Sunday, April 15, 2012

Research Paper on Mortgage

Research Paper on Mortgage

The mortgage and market crisis
The sub prime mortgage crisis is an ongoing economic issue in the United States. It started in late 2006 and caused a chain effect crisis in the financial markets worldwide in 2007 and 2008. The crisis began with the bursting of the US housing bubble and the big number of defaulted borrowers of “sub prime” credits and other adjustable rate mortgages made to people with lesser income or poor credit history. The mortgage crisis expressed itself in liquidity problems in the banking system and high number of foreclosures. The loan incentives and the trend of stable price rising in the housing sector pushed the borrower to assume mortgages, thinking that later on they will be able to refinance their loans at more favorable conditions. But when the prices of the real estate started going down in 2006 – 2007, refinancing became less feasible due to the rising adjustable interest rates. Borrowers had to pay more that their property was worth. During 2007 the default rate rose with 79% compared to 2006 and around 1.3 Million properties nationwide were subject to foreclosure. The first ones to be affected were the mortgage lenders who retained the credit risk – borrowers were unable or unwilling to make the payments. Major Banks and financial institutions suffered huge losses. As of April 30, 2008, the banks have written off approximately $280 billion.

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The sub prime mortgage crisis is the most severe real estate recession, it is far from over and it is growing drastically spreading in nearly every major US city. The prices of home decline and the number of filing for foreclosure rises with a pace unseen before. According to the S&P/Case-Shiller composite index for 20 cities the house prices tumbled 12.7% in February compared with last year. According to the National Bureau of Economic Research this drop left around 9 million people who have to pay to the lenders more that their properties are worth. This amount is 10% of the mortgage borrowers, another 6% are behind their schedule for payment. At the subprime mortgage market 17% are in arrears. Loan providers are foreclosing on many houses amounting to more than a million. The pessimistic opinions is that the amount of defaults will rise more and more and it will exercise pressure on home prices pushing them further down. It is very likely to happen in short term whereas in long term there is light in the tunnel. The falling prices have made homes a bit more affordable, the government is also putting efforts into the ongoing real estate issue. The Bush Administration struggles to reduce or eventually prevent the surge of the mortgage default payments. The Congress is debating tax incentives but the main objective is the Federal Housing Administration to be permitted to refinance at a discount the problematic loans.

Even though measures were taken by the Federal government and the Federal Reserve, the forecast for declining house prices remains until the excess inventory has been gradually removed. But the problem the US economy faces is not only the mortgage market shrinking but the three-fold effect that the price deflation brings along. The first one logically is the tougher credit conditions banks require for loans which, some experts believe, should have been done long time ago. Lax financial regulations are not advised, due to the consequences on the economy. The second effect is worsening of the labor market with rising unemployment and slowing salaries. The wages in the private sector have risen with 3.6%, in the year to March. This is the worst result since mid-2003. On the other hand the inflation hit a record of almost 4% for the same period which make the real pay falling. The third effect of the subprime market crisis is pushing the commodity prices high up, leading to increased fuel and food costs (the oil price hit the record of $120 per barrel on May 5th).

The strongest impact the crisis had, was on the financial markets. A chain effect was created around the world. As already mentioned above many banks like Bank of America, Citibank, Merrill Lynch, UBS and others have written off billions of dollars. Bear Sterns Bank was bailed out by JP Morgan Chase with the support of the government. These events made the policy makers in many developed countries to undertake more aggressive actions in order to soften the disastrous impact. The first step was to provide liquidity and undertake saving operations for some troubled bank (above ex.: Bear Sterns Bank). The second step was to cut interest rates. In order the boost the economy and to stimulate investment the Federal Reserve reduced drastically the discount rate down to 2%, the effect of which was not immediate. According to some observers this would give the opportunity for banks to borrow cheaply and lend expensively. They also fear another problem with the low interest rate: this was the reason in 2000s for the housing bubble. Now it could cause another bubble and a lot more trouble down the road. In help of the Federal Reserve the Bush Administration will pay out $117 billion between early May and mid-July in tax refunds. The average American family (with two kids) will receive from the Federal Government up to $1,800, the spending of which will help the economy.

Currently the home prices are still going down and the sales are decreasing. The experts do not see the situation otherwise until the credit markets loosen and nobody expect encouraging financial figures from the construction companies.

About the ongoing economic problem Alan Greenspan, the former Chairman of the Federal Reserve, stated: “The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.” The forecast for economic growth for USA, EU and Japan were reduced by the Organization for Economic Cooperation and Development.
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