The United States is in what can best be characterized as a deep recession. The collapse of the real estate market, and the ripple effect it has had throughout the financial system caused a drastic adjustment of the stock market, a wave of layoffs and credit restrictions have driven the economy to a standstill. Unemployment claims are high and remain steady, several banks and other institutions have gone out of business, and thousands of Americans have lost a significant portion of their retirement portfolios.
The ripple effect was caused primarily by the questionable lending practices of mortgage companies, who began endorsing sub-prime mortgages in the early 1990s. Sub-prime mortgages are higher-risk loans for property that balance the risk of default with high interest rates. In order to make the “buy-in” for these mortgages attractive and affordable, they the lenders would offer a temporarily low interest rate that would increase significantly after a short period of time.
This caused mortgage payment rates to suddenly jump, causing many defaults and foreclosures. The abundance of foreclosed housing stalled the market for new homes and mortgages, as well as the market for house-building materials and professions. Additionally, the abundance of supply in the market drove down the value of homes whose owners were in good standing, causing those home owners to lose their investments.
The real estate bubble bursting may not have been enough on its own to trigger the total collapse, but the problem was compounded by the practice by lenders of bundling the sub-prime loans into derivative blocks, labeled as medium–to-high risk, and when the market collapsed, these derivatives, representing billions of investment dollars became worthless. This caused a number of lending institutions to be caught holding devalued derivatives, and when investors cashed out, these holders were short on hard cash, and went into bankruptcy.
This initiated a rapid spiral of overall stock values, and massive credit constriction on the commercial market. Businesses could not initiate short-term borrowing, because, in essence, no one was quite sure how much real value the market holds. The combination of a 6000-point drop in the Dow Jones industrial average, credit constriction and massive foreclosures have caused the current recession. Internationally, the effects of this crisis is an international move away from U. S. investments, further restrictions on capital for loans, and a devalued American dollar against foreign currency.
Recommendations: The current administration has taken immediate remedial actions that have slowed the economic downturn, and now must focus on policy changes necessary to address the outstanding issues that have caused this crisis. With regard to the real-estate market, the administration should extend the freeze on foreclosures, and institute a two-component policy for the industry. The fist component should be fixed interest rates at no greater than 7% on mortgages. The second element is that the value of the property needs to be assessed based on real current conditions, and the loans zeroed out to match the value of the homes.
Bailout funds should be allocated to make reasonable restitution for current losses (not future ones) incurred by lending institutions by this policy. The auto companies which have had high profile failures due to the overall economic picture, and last year’s fuel crisis ought to be subsidized in the extreme short term, and given a hard deadline to come up with a realistic plan to transfer production to energy-efficient vehicles. Something similar is currently happening, but the time frame is not strict enough.
The government should employ construction companies for infrastructure projects including repair and rebuilding of the areas of the gulf coast affected by Hurricane Katrina. This should compensate for a long-term lag in new home construction, which should be limited by the availability of existing housing. Most importantly, on the domestic front, commercial credit holders should be subject to a “borrower’s bill of rights” which consists largely of simply offering full disclosure on lending policies, mandated fixed interest, and limits on penalties.
Borrowers on commercial credit should not face interest rates that are inverse to their ability to pay. The philosophy should be that some payment is better than none. Additionally, credit reporting agencies need to completely overhaul their procedures to simplify documentation. It is increasingly common that one’s credit report bears little resemblance to their true credit history. For loan approval, much more emphasis should be placed on repayment history.
It is simple common sense that a person who was maintaining monthly payments of $1500 a month can afford a replacement loan of only $1000 a month. No other questions should need to be asked. The administration has made some high-profile moves in an attempt to reduce spending and increase tax revenues by targeting the upper tax brackets. Rather than increasing rates on the upper brackets, more revenue can be attained by closing tax loopholes so that those who are supposed to be paying taxes are actually doing so. These measures will steady our currency in the international markets.