Home prices and home ownership had been booming in the United States since the late 1990s until problems in the mortgage industry began to manifest in 2007. U. S. homeownership rates rapidly increased from 1997 to 2005 when financial institutions loosen their standards in granting mortgage. As a result, many people borrowed from lending institutions despite their low financial security (Shiller, 2008). As the industry ramped up, the value of mortgages went down. The mortgages eventually soured when homebuyers had to limit themselves from making a purchase.
Despite the rise in the default and delinquency rates in 2006, the pace of lending did not slow down. Thereafter, several financial institutions started to collapse right after one another (The New York Times, 2008) There are already signs that people would abandon their homes and hand them over to financial institutions. If home owners who are tied up with their mortgage turnover their homes to their lenders, the entire capital of the U. S. banking industry would be wiped out (Coy, 2008). In response, policy-makers drafted a legislation aimed to appease the market instability.
Legislations of this nature highlight the impact of current economic situation son policy-making. Perhaps one of the most controversial legislations ever passed in the U. S. Congress is the recent $700 billion bailout plan signed by President George W. Bush. This far-reaching and historic plan by the U. S. government to bail out the nation’s financial system has been passed into a law. Its legal mandate allows the Treasury Secretary to purchase as much as $700 billion in assets to initiate lending, thus stimulating the economy.
It is regarded as the most far-reaching interventions in the U. S. economy since the Great Depression (Sahadi, 2008). According to Federal reserve Chairman Ben Bernake, the legislation is a decisive action towards stabilizing the U. S. financial markets. It also ensures a continuous flow of credit to households and businesses (Sahadi, 2008). Given the limited resource of households, there is indeed a necessity to intelligently allocate their resources. Data resulting from this research suggests that a home owner facing a heavy debt due to large home mortgage can do two things.
First, a household has the option to default payment thus, giving allocations to other expenditures. Second, a household may cut-off their expenses in other expenditures in order to pay their mortgages. Either way, this will give rise to detrimental effects in the economy. In the first option, the financial market will be direct liability as massive defaults will create financial instability within the lending market. In the second option, a decrease in household consumption will yield to lower returns for producers as lesser buyers are willing to make purchase of their products and services.
A slowdown in either the financial market or the goods market will definitely hurt the national economy as a whole. This problem then must be addressed in as early as the credit check process. Stricter financial requirements must be imposed on prospective borrowers before loans are to be awarded. The lending sector must not be complacent with borrowers and should consider thoroughly the risks of awarding subprime loans. Institutional reforms in the financial sector are necessary in order to solve the subprime problem.
In the same light, the government must exert all the necessary efforts to initiate and eventually sustain the reforms that are needed in the financial sector of the economy. Also, aside from stricter financial requirements on prospective borrowers, the lending sector must also develop consumer-oriented policies. Many aver that some of the subprime mortgages awarded decades back were tainted with deceit, aimed at further impoverishing the American household. There should also be more thorough disclosures in the grant of loans and mortgages. Many borrowers were not informed on the downsides brought by adjustable rate mortgages.
Hence, they have not anticipated the probabilities of a heavier burden in the future. Conclusion The effects of a crisis are indeed very damaging to the economy. It hinders every aspect of the economy from further growth. Economic indicators are all falling way below its standard minimum. Instead of expansion, economies under crisis suffer contraction. When an economy contracts, it lessens its output, which in turn, intensifies and worsens the current crisis. Many averred that the current crisis in the national economy began in the housing industry.
Great efforts must be existed to prevent home owners from foreclosing their homes; otherwise, the housing industry will be severely hurt and may take time to recover. Certain factors with regard to subprime mortgages must be pondered considerably. Subprime mortgages exist because some borrowers, due to poor credit history, are not entitled to prime loans. In an economy where risks are considered, those who do not possess good credit ratings are burdened with heavier interest rates to compensate for the probabilities of them backing out with their financial obligations.
Stricter financial requirements must indeed be implemented so as to prevent further instabilities in the financial market. The money market has suffered enough and can no longer handle a substantial decrease in capital. One’s financial ability to pay back must be thoroughly scrutinized before granting loans to them. In order to sustain such change in the requirements, institutional reforms must take place as well. Consumer-oriented policies and full disclosure, not only on the terms of the loan, but the possible consequences as well, are among the few reforms that should take place.
With these changes and reforms taking place, a more secure environment for the financial market will foster a healthier and more competitive economy.
Brownell, C. (2008). Subprime meltdown: From U. S. liquidity crisis to global recession. Illinois: C. Brownell. Coy, P. (2008). “Recession time. ” Business Week. Retrieved 28 October 2008, from BusinessWeek Web site: http://www. businessweek. com/magazine/content/08_12/b4076040784032. htm. Felsenheimer, J. & Gisdakis, P. (2008). Credit crises: from tainted loans to a global economic meltdown. Weinheim: Wiley-VCH.