loan will default, which came to be $ 925 billion after the full hit of the impact
The mechanisms of the failure – the mechanism of the failure lied in the Securitization of the real estate properties in US. The actual special purpose vehicles (SPV) were very complex transaction entities that added to the fall of the real estate market and people who borrowed money from banks could not meet the principle rate of the houses and defaulted on the loans. However, the interest rates were made higher by the Federal government who came to know about the amount of credit lent to the prime lenders. The prices of houses fell drastically and the lenders occurred losses due to that. The financial institutions were the one who were the centre of the crisis. Some of the largest investment institutions occurred huge losses due to credit defaults. While the credit risks were increasing, the consumers were saving less and spending more on the credits got from the banks and financial institutions. By 2008, the credit grew to 14.5 trillion dollar. An average person gets more than 13 credit cards and their spending was 134% of their non-disposable income. Less than 1% low interest rates during that time was also a stimulator in that credit crisis. The financial markets suffered great losses in the country. Through 2007 the US stock market occurred $ 8 Trillion dollar losses in the holdings. The value of the consolidated holdings declined from $ 20 Trillion to $ 12 Trillion. The losses in the countries were shocking.
Impact of the crisis in US economy and in the of the world Middle East, China, Europe – the impact of this crisis was huge in terms of monetary losses and value degradation of the real estate market. Therefore, indirectly the stock prices of the real estate market were influenced in the US economy. Moreover, the moral hazards were in the core of the crisis. The Dow Jones dropped more than 13000 points and S&P crossed the negative territory (Masera, 2011). This affected other share markets too in the Korea composite Stock price. The affect of this was virtual but the impact of this was better. The mortgage asset devaluation percentage was high. More than $ 80 Billion dollar was written down, the metal and mining companies were the most affected industry of the economy. The GDP of US economy contracted and did not start to begin grow slowly until 2010. The unemployment rose by 5% as many companies lay off their employees to control cost (Carrington, 2014). The unemployment rate rose higher than expected in different European Country like Greece, Spain, Portugal, Ireland, and the UK. The impact was high in those states and their GDP employment rate decreased drastically. The budget deficits in the countries affected the whole economy and led to depression. 4.3 million jobs were lost during that time. The Persian Gulf Banks reported $ 1.5 Billion losses due to speculation loss money of on S&P. The Bank of China Wrote off 1.3 billion dollar, due to loss in the speculation money and risk exposure in the subprime investments (McConnell & Blacker, 2011). The Sovereign wealth funds invested approximately 48.5 Billion in the S&P and occurred losses. Though the previous situation was a boom to the housing and real estate business, there were losses in the Norway, Canadian Lumber Towns and Mexican villages. Canada freezed 32 billion dollar in the country, which was asset backed commercial paper (Carrington, 2014). The Lebanon, Jordan, Iraq and Iran were indirectly hit by this global crisis. The Jordan’s financial performance was favorable in spite of the crisis. The slowdown in the sector where the Foreign Direct Investments were committed was impacted. The export earnings declined. The export of oil decreased which affected the oil prices to fall and the exported occurred huge losses. Syria projected budget deficit in 2009. The GDP of the country declined by 28.7 % to 18.2% (Dymski, 2012).
The financial plans to rescue – the impact of this were so high that some of the largest investment banks lay off millions of workers and employees. The banks had to write off billions of dollars from their balance sheets using the bad debt. The banks occurred more losses as to repackage the houses sold in the mortgage loan (Dymski, 2012). The credit crunch has begun for the new asset backed mortgages. The bank loans were wiped off from the balance sheets. The credit crunching and investigation of the reliable documents were started. The standards of credit availability were set higher than before. The insurance of the banks, which were saved by the government, were the first of the step to get the people to rescue (Korngold, 2012). Government saved both Fannie Mae and Freddie Mac. Lehman Brothers asked for help to the government but was turned down at last. Later they declared bankrupt and shut down the company. The meltdown led to great depression. President Bush and Treasury secretary announced loans of $ 700 billion to the banks to restore the faith of people in the government (Oesterle, 2013). The capital injections were very important part of this country and asset backed securities were also important part of government’s interventions. The debt guarantees were very important part of the economy and thus were very important. Average market capitalizations rate of the large investment banks were reviewed and given emphasis during that time.
The beginning of the recovery – the beginning of the recovery was also a step of the government to avoid this kind of risk and crisis further in the country. The moral hazards were related to the risks transferability of the company (Hardie & Maxfield, 2012). Home Mortgage disclosure act was one of the most important declines at that time. Full disclosure agreements were encouraged and made mandatory in the financial institutions. Mortgage brokers and underwriters adopted unethical approach in the company for compensations. They also profited from this schemes, which had lax standards.
My opinion – In my opinion, the crisis happened because of the unethical nature of investors as well as the consumers. The government of the economy has lesser control of the consumers spending , this also affected the prime consumer’s nature in more spending in the real estate on credit .greed of the investors to grow in the monetary terms. This also led to the complication that happened in the securitization. The downturn of the real estate market led to the recession in all the country directly or indirectly related to the US. The short-term profit-gaining motive of some people affected the world economy. The lack of proper standards and control in the economy was also one of the reasons that led to downturn of the market. Government’s regulatory policies and greed of the consumers to own excessive property also a contributing factor in this crisis. Less saving and more spending characteristics of the consumers were also reason to this crisis according to me. The encouragement of government to spend more in the economy was also a contributing factor. Moreover, the Government’s regulatory policies were not effective at that time. The crisis of the downturn of the market was very influential as the impact was on all the regional stock markets of China, UK, Australia and India. Therefore, it can be concluded the negligence of the proper ethics in investments affected the country’s economy.
References
Bocian, D. G., Li, W., & Ernst, K. S. (2010). Foreclosures by Race and Ethnicity. Center for Responsible Lending, 4-6.
Carrington, C. (2014). The International Impact of the Subprime Mortgage Meltdown. Dallas, Web site: https://? www.? docstoc.? com/? docs, 16138008.
Dymski, G. A. (2012). On the origins of subprime loans, and how economists missed the crisis. Subprime cities: the political economy of mortgage markets, 54, 151.
Dzikowska, M., & Jankowska, B. (2012). The global financial crisis of 2008-2009 and the Fortune Global 500 corporations. Looking for losers among the biggest-exploratory study. The Poznan University of Economics Review, 12(3), 99.
Fratianni, M. U., & Marchionne, F. (2010). Banks’ great bailout of 2008-2009.
Fratianni, M. U., & Marchionne, F. (2011). The banking bailout of the subprime crisis: size and effects.
Friedman, J., & Posner, R. (2011). What caused the financial crisis. University of Pennsylvania Press.
Hardie, I., & Maxfield, S. (2012). What does the global financial crisis tell us about Anglo-Saxon financial capitalism?. In Workshop on the Financial Crisis, EMU and the Stability of Currencies and the financial System, University of Victoria. https://web. uvic. ca/jmc/events/2010-09-financial-crisis/pdf/Oct2.
Korngold, G. (2012). Legal and Policy Choices in the Aftermath of the Subprime and Mortgage Financing Crisis.
Masera, R. (2011). Reforming financial systems after the crisis: a comparison of EU and USA.
McConnell, P., & Blacker, K. (2011). The role of systemic people risk in the global financial crisis. The Journal of Operational Risk, 6(3), 65.
Oesterle, D. A. (2013). The Collapse of Fannie Mae and Freddie Mac: Victims or Villains. Entrepreneurial Bus. LJ, 5, 733.
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