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Abstract

            The home mortgage crisis is an ongoing crisis in the United States. This crisis has greatly affected other sectors of the economy other than housing. This paper involves a review of some of the causes of the home mortgage crisis and some of the solutions which have been proposed and those that have been implemented. The research was conducted through a review of books, reliable websites and scholarly articles from journals. The results of the research revealed that some of the factors that contributed to the mortgage crisis include; a boom in the housing market, high risk lending practices, secularization, and faulty ratings by credit rating agencies and lack of government regulations. Some of the solutions that have been proposed include lowering of interest rates, homeowner's assistance, legacy asset purchases and setting up of mortgage standards.

Introduction

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            The mortgage crisis was initiated by the burst of the United States housing bubble between the years 2005 and 2006. Before the crisis began there was a lot of foreign money which flowed into the United States from oil producing countries and Asia. The decrease in US interest rates between the years 2002 to 2004 combined with the flow of this foreign money simplified credit conditions. This in turn fuelled housing bubbles. Obtaining credit any type of credit such as mortgage became very easy. Due to the credit and house booms, mortgage backed securities increased. This made the U.S an attractive place for investors and institutions. Big financial institutions which had invested in mortgage backed securities started experiencing significant losses due to the decline in the price of houses. Losses on the types of loans offered were also experienced and the crisis shifted from the housing sector to other sectors of the economy. The financial systems became very fragile. The crisis has had dramatic effects on the global stock markets. This paper will discuss the causes of the mortgage crisis which will lead to a better understanding of some of the solutions that have been put forward to fix it.

Discussion

Causes of the home mortgage crisis

            In order to understand the how the home mortgage crisis can be fixed it is essential to consider some of the factors that contributed to its being. Several factors in the credit and housing market contributed to the crisis.

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One of the factors that contributed to the mortgage crisis is the boom in the housing market. The housing market boom was facilitated by the flow of foreign money in the U.S and simplified credit conditions. The USA home ownership increased significantly in 2004. As the demand for houses increased, the prices increased. The prices of houses increased by 124%. Consumers started to spend and borrow more and to save less. The housing boom in turn led to a building boom and the result was so many unsold houses. In mid 2006, the U.S housing prices began to decline. The fact that credit was easy to obtain and the strong belief by subprime borrowers that the prices of houses would continue to increase encouraged them to take up adjustable rate mortgages. Once the initial grace period came to a halt, many borrowers were not able put up with higher payments and refinancing became an alternative. The decline in housing prices however made refinancing very complicated. Most borrowers stopped paying their mortgages and this led to foreclosures and increase in the number of houses available for sale (Chris, 2007).

 

            High risk borrowing and lending practices also contributed to the crisis. High risk borrowers including immigrants were given more and more loans by  lenders. Lenders also provided risky borrowing initiatives and loan options for example instances in which lenders ask for down payment as little as 2%. The qualification for mortgages has also been changed. Speculative borrowing within residential real estate is yet another factor that has contributed to the crisis(Alan, 2007).  People started to buy condominiums which were still under construction and later on sold them for a profit. Practices such as secularization also led to the crisis. This led to the distribution of credit risk to investors. Inaccurate ratings of credit could also be blamed for the problem. The agencies which deal with credit rating gave faulty investment grade ratings to mortgage backed securities. The high ratings given by the credit rating agencies contributed to the sale of mortgage backed securities to investors. Some of the people involved in the rating knew that they were faulty. Lack of government regulation also contributed to the crisis (Shiller, 2008).

Solutions to the mortgage crisis

            Several solutions to the mortgage crisis have been proposed by economists, politicians, business leaders as well as journalists.

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Some of these solutions have been put into action in a bid to alleviate the crisis. Some of the solutions which have been proposed and implemented have however been met with a lot of criticism. This has resulted to a lot of debate over the solutions to the crisis.

 

            One of the solutions which have been advocated and implemented to reduce the crisis is the lowering of interest rates. A reduction of the interest rates could improve the economy by making borrowing cheaper. In September 2007, the Federal Reserve changed the federal funds rate target to 0.25 from 5.25%. Globally central banks have also reduced their interest rates. The reduction in interest rates could also help banks to crawl out of their financial difficulties. This is because banks have the capability of lend at very high rates in terms of credit cards or mortgages while borrowing at cheap interest rates from depositors. This results to an increase of revenues from lending. Some arguments have however been raised with regard to this solution as some economists feel that lowering the interest rates would weaken the domestic currency and also lead to inflation (Rightrup, 2009).

            Another solution to the mortgage crisis is credit easing. Increasing money supply can encourage banks to lend and hence enhancing the economy. The Federal Reserve can be able to do this by buying treasury securities through open market operations in which member banks are provided with cash when they lend. In order to improve liquidity in the market the Federal Reserve can also offer loans with regard to various types of collateral. This is what is referred to as credit easing and is also known as expanding the Federal Reserve's balance sheet. This solution has already been implemented as the Federal Reserve has set up a range of programs in order to extend the different kinds of collateral in which it is wiling to lend against. One of these programs is the Term Asset backed securities Loan Facility (TALF). In 2008, $ 1.6 trillion was given to banks to cater for different types of collateral. The Federal Reserve has announced that it will expand TALF. The programs created by the Federal Reserve could then be unwound, the interest rates increased and the money supply reduced when the economy improves and hence eliminating the chances of inflation. Weakening of the dollar has yet again been cited as an argument against this solution but then against the dollar would improve once the economy recovered (Muolo & Padilla, 2008).

            Recapitalization or nationalization is yet another solution which has been proposed. Nationalization entails the full or limited control of a certain financial institution for bailout purposes. This solution has already been put into effect as financial institutions which are insolvent have been taken up by investors. From a balance sheet point of view some banks are insolvent meaning that they have more liabilities than assists bank system which is unstable creates low economic confidence. Insolvent banks should be taken over by the government. The government should start by identifying the banks that are insolvent. The insolvent banks or financial institutions should then be placed under receivership. This would clear other equity holders. The banks with good assets should then be privatized and the ones with bad assets could be merged. These assets could be held until they mature and then sold off. Some of the arguments against this solution are that it would result to constitutional issues since it involves the seizure of private property by the government without just compensation (Barth,  Wenling Lu & Yago, 2009).

            Legacy asset purchases are yet another solution. In this case, private investors or the government can buy investments which have a low value which are related to mortgages or credit cards. Toxic assets purchases can be advantageous for banks as they can be able to set up a price which is suitable for their assets. It also improves the level of transparency in financial institutions. In 2009, the US Treasury Secretary announced a plan in which toxic or legacy assets could be purchased from banks

            Assistance of homeowners can be a viable solution to the crisis. Between the years 2007 and 2009 a wide range of government programs were implemented to help homeowners with issues regarding mortgage assistance. Hope Now Alliance is a good example of these programs. These programs offer case by case loan modification in which mortgage balances can be lowered and the lender provided with a warrant which entitles them to appreciation of the house in the future. This would be able to reduce foreclosures (Daly,  2008).

            Mortgage lending standards should also be upheld. During the housing and credit boom the mortgage conditions and standards declined significantly.

The down payment for first time home buyers went as low as 2%. 43% of the buyers made no down payment at all. Lending standards and minimum down payments should therefore be set up and maintained. This would ensure future stability. The down payment should be set to at least ten percent followed by monthly payments. A borrower's income should also be verified very carefully to avoid cases where home buyers take up a mortgage when they do not have a reliable source of income. The mortgage crisis could have been easily avoided if home owners had set up a certain amount as minimum for deposit. Even with the fall in house prices, the negative equity would have been far less (Barth,  Wenling Lu & Yago, 2009).

 

Conclusion

            The home mortgage crisis is a crisis which is still going on in the United States and solutions to it have already been implemented. Several factors contributed to the mortgage crisis which began in 2004. Some of the factors that contributed to the mortgage crisis include a boom in the housing market, high risk lending practices, secularization, faulty ratings by credit rating agencies and lack of government regulations. Various solutions have also been suggested by economists and politicians and some of them have been implemented amidst debate. It can only be hoped that the mortgage crisis will come to an end and that effective solutions to the problem will be generated.

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