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Free «Mortgage Crisis on Money Supply» Essay Sample

It is the dream and pride of Americans to own a home. However, the biggest challenge is that these homes are expensive and hence one has to borrow cash from banks so as to fulfill his dream. This therefore prompted people to start getting mortgages which in the early 2000s were cheaper since one could borrow large amounts of money and repay with lower monthly installments (Pritchard, n.d). The conditions for borrowing from banks were attractive and this saw almost everybody rushing to get a mortgage. The rising of commodities prices in the U.S. saw most homeowners rush to create money with their homes since they had plenty of equity. This also encouraged financing institutions to lend more to customers since the mortgage business was seen as a great revenue source. Furthermore, the lending conditions were not very strict as consumers could acquire mortgages even if they had no strong financial background. Globally, people had a lot of money to invest and the mortgage business was the best option due to the low interest rates. This rush to invest in mortgaging led to a crisis in the housing sector that in turn affected the entire U.S. economy with the effects being felt not only by Americans but also by the international populace. Most people agree that the mortgage crisis is the worst economic crisis since the Great Depression that has led to severe consequences to Americans across all age groups. Below is an account of the causes and effects of the crisis as well as the intervention measures by the Federal Service.

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Causes of the Mortgage Crisis

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The mortgage crisis started being experienced in early 2007 due to several reasons which were mostly triggered by the fact that it was easy to borrow from banks due to the low interest rates. This led to lending of high amounts of cash to people so as to make them achieve the dream of owning a home. As a consequence, this lending practice created an imbalance in the financial sector due to the high number of loans being issued to United States citizens. The government saw this as a great achievement but later it was disappointing that most loaners could not repay their debts.

Another cause of the mortgage crisis was fraud that was being experienced in the mortgage business coming from both home owners and mortgage brokers (Pritchard, n.d). Fraud was facilitated by the fact that banks offered easy access to cash which encouraged people to engage in high risk mortgages. Additionally, it was possible for almost anybody including those with little cash or in other words those with bad credit (Pritchard, n.d) could easily get mortgages. Moreover, fraud became widespread in mortgaging since mortgage applications’ accuracy was not checked properly. According to Pritchard (n.d), homeowners found an easy money making opportunity through mortgages.

Furthermore, the mortgage crisis was caused by other factors such as government policies, over speculation by home owners, securitization practices and over flawed credit ratings (Zhang, 2008). The government was aggressively campaigning for easy home ownership of US citizens through mortgaging. On the other hand, homeowners saw mortgaging as an opportunity to make money.

It can also be said that the mortgage crisis was made worse by the changes being experienced in the US economy which saw the prices of commodities skyrocketing such that it was hard for both consumers and businesses to keep pace. Pritchard (n.d), explains that this economic crisis in the US is a complex financial situation which keeps on bringing up new discoveries.

Effects of the mortgage crisis

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The mortgage crisis experienced in the United States since 2007 has not only brought severe effects to Americans only but also to the world at large. According to Hirt & Block (2012), the financial crisis brought about by the mortgage crisis can be linked to lower spending rates of customers, imbalances in the stock market, increased home foreclosures as well as the tumbling of the housing market. This has seen the triangle of lenders, lawmakers and consumers being faced by disagreements especially on the real causes of the crisis and the possible solutions to the problem.

Money supply in the United States is currently being faced by a great challenge linked to the mortgage crisis. Previous research shows that the mortgage crisis led to a 1.311 trillion US dollars federal deficit that was experienced in early 2010 which according to Hirt & Block (2012) represented a percentage of more than 11% of the nominal Gross Domestic Product. As Pritchard (n.d) puts it, majority of homeowners could not repay their loans which according to Bianco (2008), led to a 52.1% drop in homeowners towards the end of 2007. In addition, statistics reveal that homeownership continues to drop as years go by whilst the rates of home foreclosures are on the rise.

The subprime mortgage crisis also led to great losses especially for financial institutions such as banks and brokers since people had started to default their loans (Pritchard, n.d). There was a great fear of banks to lend among themselves since it was not certain whether they could get their money back. Consequently, banks started to fail since there was no money to keep them operating. The HSBC, the largest bank internationally, realized great losses in 2008 which were linked to the subprime mortgage crisis. Further, studies show that in 2007, more than 100 mortgage businesses were facing closure or suspension. The financial crisis being faced in the US spread internationally and consequently saw most global financial institutions face big losses in terms of assets linked to mortgages. These losses affected the money supply chain negatively as there was insufficient money circulating in the economy.

Another consequence of the mortgage crisis was high levels of unemployment. This was mainly as a result of the closure of most financial institutions and businesses. Most workers in the banking business lost their jobs because the institutions could not afford to pay them. Resultantly, state governments lost huge sums of revenue especially property tax revenues.

The Federal Service Interventions

The mortgage crisis being experienced in the US since 2007 could not go on unnoticed and unresolved; all stakeholders involved including the government and financial institutions as well as investors had to find quick solutions to the problem to prevent further escalation. International institutions also took extra actions in an effort to solve the same problem. For instance, the Federal government according to Amadeo (n.d) spent huge sums of dollars trying to stabilize the financial markets so as to prevent further losses which can cause total collapse. Bernanke (2009) also acknowledges that the Federal Service has made tremendous efforts in addressing the financial crisis basically through use of macroeconomic goals (monetary policy) and stabilization of market liquidity. He further explains that in 2007, the Federal Reserve ensured that the interest rates were lowered so as to facilitate the borrowing of banks from the central bank. Further, the Federal Open Market Committee (FOMC) according to Bernanke (2009), lowered the federal funds rates to 50 basis points and anticipated a further reduction in early 2008. All of this was aimed at creating employment as well as increasing incomes so as to reduce the impacts of the mortgage meltdown. However, the reduction of federal funds rates did not yield the desired results and hence the Federal Open Market Committee had to further cut down the rates.

 In late 2008, the government through the treasury bailed out Citigroup with 20 million US dollars for shares (Amadeo, n.d).  The FDIC also assured banks that it would guarantee the loans that banks grant one another.  Additionally, through the FDIC financial interventions, workers who had lost their jobs could receive additional three months of benefits.

Moreover, the Federal Reserve collaborated with the Treasury in an effort to revive the credit card lending (Amadeo, n.d). Through this partnership, the freeze in the credit market was addressed. Another effort by the Federal Reserve to address the financial crisis was portrayed through increasing the funds injected in the revival of the AIG insurance company. According to Amadeo (n.d), the AIG bailout was revised from 85 million US dollars to 150 million dollars. In addition, the Federal Reserve went ahead to acquire mortgage-backed securities worth $52.5 billion (Amadeo, n.d), through this scheme, AIG insurance company was once again able lend more.

Furthermore, the Federal Reserve decided to give $540 billion to bailout money market funds so as to see the stabilization of the money supply chain (Amadeo, n.d). The money market had faced severe losses since huge sums of money had been withdrawn due to the fear of investors losing more. This consequently prompted banks to quit lending to each other.

Bernanke (2009), explains that in 2009, the Federal Open Market Committee decided to buy a huge sum of the mortgage-backed securities so as to reduce mortgage rates.  The expanding of the Federal Reserve balance sheet was aimed at strengthening the economy .This move enabled the housing sector to rise again due to the reduced mortgage rates. The expanding of the balance sheet was also anticipated to totally wipe out inflation.

The above interventions by the Federal Service in the credit markets are anticipated to stabilize the economy. Through boosting the money supply chains and lowering interest (discount) rates, consumers and investors will be encouraged to borrow from credit facilities. This will in turn boost the economy and help in the economy recovery. The interaction of the above factors will also ensure that there is easy flow of money in the economy that will eventually facilitate the bounce back of the U.S. economy. However, the institutions dealing with the mitigation of the financial crisis are taking long term measures so as to ensure that the crisis is totally wiped out.

From the above discussion, it is evident that unchecked monetary policies can lead to a financial crisis. The U.S. government’s mortgage policies led to a financial crisis that almost crumbled the entire US economy but thanks to the interventions by both private and government agencies and institutions such as the Federal Service that took the necessary steps of combating the crisis. The mortgage crisis started being felt in the U.S. in 2007. It was brought about by fraud, lending of high amounts of money, increased prices of commodities and inflation as well as government policies that encouraged easy access to mortgages. People borrowed large amounts such that it was a big challenge to repay the loans. Therefore, most people defaulted their mortgages as they could not afford to repay them. The effects of this crisis led to the closure of most financial institutions, loss of jobs as well as instability in the money markets.  Through the use of monetary policies and microeconomic goals, the Federal Service managed to reinstate some confidence in the mortgage businesses such that consumers and investors could once again participate in the mortgage business. The interventions of the Federal Service include the stabilization of the money market, creation of employment and expansion of the Federal Service balance sheet. All the interventions were aimed at reviving the U.S. economy with some of the results being seen as people are regaining their confidence in the credit market. However, it is recommended that all institutions dealing with the reviving of the U.S. economy continue implementing monetary policies that will further encourage investments in the housing sector. Though there are predictions that the crisis might get worse, the continued efforts of the U.S. government can save the country from this economic crisis.

   

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