Financial Turmoil That Reckless Borrowing Snowballed

Owning a home is the ultimate dream of a typical American family. However, as a simple fact of economics, seeking that dream can be difficult because homes are among the most expensive asset that people can buy. This is why most people have found a veritable way in securing this dream: obtaining a mortgage. Recently, unscrupulous mortgage practices are on the center stage because lower income American families have been trapped into paying up homes they couldn’t afford.

When lenders offer subprime mortgage, which are a type adjustable-rate loans, ordinary Americans are tempted to avail homes in the past years because these loans have attractively lower initial teaser interest rates. Unfortunately, when the housing market crashed early in 2007, the low teaser loans jacked up their interests to skyrocketing rates and many borrowers could no longer afford to pay up their new, higher mortgage payments. Nightmares began to materialize because it is estimated that 2. 2 million families are set to lose their homes to foreclosure that resulted unscrupulous mortgage lending (Dodd, 22 March 2007).

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

The Carsey Institute (2006) revealed that foreclosure levels at present have been the “worst” that happened “in at least 25 years”. They said that millions of American families will likely be affected “by declines in property values spurred by nearby foreclosures. ” Everyone now asks what might have gone wrong, since obtaining mortgage has been a time-tested financial instrument? The turmoil going on in American financial markets have fingers pointing at the unprecedented proliferation of a controversial type of mortgage called subprime mortgage.

With people having low credit ratings, they cannot easily obtain regular loans this is why they opt to take subprime mortgage, which is a home loan given to people with relatively low incomes and unwarranted credit records. To look attractive enough, lenders dress up subprime mortgages with lesser down payment requirements and low introductory interest rates. These are two features that make these loans tempting enough for those with meager incomes or bad credit because it minimizes the annoying barriers to homeownership.

Little that they know, almost all subprime mortgages are adjustable-rate loans, which has initial low interest rates that may shoot up after the introductory period. This is when interest rates were raised in 2007 the payments for these subprime become ridiculously higher than what they might seem at first glance. Fact is that in 6 states, the failure rate has gone up to 24 percent (See Figure 1). Figure 1. Subprime Foreclosure in the United States in 2007 (Source: www. resposiblelending. org). On the other hand, the recent subprime crisis has also been thought to be brought about by the housing boom that occurred in the past few years.

In fact, the U. S. Census Bureau reported homeownership rate in 2004 was at an all-time high at 69% – the highest rate recorded since the 1960s (See Figure 1). As part of this boom, mortgage lenders earned profits too. In fact, one of the nation’s largest mortgage lenders, Countrywide Financial Corp. , scored a portfolio of current mortgage loans as high as $645 billion in 2003 (Rieker, 14 January 2008). This is why mortgages were being offered to more and more aspiring homeowners and financial institutions facilitated the home purchases through subprime loans. Figure 1.

United States Home Ownership from 1960 to 2004 (Source: U. S. Census, 2006). The crisis was inevitable because of the uncontrollable spate of subprime mortgage in many U. S. states. In fact, subprime loans were at 5. 6% in 2001 when as the housing boom peaked, subprime loans accounted for 20% of the overall of the mortgage market, amounting to amounted to $600 billion (Eavis, 17 September 2007) . This means that between 2000 and 2006 millions of Americans became homeowners courtesy of subprime mortgages. However, when higher interest rates kicked in borrowers were shocked to know this reality.

According to the foreclosure tracking company RealtyTrac Inc. , there were 42% increase of foreclosures in 2006 than a year earlier and 35% more in the first quarter of 2007 (Gibeaut, July 2007). Fears began to materialize in 2006 when, amid an accelerating decline in housing prices, delinquent loans with payments more than 60 days overdue shot up to a rate of 13%, compared with 8% the year before, and the rate of foreclosures quickly spiked to record levels. As a result, the nation’s top subprime mortgage lenders, whose income is principally derived from their customers’ interest payments, also began to suffer.

In fact, the New Century Financial, the second-largest subprime lender in the United States, has filed bankruptcy as their loans began defaulting and the housing market began to fall downwards spiral (Cho, 3 April 2007). The impact of the ongoing subprime crisis did not just affect U. S. homeowners and lenders, but its effect triggered a slowdown in financial markets around the world. That is because a wide range of financial institutions, including investment banks and hedge funds, also sought to profit by investing in U. S. mortgages, through a variety of financial instruments.

For example, banking giant Citigroup Inc. , a heavy investor in the U. S. real estate market, joined the bandwagon of mortgage-related casualties when it announced a 60% earnings drop for the year’s third quarter (Rosenbush, 2 November 2007). The U. S. economy itself had revised projections for annual real GDP growth downward from 2. 2% to 1. 9% for 2007 and from 2. 8% to 1. 9% for 2008. This was because of the ongoing difficulties in the mortgage market are expected to continue next year driving down residential construction and investment income (Country Insight, 5 November 2007).

In analysis, the subprime crisis can easily be delineated from a complex mixture of obtaining easy money, laxity in lending standards and real estate boom that brought housing prices that skyrocketed exposing the real problems only recently. The widespread repercussions of the U. S. subprime crisis reflected not only the importance of the U. S. to the global economy, but also how the homeowners’ mortgages were secure and sold on by the original lenders to other investors in the form of tradable securities.

The underlying repayment obligations were bundled together and then redivided among these vehicles, meaning that the holders of these securities in many cases could not be sure of the extent of the losses they were exposed to in the downturn. This uncertainty led to panic in world financial markets, leading to sharp drops in stock indexes in the U. S. , Europe and Asia that were stemmed only by the prospect that central banks would take action to prevent a greater financial or economic catastrophe.

x

Hi!
I'm Mack!

Would you like to get a custom essay? How about receiving a customized one?

Check it out