Housing Crisis in US

Housing Crisis in US.

Housing Crisis in US

Since the mortgage crisis in 2008, there has been a housing crisis in the US. The low-income earners are finding it hard to own a decent home depending on the average income in the areas they reside. The housing crisis was sparked by the subprime mortgage bubble burst in 2007, which caused a significant financial crisis that had far-reaching implications beyond the United States of America. The bubble burst was contributed by a number of things that took place in a series of events. Home ownership currently plummeted and the number of those who face foreclosure for default of mortgages stands at over 1 million people. Over 7 million are underwater for buying overvalued homes using mortgages (Kenaga, 2012). The effects of mortgage crisis are still felt for over a decade.

How the Mortgage Crisis Started

The mortgage crisis was spurred by a series of events which started by creating a bubble. Owning of property is a thing that is highly valued in the United States of America. In 2002, the interest rates charged on mortgage loans were low and that attracted very many people who wished to own a home. At that moment, the value of houses was rapidly rising and everyone was rushing against time to own a home before the prices could hike much higher. Financial institutions and hedge funds, leveraged on the increasing value of houses to provide low-interest mortgages. Everyone was anticipating that the value of homes would continue going up and up hence the influx of low-interest rate mortgages. Financial and investment institutions did not mind to give high-risk loans even to low income earners. The increase in subprime loans created a bubble, which later burst in 2007.

 

Increase in Subprime Lending

The subprime lending was characterized with the issuance of loans to borrowers with a low credit worthiness. The lenders did not consider the debt-to-income ratio since they were tangible signs of a boom in the real estate business. The ownership rate had increased to the highest level since 1994 to 69.2 in 2004 (Bianco, Katalina, 2008). Most of the lenders were challenging each other to attract as many borrowers as possible to leverage on the booming business. The increase in property value prompted some borrowers to take a second mortgage against the increased value of their homes to finance their daily life. Taking a second mortgage further fueled the household debt to a new height ever in the history of the U.S. later in 2007 the interest rates began to rise, and that is when the crisis started.

Unregulated Lending

Lack of a properly lending routine among the lenders is another thing that is blamed for the housing crisis in U.S. Unlike in the past where the lending business was dominated by traditional commercial banks, the emergence of mortgage banks, hedge fund institutions and other forms of lenders loosened the lending rules. By 2007, 60% of the lending business was under the control of new lending institutions rather than traditional commercial banks (Bianco, Katalina, 2008). The level of competition in the lending sector allowed issuance of high risks mortgages to borrowers with low creditworthiness. That significantly contributed to the creation of the bubble.

Lending Standards and High-Risk Loans

The standard of issuing mortgages was compromised during the boom period. That led to increased issuance of high-risk mortgages to borrowers who did not deserve them. Unregulated lending led to the important standard being overlooked leading to a market without proper coordination. Issuance of Alt-A loans that were undocumented loans played a major role in the mortgage crisis. The undocumented loans did not describe what would be the effect of the increase in the interest rates. Such loans compromised the lending standards since they were not definite.

During the boom period, lenders used unscrupulous means to attract borrowers to take high-risk loans such as ARM. The lenders teased borrowers with low introductory rates, which later burgeoned significantly (Bianco, Katalina, 2008). That led to most people taking loans that turned out to be a heavy burden to them later. Some of the loans turned to be double the income of the borrowers in the later periods. Since most people had no knowledge of such luring tactics, they ended up taking mortgages that they could not manage later when the interest rates increased.

Secularization

Secularization allowed backing of high-risk mortgages by third parties. That led to an increase in the number of high-risk mortgages taken. The increase in the high-risk mortgages put the mortgaging sector into the risk of a crisis. In case of a crisis, mortgage providers would not be in a position to amicably deal with the situation (Bianco, Katalina2008). When the interest rates increased, so many people who had taken the high-risk mortgages defaulted in paying and that was enough to cause a crisis. Those offering security could not afford to cover for a large group of people at once and that caused further troubles. The crisis was not anticipated and it just happened when few expected. Giant insurance companies such as AIG were on the verge of collapsing after the bubble burst since they could not afford to repay all the companies and individuals they had covered. The Federal Reserve salvaged AIG from collapse by using $ 85 billion to bail it out the crisis.

 

Impact of Automated Underwriting and Mortgage Brokers

Unlike in the past where underwriting was done manually, during the boom period, much of the underwriting was generated automatically. Automated underwriting was preferred since it took minimal time to provide eligibility details of the borrower. These failure to follow a complex process provided loopholes for credit-unworthy candidates to get mortgages. If the due complex process was followed, most of the defaulters could have been eliminated and the severity of the crisis could have been abated.

On the other hand, the mortgage brokers rapidly increased during the boom period in 2002-2003. The mortgage brokers accounted for 68% of the mortgage deals transacted between mortgages dealers and banks. The 48% of the deals they made involved subprime and Alt-A mortgages (Allen, 2009). The brokers failed to provide enough information regarding the ability of the borrowers to repay their loans. That left the loan providers at risk since they did not know that many of the borrowers could have defaulted in repaying the mortgages. The brokers ought to have conducted enough research regarding the borrowers before connecting them with the mortgage providers.

Bursting of the Bubble

The increase in the interest rates sent a shocker to the booming real estate business. The value of houses began to plummet at a drastic rate. The increase in the interest rates was to the detriment of the homeowners who had bought their properties at low prices. The increase in the interest rates hiked the prices of their mortgages a thing that they had not anticipated. They now had to pay more money than their homes were worth. Most of the subprime borrowers were hit under the belt by the new turn of events. Most of them could not afford the prices their homes thus defaulting in payment of their mortgages. Banks and mortgage companies suffered significant losses from default in paying off mortgages by the subprime borrowers. Defaulting in payment of mortgages pushed the value of homes lower and that brought the real estate sector into a crisis. Banks were counting losses since foreclosure could not help offset the value of defaulted loans since the value of homes was plummeting at a worrying rate. The giant mortgage companies such as Bear Sterns, Lehman Brothers, and others were on the verge of collapsing. Fannie Mae and Freddie Mac were put under government conservatorship to salvage them from collapsing. Banks refused to fund mortgage institutions and that sparked a global financial crisis (Bianco, Katalina, 2008).

Collateral Damage

The effects of the bubble had far-reaching implications on those who were having mortgages. The decline in the value of homes meant that of people were living in homes that had been overvalued. Most of the homeowners were counting on losses for paying than what they were supposed to be charged. The banks and the mortgage companies were hit hard due to default in the payment of the loans by the borrower. The value of homes was rapidly plummeting and foreclosure was not enough for banks to recover value for their loans. Many of the borrowers continued to lose their homes and that made them homeless. In 2014, more than 1 million borrowers were facing foreclosure and they risk losing their homes and over seven million of mortgage borrowers are underwater meaning that they are paying overvalued mortgages as the value of the homes was exaggerated (Kenaga, 2012).

The bubble burst also had massive negative implications on property tax revenues. Foreclosure of homes meant that little tax revenue would be collected as the value of homes continued to plummet. For instance, California was projected to lose more than $ 4 billion in tax revenue in the aftermath of the subprime mortgage crisis. The crisis affected more than half of the states of the USA implying a massive financial crisis.

Effects on the Stocks Markets

The sublime mortgage crisis in the United States of America sent the global stock markets into shambles. The effects were not only felt in the USA but also globally hitting hard the stability of stock markets. There were widespread fears that the losses made by the U.S financial institutions would cascade a financial nightmare across the globe. That made most of the people to sell-off their shares. Massive sell-offs affected the stability of the stock market and massive declines were recorded. In Germany, there was a 7% decline in prices of shares and a 5% decline in England (Bianco, Katalina, 2008). The ability of banks to lend was affected and banks could not lend to their fellow. Banks feared of losses as it was proving difficult for them to recover their loans. The decision by banks not to lend sent financial shock waves across the globe. The wave affected the trust of most of the stock markets. That made the prices of shares to plummet abruptly hence a financial crisis in the globe.

According to a report by the Urban Institute, there is no state in the United States of America that has enough affordable homes. The cost of most houses is above a third of most income earners across U.S.A. That means that most of the people are finding it hard to own a home using the size of income they are earning. Most of the people have to make sacrifices to pay their mortgages, buy a home or to pay for their rent. The problem of home ownership is more felt by low-income earners who cannot manage to pay their mortgages using their low incomes. According to Urban institute, only 28 units of affordable homes are available among 100 low-income earners nationwide. Nevada has only 17 affordable housing units per 100 extremely low-income earners, California, Alaska, and Arizona have 21 affordable per 100 households (Subprime Mortgage Crisis).

According to a report by American   Community Survey, there is a shortage of 7.2 million affordable rental units among 10.4 million low-income earners in the United States of America (Subprime Mortgage Crisis). Most of the low-income earners spend more than 50% of their income on rent affecting their possibility to own a home. The government should put in place measures and policies that will help low-income earners to own their homes. More focus should be put on providing affordable housing units across the nation to match with the ever-growing demands for housing units.

 

References

Allen, F. (2009). An overview of the crisis: Causes, consequences and solutions. Retrieved from http://apps.eui.eu/Personal/Carletti/IRF-Overview-Allen-Carletti-26Nov09-final.pdf

Bianco,J.D. & Katalina, M. (2008). The subprime lending crisis: Causes and effects of the mortgage meltdown. Retrieved from https://business.cch.com/images/banner/subprime.pdf

Subprime Mortgage Crisis.(N.d) Retrieved from http://www.stat.unc.edu/faculty/cji/fys/2012/Subprime%20mortgage%20crisis.pdf.

Kenaga, N. (2012). Causes and implications of the US housing crisis. The Park Place Economist 20(1), 40-46.

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Housing Crisis in US