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Financial Crisis In Relation To Subprime Mortgages
Introduction
Carmen and Rogoff stated that financial crisis is not a new thing in a country like USA, but sometimes it comes as a surprise. This statement reflects the situation experienced in the country during the 2008 financial crisis (Allen 3). The 2008 financial crisis is believed to be as a result of the subprime mortgage crisis in the USA. The crisis came at a time when the country was facing an economic boom. Between the year 1997 and 2006, the prices of houses had risen up to 188% in the country. However, by the year 2009, the prices had gone to 33%. As a result of this decrease, the country enjoyed low prices in the housing sector but this brought about a sequence of other problem in the country’s financial system. The country experienced a period of mortgage felony, devaluations in securities, decline in house investments, foreclosures, and other financial investments problems. All these outcomes form the US subprime mortgage crisis of 2008.
This paper is an analysis of 2008 financial crisis and its relation to subprime mortgage crisis in the same year. In this paper, a look at the causes of the financial crisis are analysed to try and develop an argument that it was really the subprime mortgage crisis that fueled the financial crisis.
From 2007, the US economy started facing difficuties where investors were losing money day by day and others going bankrupt. Joseph Cassano, an executive at belmoth AIG at the time of the crisis, predicted a loss of one dollar in every transaction the company did .In the same year, investors like AIG experienced a continued devaluation of their invested assets (Helleiner 3). The crisis extended to all sectors of the economy leading to deteriorationof financial markets, fuelling inflation, and high losses in wealth. Individual were highly affected and the only thing they could rely on were the assets they had kept such as equity loans from houses and retirement funds (Treasury.gov)
Within a period of one year, the crisis had spread from a financial sector problem to an economy-wide recession. There was continued reduction in investment, workers retrenchments, and reduction in household spending. This led to high unemployment rates, low production, and less earnings each year. The continuity of this problem affected foreign banks and thecountry’s export and imports. The government was then faced with criticism from all sides.
The Housing Bubble
To determine the root cause of this financial crisis, we look at the situation a few years back before this crisis happened. According to Shiller ( 38), due to control of inflation, the price of houses was stable from 1890 until 1970. The changes in the prices then started being seen from late 1990’s and early 2000.. The increase stated with a genuine increase in demand, with people purchasing financial assets each and every day hoping that they will benefit from the expected changes in prices of assets that were occurring by then. The prices of houses went up with those who were selling and buying expecting further changes and bigger profits from the real estate industry.
With assumptions that the prices would continue rising, buyers were willing to pay more for the houses hoping that there would be better returns from their investments. With this in mind, real estate agents also increased their rates with speculations that the prices of houses would continue going up. There was some assurance of extensive profits in the housing business and for this reason, individuals and families were convinced to buy houses at high rates. This registered a 1.5% increase in the value of houses form 1998-2003. There was also an increased supply of rental spaces and construction rate of 9.0% (Baker 2). Economic analysts came up with several ideas to explain this issue. For instance, John Maynard Keynes, who is known to be the founder of modern macroeconomic, in the