Housing Market Crash Subprime Mortgage Crisis Term Paper

Download this Term Paper in word format (.doc)

Note: Sample below may appear distorted but all corresponding word document files contain proper formatting

Excerpt from Term Paper:

Subprime Mortgage Crisis

A major issue for today's economy in the U.S. is the subprime mortgage crisis. The mortgage crisis has sent the U.S. economy into a recession with greater impact than the Great Depression of the 1920s. One will discover some important terms that will allow the reader to better understand this topic. Additionally, this paper will examine some background information and events that led to the housing market crash and examine the causes and impact on the U.S. economy and current housing market. Also reviewed will be the role of Fanny May and Freddie Mack. This work will additionally make recommendations of what it is that might possibly be done that would serve to improve the current situation.

Sub-Prime Mortgage and Housing Market Crisis


Many factors contributed to the subprime mortgage crisis, which began approximately ten years ago when the expansion of the housing market was increased by easily accessible loans. There was a great deal of encouragement for buyers, many with poor credit, to purchase homes and take loans that were above their means of repayment. The mortgage lenders many times failed to perform accurate credit and background checks to ensure that the buyers could make their payments. In many instances, buyers were offered loans with adjustable rates. Such loans were termed as 'subprime mortgages'.

The initially low interest rates enticed buyers however these low rates later changed into higher rates. Many buyers, when faced with the higher mortgage payments were not able to meet the obligations to make these payments. Many buyers also took out home equity loans or second mortgages because of the rising home prices and used the money for various expenditures and even for extra spending money. CDO's, or collateralized debt obligations, were sold to investors. CDO's were comprised of high-risk loans, which were packaged by banks who then sold off these risky loans to investors.

I. Financial Innovations and Rising Foreclosures

Bianco (2008) in the work entitled "The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown" writes that a "steep rise in home foreclosures in 2006 spiraled seemingly out of control in 2007, triggering a national financial crisis that went global within the year." Consumer spending fell while the housing market "plummeted [and] foreclosure numbers continued to rise…" (Bianco, 2008) The International Monetary Global Financial Stability Report published April 8, 2008, stated that the "falling U.S. housing prices and rising delinquencies on the residential mortgage market could lead to losses of $565 billion dollars. When combining these factors with losses from other categories of loans originated and securities issued in the United States related to commercial real estate, IMF puts potential losses at about $945 billion." (Bianco, 2008)

According to the International Monetary Fund there was "a collective failure to appreciate the extent of leverage taken on by a wide range of institutions -- banks, monocline insurers, government-sponsored entities, hedge funds -- and the associated risks of a disorderly unwinding." (Bianco, 2008) It is the belief of many economists that the U.S. housing bubble was at least in part caused by "historically low interest rates." (Bianco, 2008)

The work of Jaffee (2008) reports a study that analyzes the key issues that the subprime mortgage crisis raised and states that financial market innovations are known to occur under three fundamental conditions and that these are all very relevant to the subprime mortgage-lending crisis. Those three are:

(1) The existence of previously underserved borrowers and investors;

(2) The catalysts of advances in technology and know-how; and (3) A benign and even encouraging regulatory environment. (Jaffee, 2008)

Financial innovations are described by Jaffee as "risky undertakings, all the more so when they create new classes of risky loans and securities." (2008) Stated as the primary issues that require analysis in relation to the subprime mortgage crisis are those:

(1) Directly and specifically relating to subprime mortgage lending;

(2) Issues relating to the securitization of subprime mortgages; and (3) Issues affecting financial markets and institutions. (Jaffee, 2008)

Jaffee writes that the benefits of subprime mortgage lending includes that this type of mortgage lending "funded more than 5 million home purchases, including access to first-time homeownership for more than 1 million households." (2008) It is noted that predatory lending usually is prevented by competitive market forces, which serve to "protect uninformed consumers from predatory forces." (Jaffee, 2008) Of loan modifications, Jaffee reports that home mortgage lenders and servicers "have traditionally been reluctant to modify loan terms, nevertheless, lenders and servicers have been amendable to current governmental plans, perhaps because the resulting loan modifications can be characterized as one-time emergency transactions." (Jaffee, 2008)

Jaffee states that the report of the President's Working Group on Financial Markets (2008) indicates that "incomplete disclosures and the securitization process caused investors to be duped into purchasing high-risk subprime mortgage securities. The purchasers of these securities, however, almost uniformly include only the most sophisticated institutional investors worldwide. The name 'subprime' also seems clear enough and data documenting the extremely high foreclosure rates on subprime loans have been publicly available at least since 2002." (Jaffee, 2008)

In regards to house price inflation, Jaffee (2008) states that "rising home prices will discourage mortgage defaults -- whereas falling home prices will dramatically increase the default rates." Underwriting standards have also come under questioning as the lenders are reported to potentially have "more access to other borrower information that is not objectively available to investors. " (Jaffee, 2008) The example stated is that loan officers "may enforce either weaker or stronger standards at different times with respect to factors that are not objectively included on loan applications." (Jaffee, 2008)

Jaffee and Quigly (2007b) are stated to proffer "…two innovative proposals for dealing with the predatory lending problem:

(1) use a specifically designed FHA mortgage as a standard alternative loan; and require that all subprime lenders bring this alternative to the notice of their borrowers; and (2) create a new suitability standard, which would require that subprime lenders affirm that the borrowers to whom they are lending meet the standard." (cited in: Jaffee, 2008)

II. Impact of the Mortgage Crisis on the Economy

A report published in the LA Times states that homeowners witnessed their property values fall by $1.2 trillion in 2004 and 524,000 fewer jobs were created. Both of these are reported to be an outcome of the situation created by defaulting on loans and foreclosures rising. Consumer spending was weakened and auto sales fell drastically. Fannie Mae and Freddie Mac are reported to be the two government sponsored enterprises that "created, and remain highly involved in the secondary market for mortgage backed securities" since prior to the subprime mortgage crisis" these two "owned or guaranteed $1.4 trillion, or 40% of all U.S. mortgages." (Amadeo, nd)

III. Who Really is to Blame for the Sub-Prime Mortgage Crisis

Opinions differ on who is in actuality to blame for the subprime mortgage crisis. The work of San Jose State University, Department of Economics entitled "The Nature and the Origin of the Subprime Mortgage Crisis" claims that Fannie Mae and Freddie Mac are primarily to blame for the subprime mortgage crisis because these two agencies "made a market for subprime mortgages the lenders did not have to worry about the soundness of the mortgage contract they wrote." (San Jose State University, Department of Economics, nd) Therefore, it was possible that lenders "could write the mortgages as adjustable interest rate mortgages knowing full well that an upturn in the interest rates could easily throw the borrower into insolvency." (San Jose State University, Department of Economics, nd)

The subprime borrowers were charge interest rates that were higher to somehow attempt to compensate for the higher level of risks however, it is stated that "everyone but the dimwits running Fannie Mae understood intuitively that a poor risk for a mortgage cannot be made a better risk by charging a higher interest rate." (San Jose State University, Department of Economics, nd) It is reported that Fannie Mae and Freddie Mac "pooled the subprime mortgages and then crated securities which were sold around the world." (San Jose State University, Department of Economics, nd) Subprime borrowers are reported to have been charged higher interest rates as well as being required to pay for default insurance, which resulted in a higher burden that "increased the risk of default." (San Jose State University, Department of Economics, nd)

IV. Preventive Measures Against Future Occurrences of Housing Crisis

There are various remedies stated for ensuring that the subprime mortgage-housing crisis does not reoccur in the future and among these are tightening of regulations that govern mortgage financing. One measure that is stated as necessary is the amending of the bankruptcy code to protect families from foreclosure. The present bankruptcy code does not allow the debt courts to modify mortgages. Amending the bankruptcy code would enable borrowers to "pay the fair market value of their home and to keep that home…" (Schumer and Maloney, 2007)

An additional measure to prevent future occurrences of the subprime mortgage crisis…[continue]

Cite This Term Paper:

"Housing Market Crash Subprime Mortgage Crisis" (2011, September 09) Retrieved October 24, 2016, from http://www.paperdue.com/essay/housing-market-crash-subprime-mortgage-crisis-117412

"Housing Market Crash Subprime Mortgage Crisis" 09 September 2011. Web.24 October. 2016. <http://www.paperdue.com/essay/housing-market-crash-subprime-mortgage-crisis-117412>

"Housing Market Crash Subprime Mortgage Crisis", 09 September 2011, Accessed.24 October. 2016, http://www.paperdue.com/essay/housing-market-crash-subprime-mortgage-crisis-117412

Other Documents Pertaining To This Topic

  • Subprime Mortgage Crash in the

    Enter the Fed, Yet Again Unable to understand that rapid interest rate moves create shocks to the market, resulting in distortions in supply and demand, the Fed dealt with the bursting of the housing bubble by lowering interest rates rapidly, this time to next to nothing. This response was intended to stimulate the economy. In 2001, the rate decreases were also intended to stimulate the economy, but they mainly stimulated one

  • What Is the Future of the Housing Market of 2011 Into 2012

    Future of the Housing Market The housing crash that began in 2007 resulted in the worst economic catastrophe in the United States since the Great Depression of the 1930s, although few observers who realized that the bubble was about to burst truly understood the severity of the depression that would follow. In reality, it led not only to a collapse of the housing market but also to the failure of large

  • U S Housing Market Boom to

    (Der Hovanesian, 2010) Increased Promotion of Discounted mortgages. The way that subprime lending practices, and some call predatory lending practices affect the housing market has yet to be realized on such a large scale, as these tactics have always been carefully controlled by lending institutions, due in large part to their historical long-range view. Subprime lending on the other hand is fundamentally not a long-term view practice; it is a short-term

  • Housing Price Dynamics Within a

    Houston's large supply of land means that demand growth primarily results in more construction, not higher prices" (McCullagh & Gilmer, 2008). However, it is important to realize that land supply is only one part of the reason that new home construction formed such a large part of the Houston housing market. Yes, Houston has more available surrounding land than almost any other major metropolitan area in the United States, but

  • Influence of 2007 Economic Crisis on American Car Market

    2007 Economic Crisis on American Car market Effect of the 2008 global economic crisis on automotive industries Crisis in the United States Crisis in Canada Crisis in Russia Crisis in European markets Crisis in Asian markets Effects by other related crisis events In this paper, we will review the effects of 2008 global automotive crisis. Our main focus will be on the American car manufacturers and the negative impact they suffered due to the crisis. We will

  • Financial Crisis and Predatory Lending

    Many laws have been successful in restricting such practices in order to avoid a similar situation in the future. Today, "when a mortgage borrower wins a rescission case in court, the bank loses the right to foreclose, and has to give up all profits from interest and fees on the loan" (Carter, 2012). However, just a few years after predatory lending caused so much damage, there are already movements

  • Economics Crisis as an Inevitable

    The U.S. is a property owning civilization and a number of the people wanted land and housing. Americans however scarcely ever create savings. "The country itself lives on other countries' savings by issuing bonds to finance its excessive consumption. The current crisis began with cheap housing loans offered by banks. Banks provided loans but instead of holding the loan in their books, they packaged them into collateralized debt obligations (CDOs)

Read Full Term Paper
Copyright 2016 . All Rights Reserved