Global Financial Crisis Causes Housing Market Cause Finance Essay - Free Essay Example

Sample details Pages: 4 Words: 1328 Downloads: 9 Date added: 2017/06/26 Category Finance Essay Type Narrative essay Did you like this example? Between 1997 and 2006, the price of a typical house increased by 122%. During the two decades ending in 2002, the national median home price ranged from 2.5 to 3.2 times median household income and the proportional ratio is 4.2 in 2004 and 4.4 in 2006. This housing bubble result moved in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation. In the year 2006 last quarter the average housing prices by September 2008 had declined by 20% over in peak time. Easy credit, and a belief that house prices would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages and these mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by market interest rates for the remainder of the mortgages term. These Borrowers could not make the higher payments once the initial grace period ended would try to refinance their mortgages. Refinancing became more difficult, once house prices began to decline in many parts of the developed and developing countries. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. In the year 2007, lenders had begun foreclosure proceedings on nearly 1.3 million properties, a 79% increase till 2006. This increased to 2.2 million in 2008, an 82% increase vs. 2007. By the month July 2008, 9.2% of all mortgages outstanding were either delinquent or in foreclosure. Don’t waste time! Our writers will create an original "Global Financial Crisis Causes Housing Market Cause Finance Essay" essay for you Create order Risk-taking behavior cause The key theme of the crisis is that many large financial institutions did not have a sufficient financial cushion to support the commitments made to others or absorb the losses they sustained. Using technical terms, these firms were highly leveraged (i.e., they maintained a high ratio of debt to equity) or had insufficient capital to post as collateral for their borrowing. A key to a stable financial system is that firms have the financial capacity to support their commitments. The Economists are argued: The major critical role for regulation is to ensure that the sellers of risk have the capital to support their bets. The Risk-taking behavior includes Home equity extraction, Consumer and household borrowing, Housing speculation and corporate risk-taking and leverage factors Pro-cyclical human nature. Financial market factors cause During a period August 2007 of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators, increasingly complex and opaque financial products, and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, or take into account the systemic ramifications of domestic regulatory actions keep pace with financial innovation. Macroeconomic conditions Interest rates contributed to an increase in one year and five year adjustable-rate mortgage (ARM) rates, making ARM interest rate resets more expensive for homeowners. This may set asset prices high generally move inversely to interest rates also contributed to the deflating of the housing bubble and it became riskier to speculate in housing Trade deficits created demand for various types of raising the prices of those assets while lowering interest rates, financial assets. International investors had these funds to lend, either because they had very high personal savings rates (as high as 40% in China), or because of high oil prices. These referred to as a flood or saving glut of funds (capital or liquidity) reached the financial markets. Stock market crash cause One of the key area stock market crashes is a sudden dramatic decline of stock prices across a significant cross-section of a stock market which is the major factor trade investors. Crashes are driven by panic and also as much as by underlying economic factors. They often follow speculative stock market bubbles in the real business factor. Stock market crashes was in fact social phenomena where external economic events combined and also with crowd behavior and psychology in a positive feedback loop where selling by some market participants drives more market participants to sell in loss. In general speaking, crashes usually occur under the conditions of prolonged period of rising stock prices and excessive in economic optimism. The P/E ratios exceed long-term averages in market and extensive use of leverage and margin debt by market participants. There is no numerically specific definition of a crash but the term commonly applies to steep double-digit percentage losses in a stock market index over a period of several days and carried it to more than a year. In general crashes are often distinguished from bear markets by panic selling and dramatic, abrupt price declines. The Bear markets are periods of declining stock market prices that are measured in months to years during late 2007 and early 2008. While crashes are often associated with bear markets, they do not necessarily go hand in hand. The crash of 1987 for example did not lead to a bear market. In the same way, the example is Japanese Nikkei bear market of the 1990s occurred over several years without any notable crashes. Boom and collapse of the shadow banking system The significant and key blame for the freezing of credit markets on a run on the entities in the parallel banking system. It also called the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls. Further, these entities were vulnerable because they borrowed short-term in liquid markets to purchase long-term, risky assets and illiquid. It means that disruptions in credit markets would make them in order to rapid deleveraging, selling their long-term assets at depressed prices during the crisis. The experts described the significance of these entities: In early 2007, asset-backed commercial paper conduits, in auction-rate preferred securities, in structured investment vehicles, tender option bonds and variable rate demand notes, had a combined asset size of roughly $2.3 trillion. The Assets financed overnight in third party repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the five major investment banks which are totaled $4 trillion. The comparison with, the total assets of the top five bank holding companies in the U.S at that point were just over $6 trillion. So the total assets of the entire banking system were about $10 trillion. The experts stated that the combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles during decade. Mortgage compensation model, executive pay and bonuses cause In the booming period, enormous fees were paid to those throughout the mortgage supply chain. Which are from the mortgage broker selling the loans, to small banks that funded the brokers, then the giant investment banks behind lenders? During the period whichever originating loans were paid fees for selling them irrespective of how the loans performed. Finally the default or credit risk was passed from mortgage originators to investors using various types of financial innovation with ingenuity process. This final result came to known as the originate to distribute model, as opposed to the traditional model where the bank originating the mortgage retained the credit risk of the system. In effect, finally the mortgage originators had no skin in the game, by giving rise to moral hazard, in which behavior and consequence were separated from the model. Regulation and Deregulation cause The critics have argued that the regulatory framework did not keep directly with financial innovation, such as the increasing importance of the shadow banking system, off-balance sheet financing and derivatives. In other ways the cases, laws were changed or enforcement weakened in parts of the financial systems. Finally several critics have argued that the most critical role for regulation is to make sure that financial institutions have the ability or capital to deliver on their commitments. Main Global Financial Crisis Root Cause Workflow