Keynesian Economics and the Mortgage Crisis

The mortgage crisis of 2007 marked catastrophe for millions of homeowners who suffered from foreclosure and short sales. Most of the problems involving the foreclosing of families’ homes could boil down to risky borrowing and lending. Lenders were pushed to ensure families would be eligible for a loan, when in previous years the same families would have been deemed too high-risk to obtain any kind of loan. With the increase in high-risk families obtaining loans, there was a huge increase in home buyers and subsequently a rapid increase in home prices. As a result, prices peaked and then began falling just as fast as they rose. Soon after families began to default on their mortgages forcing them either into foreclosure or short sales. Who was to blame for the risky lending and borrowing that caused the mortgage meltdown? Many might blame the company Fannie Mae and Freddie Mac, but in reality the entire system of buying and selling and free market failed home owners and the housing economy.

The bursting of the housing bubble, known more colloquially as the 2008 mortgage crisis, was preceded by a series of ill-fated circumstances that culminated in what has been considered to be the worst financial downfall since the Great Depression. After experiencing a near-unprecedented increase in housing prices from January 2002 until mid-2006, a phenomenon that was steadily fed by unregulated mortgage practices, the market steadily declined and the prior housing boom subsided as well. When housing prices dropped to about 25 percent below the peak level achieved in 2006 toward the close of 2008, liquidity and capital disappeared from the market.

The housing bubble went into full effect by December of 2007, and is seen to be the leading cause of the Great Recession. With the lowering of interest by mortgage associations, lead to those who had poor credit to obtain a mortgage. Those

Before the pre-2008 economic recession era, people were ignorant of what was bound to happen. Life was a party. Incomes were steadily rising: most people in every financial class had a credit card, a family to support, and an opportunity to do so by moving into the biggest house they could find. Mortgage loans were given out to anybody with a heartbeat and credit rating, this is called a subprime mortgage. If somebody wanted a new home they could get it, no matter if they could afford it or not. However, when interest rates started to rise people were not able to pay their mortgages and their homes were foreclosed upon. Homeowners who were not careful — or just plain unlucky — when choosing what mortgage was suitable for their income were either left homeless or stuck living paycheck to paycheck. The capitalism party was over. Everyone stopped buying what they once thought they could afford just so they could maintain proper housing, in turn a recession began. So was the 2008 financial crisis caused by the homeowners? Homeowners in the United States — for the most part — are not gluttons for bigger and better homes they can not afford, it was a case of misinformation perpetrated by investment banks and mortgage lenders in the pursuit of more money. When higher interest rates began to kick in misinformed homeowners could not pay their steep mortgages anymore, resulting in multitudes of mortgage defaults. Mortgage defaults and the housing bubble did play a significant role in

The house 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.

Therefore, house prices were not going up any more, they were instead falling substantially. This in turn also created a problem for prime home owners because as the houses in their neighbourhood went up for sale, the value of their house went down. Home owners began to wonder why they should be paying back their $250,000 mortgage when their house is only worth $70,000. They decided that it didn’t make any sense to continue paying even though they could have afforded to and so they walked away from their house and as they did, default rates swept America and house prices plummeted even further. Additionally, by the middle of 2006 people were starting to take notice of the effects of the consecutive rises in interest rates which are shown to the left. “All of the easily underwritten mortgages and refinances had already been done, and the first of the shaky ARMs, written 12 to 24 months earlier, were beginning to reset.” (www.forbes.com/2007/09/10/subprime-default-mortgage-pf-education-in_rb_0910investopedia_inl.html)

Once loan qualification standards decreased the issuance of subprime mortgage loans spread throughout the country. Subprime mortgages are defined by Funk & Wagnall’s

In addition, members of the market were looking for “higher yields” without realizing the risks and did not do proper research on the real estate industry. Meanwhile, insubstantial financial standards, unreliable preparations of risk management, and gradually complex and not clear financial products together created some weaknesses in the real estate system that led to the so-called “subprime mortgage crisis.” These are some of the causes of the subprime.

Over the past couple years, the United States government has learned from its mistakes and loopholes within the mortgage market. Changes within the Fiscal or regulation of government taxes imposed on citizens, and use of quantitative easing, a macro policy, of buying and selling bonds in open market to inject money in the economy has helped jump start the economy. The cost of the economies revival was at the expense of banks giving out mortgage loans to individuals with poor credit. With the help of deregulation and historical trends of the housing prices, financial analysts felt no harm in giving loans to individuals as long as house prices were rising, the default risk would be zero. Soon the mortgages went underwater,

In September and October 2008, the US suffered a severe financial dislocation that saw a number of large financial institutions collapse. Although this shock was of particular note, it is best understood as the culmination of a credit crunch that had begun in the summer of 2006 and continued into 2007. The US housing market is seen by many as the root cause of the financial crisis. Since the late 1990s, house prices grew rapidly in response to a number of contributing factors including persistently low interest rates, over-generous lending and speculation. The bursting of the housing bubble, in addition to simultaneous crashes in other asset bubbles, triggered the credit crisis.

The three main ingredients of the crisis were the following: a housing bubble, the securitization of mortgages – or Mortgage-Backed Securities (MBSs) – and a credit expansion to leverage financial gains. In its most simple characteristics, the housing bubble was a long-term trend in US housing markets for loans below the quality standard. More precisely, people were buying houses with loans that they had a low chance of repaying, especially considering the unpredictability of markets. After the issuing of these loans, the mortgages as financial

Low interest rates and large inflows of foreign funds created easy credit conditions. Subprime lending contribute to increase the housing demand.This fueled rising house prices.This housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates. This led to a building boom. Easy credit encouraged borrowers to obtain ARM. If borrowers could not make the payments ,they would try to refinance. Refinancing became more difficult, when house prices began to decline in USA. Borrowers found themselves unable to afford higher monthly payments ,then default. This places downward pressure on housing prices.

As the house market crashed, those owners that could have enough money to get out from their mortgage often sold at a loss. Most owners stay stuck paying mortgages that now more than the value of their houses and more still have been pushed into foreclosure. Following the collapse of the housing market, it is unclear that these dangerous financial practices have come to an end, raising the possibility of another bubble in the time ahead. So who are the key people to blame for house market crash and what caused the house market crash? The powerful people in finance and politic together set into motion a house market crash. And these top financial executives had key roles in house market crash….

The decline in the housing market set off a domino effect across the U.S. economy. When home values declined and adjustable rate mortgage payment amounts increased, borrowers defaulted on their mortgages. Investors globally holding mortgage-backed securities (including many of the banks that originated them and traded them among themselves) began to incur serious losses. Before long, these securities became so unreliable that they were not being bought or sold.

No single cause can fully explain the crisis but, in my opinion, the two major bases were legislation that promoted homeownership and subprime mortgages. To fully understand the environment that spawned the housing bubble, we’ll have to travel back to the 1930s, when the country was in the midst of the Great Depression. During this time frame, homeownership represented only about 40 percent of the U.S.