Subprime Effect on U.S. Unemployment

In recent decade, mortgage brokers in the United States (U. S. ) engaged heavily in securitization of subprime mortgage loans into high yield mortgage-backed securities being sold to investors, pension funds and financial institutions. With this profitable model, it generated additional funding to create more loans, resulting to loose lending practice, poor credit rating, and overleveraging (BBC, 2007). Sudden increases in foreclosures from second quarter 2007 led to job cuts in constructions and financial activities. With the U. S.

subprime market unfolded, how did the current unemployment rate reach 5% from 4. 4% in December 2006 (Appendix A)? This essay attempts to explain the magnitude of the U. S subprime crisis and analyze the impact on its unemployment. Causes of the Subprime Crisis "Subprime" refers to borrowers with less than good credit ratings, and unable to qualify for prime conventional loans (Wikipedia, 2007). The Mortgage Asset Research Institute published a survey that borrowers stated income with little documentation and most overstating income of more than 50% (Sharick, M.

et. al. 2006, p. 12). Increased foreclosures resonated from borrowers' inability to meet their increased loan installments through Adjustable Rate Mortgages (ARMs). Example, ARMs offer low fixed interest rate for two years with periodically adjustments based on selected indexes (BBC, 2007). Appendix B shows an expected subprime ARMs reset of $282 billions in 2007 and $210 billions 2008. The upward trend in foreclosures had steepened from June 2007 because of the increasing ARMs reset before June 2007 (Appendix C).

Subsequently, increased vacancy rates; downward trend in building permits; housing starts and new home sales, indicated lower demands for labor in construction (Appendix D & E). Slow financial activities have triggered job losses through losses in investments, tighter credit environment, and lesser mortgage business (Appendix F). Job Losses on U. S. Non-farm Payroll The non-farm payroll (NFP) establishment measures the number of jobs added or lost in the economy during a month. Appendix G shows the total change since January 2007 with recent negative payrolls for four months consecutive.

Given the large housing inventories, construction industry had consecutive job cuts for the last 10 months, total of -422k since January 2007 (Appendix H). November 2007 marked the largest loss of -13. 9k in real estate and -9k in finance and insurance (Appendix I). To date, job losses totaled -126k in financial activities since January 2007 (Appendix G). With lesser consumer spending, manufacturing employment had job losses totaled of -437k from January 2007 to current. Trade employment had been stable for 2007 until recent job losses totaled -169k for 2008 (Appendix G).

Consumer sentiments in May 2008 plunged to 28 years low, expecting to create further decline on consumer spending (Willis, B. & Chandra, S. , 2008). The Effects on U. S. Unemployment Rate In compiling unemployment statistics in the U. S. , the term unemployment is one description of the state in which a person above 16 years; is without work; available to work; and have actively looked for work in the prior four weeks (Parkins, 2008, p. 504). According to the U. S. Bureau of Labor Statistics (2008) in April, over 7. 6 million people are unemployed at the rate of 5% based on the labor force of 153. 9 million.

Since January 2007 to April 2008, job losers have increased from 48. 6% to 52. 6% (Appendix J). Longer duration of unemployment increased from 15 weeks and above, leaving the only tenor of less than 5 weeks dropping by 4. 2% (Appendix K). U. S. unemployment benefits are available for those who lost their job through no fault of their own (U. S. Department of Labor, 2004). By using initial jobless claims, we can assume the increasing number of job destructions on a weekly basis. The continued claims may indicate changes in frictional unemployment and how hard is for displaced workers to find new jobs (Parkins, 2008, p.

512). Continued claims have increased to a four years high of 3. 03 million on 19 April 2008 (Appendix L). This indicates that employers are still hesitant on adding new jobs. With the current stimulus package, extended unemployment benefits may poise greater frictional unemployment; discourage people from searching for jobs (Orszag, P. , 2008); driving up the unemployment rate; thus extending a recession. Evidence from previous recessions showed a similar trend line of continued claims and unemployment rate (Appendix A & L).

"Full employment occurs when there is no cyclical unemployment, when all unemployment is frictional and structural. The natural rate of unemployment arises from the existence of frictional and structural unemployment" (Parkins, 2008, p. 512). Therefore, the rate at full employment equals natural unemployment and cyclical unemployment arises when unemployment rate is above natural unemployment rate. Current unemployment rate is over the natural unemployment rate by 0. 2 % (Appendix A). Therefore, U. S. economy is not operating at its full potential and cyclical unemployment exists, indicating a possible recession.

The deterioration in the job market resonated from the problems in real estate and construction are spilling into the broader economy, triggering loss of income resulting to weaker consumers spending. In the effect of a recurring cycle, this in turn hurting sales and feeding back into further loss of labor demands in the economy. More job cuts have made it more difficult for job losers to gain employment. Furthermore, the efforts of the stimulus package may be detrimental to the future unemployment rate, as cyclical unemployment already exists.