StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

The United States Housing Bubble and its Consequences - Essay Example

Cite this document
Summary
The paper "The United States Housing Bubble and it’s Consequences" is an outstanding example of an essay on finance and accounting. In 2007, America was facing a looming Financial Crisis as a result of the Housing Bubble. This happened after the dotcom bubble. The housing bubble was not just instant; it happened gradually…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER95.5% of users find it useful

Extract of sample "The United States Housing Bubble and its Consequences"

COURSE INSTRUCTOR INSTITUTION DATE The United States Housing Bubble and it’s Consequences In 2007, America was facing a looming Financial Crisis as a result of the Housing Bubble. This happened after the dotcom bubble. The housing bubble was not just instant; it happened gradually. The events of year after year in America and the financial decisions the government undertook led to the housing bubble. When the first signs started to appear, the government decided to overlook the issue instead of addressing it. It was mainly due to the danger of protecting the investors and consumers from the consequences of their decisions. The crisis began in 2001 when America was getting into recession after the dotcom bubble had burst. The situation was worsened by the 9/11 attack on the World Trade Centre. After that, the Americans had to get the economy back in place, but instead of making the right choices when making financial decisions, they made worse decisions that led into a crisis several years later. The main cause of the bubble was the lowering of interest rates by the government. In Spring 2001, the Financial bubble burst and the Federal Reserve started lowering interest rates. It was mainly done to save companies that were on the brink of collapsing and to keep the unemployment rate down. This had become apparent at the beginning of the year as the Fed sought for ways of how to control the situation. Businesses reduced investment spending leading to big cuts in the production of modern technology equipment. This was done because there was low demand for technological equipment by foreign countries and an oversupply by the American companies. As sales declined the companies got worried about the high number of stock they had. Apparently, the demand from foreign economies declined, and that was a big blow to the U.S companies that dealt with manufacturing and exporting goods. The situation worsened in the summer of 2011, and there was a massive job loss and the unemployment rate increased. The U.S. government had to act immediately Before 2001, there was consistent growth, and it was a continuous party, but after the party, the punchbowl dried up. Instead of the federal government allowing the investors to leave due to decline in the economy, the Federal Reserve added them some more money leading to the worsening of the economy. At this point, the interest rates were not supposed to be low for a long time as people could take advantage of the situation and make decisions they would regret later in life. The government kept re-filling the punchbowl and people went on with their business. The only institutions that benefited were banks, and this was because they received that money and they could take greater risks and know that the Federal Reserve will clean up the mess in case anything bad happens but they received profits too in case things go as planned. After the 9/11, the stock market was collapsing as well as the Real Estate industry, but that did not deter Americans from their spending habits. In fact, the situation got worse. Americans spent more money than they had. Most of the money was from borrowing. They borrowed funds to sustain their lifestyles not thinking about the impact it had on the economy. There was a prediction about America getting into a recession, but the predictors were condemned. All this happened because the Americans were busy getting drunk on the Fed alcohol and not thinking about the consequences. The Fed kept releasing more money leading to more expenditures. The money that was spent on shopping sprees was borrowed money. The rates kept declining too, and in 2003 it was at 1% which was a very low return on investment. The interest rates stayed at 1% for a whole year. The banks borrowed money from the Feds at that rate. But after all, that happened there was the American dream, the dream of everyone owning a home. That drove the economy that was already in a bad state to worse. That was driven by the low-interest rates that eventually led to the housing bubble. Whether you had money or not, you could own a house. The house prices increased by 10% a year. Many Americans decided to take a second mortgage on their old houses to fund consumption. If you had no money, then there was the home equity loan available. It did not matter whether one had any income or assets. That is where the term NINA loans were derived from. Meaning No Income No Assets loans and of course no down payment. They were given to anyone who wanted to buy a home. The banks and mortgage lenders originated home loans and resold them to investors as security on Wall Street. This method allowed banks to loosen guidelines and pass the blame on investment banks. The result was more aggressive financing, casual underwriting, less oversight that later led to a lot of bad loans. The government then introduced Government Sponsored Enterprise. The main role of the Government Sponsored Enterprise was to enable distribution of money to specific parts of the economy. This was after the politicians created deductions, subsidies, and insurances. Then the government introduced Fannie Mae and Freddie Mac as government-sponsored enterprises. Their main aim was to provide home ownership loans to people who could not get them on the open air market. Their owners were private, but all the transactions they made were government sponsored. But the most interesting thing about these two companies is that they were gaining a lot of profit and people wondered if they were meant to help the Americans or make a profit. The funds in the two enterprises were compromised resulting in a moral hazard. This was because the government started to guarantee mortgages and the lenders were no longer worried about getting their money back. People took loans that eventually were to be paid by the government. The houses became expensive and unaffordable. This was not good for the U.S economy because people went ahead and bought homes only to resell them at a higher price and they knew very well that the government was the one paying the down payment for the houses. The lenders added risk to new mortgages The borrower was at an advantage because they would eventually buy a home whether they had money or not. And the government was the one that was to repay all these money that the buyers would use and as long as the government agreed to pay the down payment then the banks got losses when the house prices increased. But at this point, the government should have let the private sectors run the mortgage companies as they would have restored sanity and the house prices could have become affordable and new guidelines set. But that is not what happened. The banks repackaged loans and sold them as securities. They sold them to different banks, different countries and the most interesting is that they sold them to Fannie Mae and Freddie Mac who were the government sponsored enterprises that were supposed to give people loans to buy homes. In case the loans turned bad, then the buyers would get losses. There was an increase in the number of buyers because the rating agencies gave the mortgage-backed bonds their highest rating. That resulted to more trust in the mortgage sellers hence more money for them. This was because of an assumption that the house prices will keep rising. But the conflict of interest came in where there was a claim that the rating agencies were being paid by the sellers of the securities. In their research, Daniel M. Covitz and Paul Harrison Suggest that "Bond rating agencies have an obvious conflict of interest. They have a financial incentive to accommodate the preferences of bond issuers because they are selected and paid by the issuers" (03). It later was discovered that there was a relationship between Wall Street and the rating agencies. The agreement was that the rating agencies give the securities a good rating so that they can sell and the result was that the rating agencies would be paid upon giving them good ratings and that compromised with the legibility of their work. The mortgage-backed securities benefitted people without money the most. They brought about change in the housing industry. Previously, the banks could not give mortgages to people with low credit rating. But at the entrance of the Mortgage-back securities, the banks agreed to give mortgages to the people they had previously shunned. The Mortgage-back securities enjoyed the good ratings they received from the rating agencies and on top of that lenders didn't assume the risk of a loan default. This was because in case they issued a loan, they sold it to the investment banker who eventually took the risk in case the borrowers could not pay for the loan. The investment banker turned the mortgages into collateralized debt obligations and later sold them to investors who eventually wanted more of the shares. Here is the cycle of events that happened before the housing bubble. The low-interest rates affected the market to the point of availability of cheap loans. This was after the bank had realized there were no people to take the prime mortgages. The prime mortgages were available to people who could pay back the mortgage without default. But there were no more people to take the prime mortgages so what did they do? They ended up creating subprime mortgages that were available to mostly people who were not responsible homeowners and could default at any time. At first, it worked out fine from the lenders to the investment bankers to the investment. Surprisingly the homeowner's default, the banks foreclose and take back the house. But this happened to so many homeowners that there were more houses in the market than demand. All the houses were owned by the investment bank who had nowhere to sell them. In 2006, the interest rates went back to normal. This was after the gradual increase since the year 2004. There was a decline in house prices, and people could not get loans to pay off the old ones they had. The people who had been given loans despite having a low income could not afford to stay in the houses because they could not pay off the mortgage. They had to vacate the houses. This is because they realized that there was no need of paying a high price for a house whose price had fallen. The price fall on the houses rendered the mortgage-backed security worthless as they did not have money to sustain the project due to the decrease in the prices of houses. In 2007 the situation got worse, there was a peak house sale in February with no buyers. In the same month, the former Federal Reserve Chairman Alan Greenspan mentioned of a possible U.S budget deficit. The Investment banks ran out of money because they could not get enough money to stay in business. The Government sponsored enterprise Fannie Mae and Freddie Mac could no longer stay in the dark about going bankrupt. Upon that realization, the government decides to save the situation. The Fed lowered the interest rates from 5.75% to 2%. It gave banks billions of dollars to restore liquidity. But that was not enough because the banks could not trust each other. The money given to banks was not enough to restore the situation because of the panic that was in the Financial Markets. One of the ways the government could have prevented the Financial Crisis was by letting the private sector control the home ownership market. Because then the banks could have lent out money to creditworthy people and they would be sure of loan repayment. In 2008, the government came in and tried to save the situation, even though they saved the situation, they could have done more. They inflated a new bubble. As the Financial Crisis was ongoing, the government allowed the Federal Reserve to release $700 million to purchase assets that were not bringing any profit to the troubled financial system. These are assets that have faced a recognizable drop in market price. The drop in value makes them lack a market where they can be sold. A good example of TARP was the subprime mortgages. In 2008 the market had become illiquid and that made it impossible for them to sell any more mortgages. Other TARP programs were the Auto industry that the government helped to save because it feared that Americans would lose their jobs. The most interesting thing is that the government did no care to look deeper into the Auto crisis because it could have been cheaper to pay off people to go and get other jobs than to try and spend millions in trying to save the Auto industry. The people who owned the Auto industry over-estimated some losses and the effect it would have on the Economy. As a result, the government gave the Auto industry and Chrysler over one hundred billion to enable the Auto industry keep doing business. Another industry that is said to have benefitted from TARP was the Credit Markets. The credit markets that were essential for ensuring there was a continuous flow of credit in the household was a TARP initiative. By the time of the Obama era, the credit markets were frozen making it hard for people to get any loans. Then there came a time that the consumers had to rely on the local community banks to get loans. At the same time, there was the bankruptcy they hit the American Investment Group that included the Lehman Brothers. That was a big hit to the investment fraternity because they largely relied on the investment banks for funding. They were majorly hit by the housing bubble, and neither the Banks nor the investors were willing to help them out. The only option left was for the Federal Reserve to bail them out. The bail-out funds were available, but they were not used as expected. Yes, there was a financial crisis, and they were trying to take the right steps to get the economy back on its feet. But the worst happened when the money supposed to be for a bailout was not used correctly to bail out the financial sector. But the government also involved other sectors that were on the verge of collapsing. This happened after Wall Street crashed the economy and they were the major receivers of the bailout money. The bailout did not only happen in America because in other countries the same happened, but countries also did what America did. They also released funds from their Federal Reserve and funded banks so that they do not collapse. Finance analysts say that a lot of the money was wasted. It was because once the bailout money was released, the institutions did not have definite plans of how the funds were going to be used. On December 18th, 2009, the Federal Reserve was at it again. They decided to reduce interest rates to zero to restore the investor confidence once more. As America lowered their rates, other countries did the same. There was a lot of money on Wall Street with fewer consumers. The Americans were already in debt, but the Feds released more money into the economy. They knew very well that there was a crisis looming. What had happened before the housing bubble, was going on again. The Feds were printing out money and buying mortgages, bonds student loans and so many things that could lead America into more debt; Banks were loaning out money to everyone including people who were not creditworthy. But all this happened when President Bush was leaving office. Then in came the Obama era. President Obama prepared a package that was meant to keep the U.S government running. He came in with the American Recovery Reinvestment Act. The $787 billion approved by Obama added onto the $700 billion approved by President Bush before he left office. The total amount was more than $1 trillion to stimulate the economy. The money was spent on roads airports, education, unemployment, and other benefits. Some of it was also used on health, housing, improve public land and also an investment in fossil energy. His government also ensured there was the investment in fossil energy, finance job training, modernize the electric grid and so on. Ina a research is later done, Pic claims that not all the money given as stimulus was used as spent wisely. For example in the town of Uniontown, they received $600000 to be used to combat homelessness. This was a good initiative, but there were no homeless people in that town. It was a small town, and there wasn't much going on. That means that there was no need of sending them the stimulus money, it should have been used in areas where people needed shelter because then that would be so much better. Another case was that of the Rodeo Drive in Beverly Hills where the streets were to be repaired for $1000000. But when you look that area closely does not need stimulation. The roads might be having potholes but $1000000 is a lot of money to be used in repairing roads especially in Rodeo drive. That money could have been profitable under a different project or in another area that has bad roads. Only a third of the stimulus money had been well planned for. The rest of the amount was money that people wanted to use for their personal benefits and ensure the government paid for it. In another case we see the John Murtha airport receive $800000 from the stimulus money to be used to repave the backup landing strip. When asked if there is the need to repave the landing strip the manager of the Airport says there is no need because the strip that is there is in good condition. On top of that the John Murtha Airport in not very busy and rarely has people around. So where did the money go? The other absurd project that consumed the stimulus money was the clunkers project where you turn in your old car and you were given a new one. The money allocated for it was $1billion; the project became so popular that in a week they had run out of money and what did the government do? Add the auto industry some more money. All this was done to support the German Auto Industry which would eventually benefit as Americans got into more debt. But interestingly after the destroying cars and giving people new ones the German Auto Industry was back into doldrums. But after all that the stocks have gone up and the banks are doing quite okay. The Financial crisis was the worst things that could ever happen in the history of U.S., But all this could be controlled and prevented from happening. Though they tried controlling the crisis, they could have done it in a much better way. One thing they should not have done was to lower the interest rates. Lowering the interest rates to 1% meant that there was no return on investment. The another problem is whenever the government runs out of money, it calls up the Federal Reserve and tells them to stock money in the banks. There being a lot of money in the banks the Government tells the banks to loan put money to the citizens whether they have a good or bad credit rating, That is where the problem comes in. There will be a lot of money in the market, and the money is likely to lose value. That is inflation. Another thing is there will be many loan defaulters, and therefore there will neither be interest for the bank, and that will make the government take a long time to repay its debt. The US government shouldn't have borrowed money from foreign countries because when it did, the dollar had more value than money in their country and therefore when they manufactured goods and sold them to America they sold them at a lower price than what the manufacturers in America sold them at. Eventually, American companies moved their businesses overseas to get cheap labor and cheap raw materials, that resulted in the recession. Americans lost their jobs, stopped paying taxes and they relied on government benefits. The U.S has a debt of over 1 trillion dollars debt it is supposed to pay. The only thing they can do is not borrow anymore but instead, try to develop channels that can generate more revenue that will lead to more tax collection. They should also brace themselves to start paying debts that they have i9ncureed from one government to the next. The another thing is to stop excessive spending on things that are short term like spending money to destroy old cars and buy new ones. Works Cited Covitz, Daniel M. and Paul Harrison. "Testing Conflicts Of Interest At Bond Rating Agencies With Market Anticipation: Evidence That Reputation Incentives Dominate." SSRN Electronic Journal, Elsevier BV, doi:10.2139/ssrn.512402. "Overdose: The Next Financial Crisis". Youtube, 2016, https://www.youtube.com/watch?v=4ECi6WJpbzE. Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(The United States Housing Bubble and its Consequences Essay Example | Topics and Well Written Essays - 3500 words, n.d.)
The United States Housing Bubble and its Consequences Essay Example | Topics and Well Written Essays - 3500 words. https://studentshare.org/finance-accounting/2075066-the-united-states-housing-bubble-and-its-consequences
(The United States Housing Bubble and Its Consequences Essay Example | Topics and Well Written Essays - 3500 Words)
The United States Housing Bubble and Its Consequences Essay Example | Topics and Well Written Essays - 3500 Words. https://studentshare.org/finance-accounting/2075066-the-united-states-housing-bubble-and-its-consequences.
“The United States Housing Bubble and Its Consequences Essay Example | Topics and Well Written Essays - 3500 Words”. https://studentshare.org/finance-accounting/2075066-the-united-states-housing-bubble-and-its-consequences.
  • Cited: 0 times

CHECK THESE SAMPLES OF The United States Housing Bubble and its Consequences

Should the Fed Intervene in Asset Bubbles

INTRODUCTION The current global recession has its origins in the housing mortgage meltdown of the united states that started in December 2007.... The practice of American banks to originate and distribute (in contrast to other countries in which banks originate and hold) is seen as further hastening the expansion of the housing bubble.... Some experts blame complex financial instruments known as derivatives as the prick that finally caused the bursting of the housing bubble; in particular, they liked to cite collateralised debt obligations (CDOs) as the culprit....
46 Pages (11500 words) Thesis

Effect of Credit Crunch on Consumers

But this term has gained a more widespread currency lately due to the implosion of the housing market in the united states of America which in turn triggered a global financial crisis which affected not only big businesses but even entire countries (like Ireland, Greece, Spain, Portugal, etc.... Discussion Consumer spending accounts for roughly 70% of the united states economy.... the united states economy has a big impact on the world economy because of its sheer size....
4 Pages (1000 words) Essay

Argument of After Shock

housing bubble and its downward impact on the stock market bubble, the private debt bubble, and the discretionary spending bubble… Next, in the Aftershock, the dollar bubble and the U.... The writers use the concept of a ‘Bubble' as a metaphor to illustrate the unpredictability and the temporariness of the economic conditions of the united states.... The book Aftershock is a manual that illustrates the declining state of US economy, its consequences and after effects although the authors justly verify the purpose pf the book as stated in the text, “It 's only bad news for your personal economy if you don ' t do anything about it” ....
7 Pages (1750 words) Essay

2006 New York Housing Market Bubble

Housing Market bubble and New York City economy in 2006 During a housing boom, there is a substantial rise in real output as investment in houses and their related investments increases.... A housing bubble can be an economic bubble, which occurs in either local or worldwide real estate market.... 2006 New York housing bubble Introduction A housing bubble can be said to be an economic bubble, which occurs in either local or worldwide real estate market....
4 Pages (1000 words) Research Paper

The 2007 Real Estate Market Crash

and world economies, what could be done to recover from potential negative consequences, and how similar events could be avoided in the future. ... the reasons that led to it, why and how it happened, its possible effects on the U.... New Century Capital Corporation of Irvine, California, filed for Chapter 11 bankruptcy protection and fired 3,200 employees in the wake of its own "financial missteps" and troubles with the SEC and U.... economy was doing well, the truth was much darker than what most people believed: the economy's weakest link, the housing market, was in even worse shape than many realized....
11 Pages (2750 words) Research Paper

Capital Markets Effects on the New Economy Bubble

As cited by Carmen and Rogoff (2010), the ‘new economy' bubble and the banking crisis are regarded as facets of the global financial crisis. ... The paper will offer evidence supporting the view that capital markets created the conditions that led to the ‘new economy' bubble and the banking crisis.... It usually takes several months or even years before the investments start generating sufficient return to pay back its cost thus leading to an economic crisis....
9 Pages (2250 words) Essay

China Housing Bubble

The paper "China housing bubble" informs that most economic observers believe that the Chinese economy is being spurred by a real estate bubble, most likely caused by the fiscal stimulus package and credit expansion which has been observed in the country.... However, although increasing house prices may indicate a bubble, is existence is still debatable.... A burst in the house price bubble can present major destabilization in the economy.... Banks have also allowed for credits on housing development, even without assessing risks involved....
40 Pages (10000 words) Dissertation

Study Case of Goldman Sachs and the Real Estate Bubble

The bursting of the real estate bubble also referred to as the housing bubble, in the year 2008 and the consequent economic and financial crisis dealt a huge blow to the economy of the united states, with ripple effects affecting other economies of the world, both directly and.... This paper will examine the cause of the real estate bubble hit, with specific reference to Goldman Sachs's involvement, which was a significant player in the events leading up to the housing sector crisis that rocked the economy of the united states....
4 Pages (1000 words) Case Study
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us