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The Mortgage Crisis

Mortgage borrowers are rated high on the credit risk scale. This means that the chances of retrieving loans from them are low. Yet, since the early 1990’s in the USA, mortgage loans have been given to household builders albeit at ‘Sub prime rates’ or rates higher than charged to corporate borrowers. The present crisis originating in America is similar to the 1980’s savings crisis. The sub prime crisis grew from the saving and loan (S & L) balance sheets under the Carter Administration when funds in this account took a battering from high interest rates during the period. This time, predictably, states relaxed regulations in order to attract funds, because they stood to earn large fees by registering these funds. In the ensuing race to financial destruction, states lowered regulatory barriers even more. The brunt was taken by American taxpayers. Consumers took the rap on other fronts as well in the situation of severe wealth division. As it is, MacEwan pointed this out effectively, “Since 1993, half of all income gains in the United States have gone to the highest-Income 1 % of households” (MacEwan, 2009). There is a serious need of government regulations. As a result of the devastation from the mortgage crisis, government needs to monitor and help eliminate high risk mortgage loans, restructure lending and borrowing practices, as well as assist in revitalizing the housing market from the effects of the recession.

The present crisis has snowballed due to the imprudent handling of rating agencies who are supposed to protect the average investor, financial innovation that has gone all wrong, and inept market regulation. Consumers are now threatened by many negative shocks: falling home values, falling home equity, rising debt servicing ratios, a credit crunch in housing and consumer credit, rising oil and gasoline prices, weakened labor markets and, inevitably enough, a falling stock market. The securitization of mortgage loans was stepped up in the 1990’s. What this did was to immunize or conveniently distance the originators of loans from the consequences. The mediators – banks took over and this encouraged the institutions behind the loans that indiscriminately release loans into the market without care for the consequences. In tandem, a couple of financial innovations introduced at this time, helped the crisis to spiral. The introduction adjustable rate mortgage loans or negative amortization loans was given the nod by the Federal Bank. This allowed loans to less creditworthy clients.

Next was the increased use of collateralized debt obligations, which allowed AAA ratings to be obtained by a large section of the subprime mortgage loan pools. This validated the loans, they began to attract pension and insurance funds, and soon these loans expanded their presence here. As loans over dollars 1000 billion were rapidly shot into the system, the Federal Reserve, state and federal regulators, strangely, somnambulated through the whole thing. Had this not been so, the equivalent of about 10% of America’s GDP would not have been loaned out. To learn vital lessons from this period, one only has to look at official estimates concerning the crisis at the time, to see how reality always bites hard. As the dust settled after the S & L crisis, the official figure, quoted far lower, rose to $150 billion. After the fallout of the Mortgage crisis, US government officials revealed that the actual wipe out could be close to $100 billion. This looked like rising even further if the amount accruing as write offs were to be factored in. The write off figures on just alt –A and sub prime loans, would heave up the loss figure to about $250 billion, assuming a write off rate of 10%. Incidentally, alt –A type loans are made to customers with a better credit risk in relation to sub prime mortgage borrowers. However, Dickerson points a genuine problem in this context, “The unaffordability problem that housing price appreciation created, coupled with a negative savings rate, made it difficult for renters in most income groups to amass the funds needed to make a down payment” (Dickerson, 2009).

At the height of activity in sub prime mortgage markets in America, financial institutions were confident in their forecasts. They claimed the risk was spread out among the many players due to the massive securitization of loans. Now, the taxpayer in America takes the heat of the crisis, when in fact, the financial institutions should be. Financial institutions have used wrong models, overestimating the capacity of the mortgage markets. The optimism seems to have infected counterparts the world over. Result, many European nations face their own versions of economic catastrophe along with the mainstream US mortgage crisis (Wolfson, 2007).

For many months after August 2007, the financial market has been loosing, more than making, money. The consumers in USA have been living beyond their earnings. They have been constantly borrowing money to pay for their houses and sustain their everyday requirements. Most of the asset prices, like the cost of houses, have elevated rapidly, making it a huge burden on first time purchasers. The lenders have been practicing securitization, where they have clustered the poor-quality loans by mixing them with some good-quality mortgages, and selling the whole thing as a package of debt. They have also lessened the criteria for giving a loan.

Focardi specifically notes, “Revamping should start with re-evaluating traditional assumptions about credit risk, credit product features and default; employee training; and new analytic tools and technology” (Focardi, 2009). However, in the event of magnifying unemployment and inflation, the Federal Bank cannot afford to sit still. It has to fight for a stable equilibrium in prices and combat unemployment. The most innovative plan to diminish the credit crunch has been to increase lending with the motivation tom restore liquidity to troubled markets and look after the demands of the inter-bank loaning facilities. The current crisis made the Federal Bank to decrease the interest rates on lent amounts and lengthen the time limit for the repayment of the loan. “Term Auction Facility” was adapted as a scheme for slow banks through which loans at a cheaper rate could be made available from discounts windows and the deals were guaranteed anonymity. As Neiman wrote, “Lenders should provide homeowners with a cash credit each month for as long as the homeowner makes monthly payments, which the homeowner can gain access to after the mortgage is paid off or refinanced. Thus, the homeowner will have an incentive to stay in the home and keep making payments while the lender avoids a near-term writedown” (Neiman, 2010). Thus, it is obvious that the government needs to monitor and help eliminate high risk mortgage loans, restructure lending and borrowing practices, as well as assist in revitalizing the housing market from the effects of the recession.


Dickerson, A. M. (2009). Over-indebtedness, the subprime mortgage crisis, and the effect on U.S. cities. Fordham Urban Law Journal, 36, 3. p.395(31). Web.

Focardi, C. (2009). The Mortgage Crisis: How Are Credit-Risk Managers Responding? Mortgage Banking, 70(3, Pt. 3), p72-110. Web.

MacEwan, A. (2009). The Giant Pool of Money. [Editorial]. Dollars & Sense, 1(284), p39. Web.

Neiman, R.H. (2010). The Mortgage Crisis: Suggestions for Some Relief :[Letter]. New York Times (Late Edition (east Coast)), p. A.32. Web.

Wolfson, M.H. (2007). Financial Crises: Understanding the Postwar U.S. Experience. NY: M.E. Sharpe.

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