Mortgage Credit Crisis Of 2008 Essay ⋆ Business Essay Examples ⋆ EssayEmpire

The mortgage and credit crisis of 2008 is a financial crisis that originated in the United States but contributed to the global economic crisis of 2007–09, and has its most direct origins in the housing bubble and the disastrous consequences of irresponsible subprime lending. Though not solely complicit in the larger economic crisis—which also involves a fuel crisis, the bailout of the American automobile industry, and erratic commodity prices worldwide— the subprime mortgage panic is nearly synonymous with it in the minds and mouths of the public, due to its scope, the clear involvement of human error, and the consequent havoc wreaked on the American finance industry.

The Housing Bubble

The United States housing bubble affected much of the American housing market, especially California, Florida, and the northeast and southwest. Prices peaked in 2005, began to decline in the following year, and as of 2009 were continuing to decline in most markets. As with the dotcom bubble several years earlier, what seems a very obvious inflated peak and inevitable drop in hindsight was not at all clear at the time, and historical perspective has not yet detailed all of the factors or causative nooks and crannies of the event. Though some economists and industry publications had warned of the likelihood of the bubble and of overvaluation of property, former Fed chairman Alan Greenspan, for one, admitted to not recognizing the phenomenon until a year after the peak. In hindsight, what could have seemed like alarmism or over cautiousness at the time—like warnings within Freddie Mac as early as 2003, and at the Federal Reserve in 2001, that subprime mortgages were burdening institutions with too much high-risk debt—seems prophetic now.

It is not clear whether the bubble was fully a national phenomenon or a number of local bubbles, though in Greenspan’s words, “all the froth bubbles add up to an aggregate bubble,” making the distinction less than critical except perhaps in some discussions of causation. Some areas of the country—the southeast, for instance—certainly saw less growth in housing prices than areas like Tampa, Phoenix, and San Diego, where prices appreciated more than 80 percent from 2001 to 2006. The effects of the bubble’s collapse, though, have been more uniform, and foreclosure rates in the low growth areas have been nearer to those of the high growth markets. Of the largest metropolitan areas in the United States, only Milwaukee has seen housing prices increase since 2007.

There are a number of contributing causes to the housing bubble, and again, their exact mixture is not yet a matter of historical consensus, but their presence is generally agreed upon. There is, for one, a characteristically American ambition toward home ownership, which is coupled with other accessories in the American Dream, and which tends no longer to involve the multigenerational residence in a family home. Each new generation needs a home of its own, in other words; sons no longer bring wives home, with two or three or even four generations sharing a living space, not even to the limited extent to which that once was true. Many of the subprime borrowers significantly worsened their financial hand with a home purchase, but their perception of their financial health was much the better, because of the cachet of owning one’s home. Home ownership remained about the same in the United States from 1980 to 1994, at 64 percent, and then gained more than 5 percent in the next 10 years to peak at 69.2 percent in 2004, shortly before the housing price peak. Mortgage fraud increased by nearly 1,500 percent in that same period. Those two figures alone are sufficient to raise concern.

There is a longstanding belief in the United States that a home is a more stable, risk-free, and responsible investment than nearly any alternative—that housing prices not only won’t fall, but will yield greater than average returns. Part of that is based only on the fact that stock prices are tracked in real time, making fluctuations obvious, while houses are valued annually. Part of it is due to the fact, widely spread by realtors, that American housing values as a whole have risen since the 1930s. There is a practical aspect as well. The interest on a mortgage provides a greater tax break than anything available to renters, and the principal paid provides equity in a form renters do not have. But local and regional housing prices have always experienced volatility, and while it is possible to own only a little stock, only a few bonds, or to put only a small portion of one’s assets into a mutual fund, a home mortgage is a significant and burdensome long-term debt. Homeowners generally pay much more per month than renters do, even without accounting for possible maintenance and property taxes: the national median mortgage payment ($1,687) is nearly twice the median rent ($868), and the rapid rise of housing values hurt both mortgaged homeowners and landlords, as in many parts of the country, landlords found themselves paying a mortgage that their collected rents did not cover.

Over the long term, home ownership as an investment barely beats the rate of inflation, when you account for the expense of upkeep and property taxes. But the perception of its worth as an investment is so strong that it may have accounted for the difficulty in perceiving the existence of the housing bubble.

Further, the housing bubble and attendant mortgage and credit crisis is the first major economic crisis in which reality TV can be implicated. In 2005 and 2006—during the price peak—there were a number of television shows promoting “real estate flipping.” Primarily an American activity, real estate flipping is the purchase and rapid resale of a property for profit, usually with some improvements done on the property before resale. Skillful flipping could involve an understanding of the psychology of buyers, and the ways to maximize the resulting profits of the money put into those improvements. The collapse of a flipping-driven housing bubble in Florida in the 1920s led to the depopulation of new cities and the abandonment of numerous housing developments, which when combined with the effect on the citrus industry of the introduction of the Mediterranean fruit fly devastated Florida’s economy until the country’s general upswing during World War II.

The TV shows both encouraged and reflected the flipping trend, embarked on as a hobby or parttime job for many of its participants. When a home is purchased with the intent of reselling it quickly, the terms of the mortgage become less important, because it will be paid off in full at the time of sale, long before the consequences of high interest rates have time to come to fruition; many of those advocating flipping as an investment activity promoted lowor no-money-down mortgages, which naturally cost much more in the long run. Flipping was a significant part of the housing bubble: Only 60 percent of homes purchased in 2005–06, that period when a flurry of flipping-centered shows entered the basic cable slate, were purchased as primary residences. While some of the remaining purchases were vacation homes, this is still a startlingly low figure, and flipping of that volume leads to an artificially inflated demand: Because so many houses sell, more houses are built, prices are raised, empty lots are purchased for new developments … but the demand does not truly exist for that many residences. In 2005 twice as many new single-family homes were built as there had been 10 years earlier. As with the Dutch tulip bubble, such activity only pays off so long as everyone continues to play the game. As soon as the market returns its emphasis to only those tulip bulbs buyers actually mean to plant and grow, a correction must occur.

Such a correction did occur, as by late 2005 many economists were warning it would. Fed chair Benjamin Bernanke confirmed in October 2006 that the housing market was experiencing “a substantial correction,” which would put a drag on economic growth. Many placed the blame on Greenspan, who as Fed chair had been responsible for the interest rate on 30-year fixed-rate mortgages reaching a historical low of 5.5 percent, encouraging more mortgagees. But subprime loans would do the most damage. Subprime lending extends loans to borrowers who do not qualify for the usual interest rates because of their risk factors, thus bestowing a greater amount of debt upon those with the least ability to repay it, a practice both ethically and practically questionable. Because the potential profit is high, lenders took many risks, including “ninja” (no income, no job, no assets) loans made to borrowers with no means of repayment except the sale of the house.

The Subprime Industry Collapse

The subprime mortgage industry collapsed in 2007, amid the steepest plunge in home sales since the 1980s. Subprime mortgages represented a disproportionate amount of foreclosures in 2006 as debts came due that the borrowers were unable to repay, and lenders began to face bankruptcy as they were unable to recoup the money they had lent out and were left only with seized assets with rapidly declining values. By the spring of 2008, 10 percent of homeowners had zero or negative equity: their homes had declined in value to such an extent that they were worth less than the mortgage on them, a situation that encourages strapped borrowers to neglect the debt, because that perception of home ownership as equity building and sound investing has been burst.

Subprime lenders began to go into bankruptcy at the start of 2007, including the largest, New Century Financial, which filed for Chapter 11 on April 2, 2007. Because of the practice of securitizing mortgages and other debts, turning them into mortgage-based securities (MBS) and collateralized debt obligations (CDO), far more institutions were put at risk than the lenders themselves. Financial institutions that had made significant investments in MBSs and CDOs began to falter and fail, the value of those securities dropping as housing prices dropped. Profits at FDICinsured banks fell 31 percent in 2007, most of the damage coming in the fourth quarter. Investors panicked, withdrawing from such securities.

The extent of subprime-backed securities quickly became apparent, as they had insinuated themselves into portfolios worldwide, from American hedge funds to the Bank of China. The global credit crunch began around August 2007, causing the European Central Bank, the Bank of England, and the Federal Reserve to inject capital into the markets to deal with the sudden liquidity crisis. Investor panic, bank runs, and bank failures continued regardless, and even the mild relief offered by the remedy proved temporary. The first of several increasingly sizable bailouts began in the United States, with a limited bailout of mortgage debts announced on August 31. A planned superfund to buy up mortgage-based securities failed within a couple months of its announcement, due to still-falling values and the infeasibility of implementation. Investor panic and bank failures impacted stock markets worldwide, amid fund managers arrested for fraud for misreporting the health of their funds in order to give them time to withdraw their own investments, reported losses of hundreds of billions of dollars at American financial institutions, and the July 11, 2008, failure of Indymac, the fourth-largest bank failure in American history.

All of this transpired in an economic climate already affected by the worldwide commodities crisis. The price of crude oil had skyrocketed after a long period of reasonably cheap energy, reaching an all-time inflation-adjusted high in 2008. The cost of food goods soared worldwide, thanks to the crop diversion of biofuel and the increased demand for more profitable foods that led to shortages of basics like rice and grain. Wheat hit an all-time high, rice a 10-year high, and soy, dairy, meat, and corn all skyrocketed. Foods that had already risen in price due to climate-related shortages, like citrus and chocolate, remained high, and “Big Chocolate” companies like Hershey rejiggered their American-market products to use chocolate-flavored coatings in place of chocolate whenever possible, to avoid exceeding the $1 ceiling on impulse-rack products.

Fall 2008 Global Crisis

In September 2008 the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) were placed into conservatorship of the federal government, with the Treasury Department making $200 billion available through 2009 to try to keep the enterprises solvent. The collapse of the subprime mortgage industry infected investment banking, as AIG, Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley all found themselves in peril because of their MBS investments. Lehman Brothers and Washington Mutual (the country’s largest savings and loan) collapsed in September, while Morgan Stanley and Goldman Sachs announced they were divesting themselves of investment banking, the dominant force on Wall Street since the New Deal. The Dow Jones Industrial Average fell repeatedly during that month, nearing 8,000 after a historic high of 14,000 less than a year earlier. No longer revving up or looming, the global economic crisis had entered its acute phase.

In the highly politicized environment of the 2008 presidential election, the Emergency Economic Stabilization Act of 2008 was defeated in the House of Representatives at the end of September, but a version was passed by the Senate on October 1, and President George W. Bush made the unpopular decision to sign it, creating a $700 billion bailout fund called the Troubled Assets Relief Program. The following week was the worst for the American stock market since the Great Depression, prompting the IRS to alter its rules on repatriated currency, encouraging corporations to return money home from overseas investments and foreign subsidiaries, in order to inject liquidity into the stiffening financial market.

The annual G20 meeting, held between 19 countries with the largest economies in the world and a representative of the European Union, was conducted by heads of state instead of ministers of finance, in November. Quickly dubbed “Bretton Woods II,” the meeting took on a much broader scope and grander importance than most of its sort, and in essence became a planning session for the 2009 summit planned for April in London. At the core of the meeting was the need for a common approach to the global financial crisis, and a reconsideration of international financial institutions like the International Monetary Fund.

Bibliography:

Richard Bitner, Confessions of a Subprime Lender: An Insider’s Tale of Greed, Fraud, and Ignorance (Wiley, 2008);
Laurie S. Goodman et al., Subprime Mortgage Credit Derivatives (Wiley, 2008);
Edward M. Gramlich, Subprime Mortgages: America’s Latest Boom and Bust (Urban Institute Press, 2007);
Alan Greenspan, The Age of Turbulence: Adventures in a New World (Penguin, 2008);
Paul Muolo and Matthew Padilla, Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis (Wiley, 2008);
Robert J. Shiller, The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do About It (Princeton University Press, 2008);
Mark Zandi, Financial Shock (FT Press, 2008).

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