(5) - What did the FED do?

In order to stabilize the market and prevent the shadow of the crisis from spreading, Federal Reserve System (FED) immediately pumped lots of money into the banking and credit systems. They would have been even committed to supply more funds if needed. However, despite hundreds of billions of dollars provided, the thirst for funds from banks and credit institutions still could not be quenched. Until March in 2008, there were more than 300 billion dollars injected into the system but still many financial institutions (banks and credit companies) were queuing up for loans. (Robin Blackburn, 2008). The financial systems still suffered from the shortage of capital. 

Another plan was also proposed simultaneously in order to support the housing market which was still on ice (freezing) and also to tighten lending standards. Specifically, mortgage borrowers needed to meet requirements as follows: (1) credit risk might be acceptable; (2) loan contracts were made between a period of time from 1/1/2005 to 31/7/2007; (3) those borrowers needed to prove themselves that they were living in their own houses and in cases of high level loan interest rates adjusted the fixed rate would have been applied instead for 5 years. (Bill Hampel, Mike Schenk, and Steve Rick, 2008). 

FED with the U.S. Congress were also involving in alternative supporting measures such as refinancing or guaranteed mortgage loan programs. 

Though the U.S. government and FED as well had attempted to make positive moves, in circumstances of oil price escalation (new consecutive records), severe dollar devaluation there would be still more concerned that global financial market could get further worse.      




PS: Through my research, I tried very hard to bring you the best view of the credit crunch occurred in America. Because of time and knowledge restrictions imposed on my work, I find it hard to avoid facing problems. In the near future, I will continue investigate more this field...& if you leave on my blog your own comments I am definitely very happy. 


                                                                                   
                                                                                  
                                                                                   Thanks. 




                                                         

(4) – Consequences of the U.S. credit crunch

The year 2006 started to experience warning signals of the U.S. housing sub-prime mortgage crisis. Forecasted housing demand index consecutively dropped from 128.2 (8/2005) to just 89.9 (7/2007). From 3/2007, plenty of financial holdings announced total revenue losses of approximately 150 billion dollars mainly due to bad loans (50 % of which was caused by housing loans). (Bill Hampel, Mike Schenk, and Steve Rick, 2008). However, The U.S. government and financial institutions paid little attention to such very first signals. Only until a series of “big” banks and credit institutions staggered could the situation probably be so far out of control.

Reputable Wall Street banks such as Merrill Lynch (currently owned by Bank of America), Citigroup, Morgan Stanley, and Lehman Brother made consecutive announcements about their losses of billion dollars. In addition, the worst occurred by 9/2008, Lehman Brother holdings, one of the biggest banks in the US, declared bankruptcy with roughly 613 billion dollars in debts. The collapse of Lehman Brother was mainly from lots of its borrowed money pumped into “too risky” investments such as housing projects and mortgage-backed securities (MBS) trading. (Lawrence G.McDonald, “A Colossal Failure of Common Sense”, 2009).

The number of home foreclosures for 2008 increased by 53% if compared to that of 2007. (RealtyTrac Press Releases of “U.S. Foreclosure Market Report”).

The shadow of crisis not only covered America but also spread to Europe. As of 9-10/8/2007, BNP (the French biggest bank) closed three investment funds worth about 2.2 billion dollars in the U.S., which led the world stock market as a whole to decrease rapidly. (Bloomberg News). In the first 3 months of 2008, HSBC reported a sub-prime related loss of 3.2 billion dollars. (BBC News)

According to IMF, U.S. and European banks’ losses due to toxic assets and bad loans were up to greater than 1 trillion dollars from 1/2007 to 9/2009. By 11/2008, total subprime-related losses of financial institutions around the world were roughly 750 billion dollars, which cancelled out much of global banking system’s capital.

In summary,  the U.S. credit crisis had spread and devastated the global system of finance.


FED - What did they really do???

:) Let's come and see me in the final part. Thanks.

(3) - Causes of the U.S. credit crisis

The root cause of the U.S. credit crisis was originally from massive and easily accessible lending activities of banks in America for those who were in need of funds for purchasing their own houses by instalment and then sold for profit. From 2004 to 2006, the percentage of sub-prime mortgages in the mortgage market as a whole accounted for approximately 21% that was much higher than 9% (1996-2004). By 2006, the U.S. sub-prime mortgages were up to 600 billion dollars (roughly 20%) (Yuliya Demyanyk and Otto Van Hemert, 2008). These rapidly increased sub-prime mortgages combined with the housing market boom in America were caused by declining interest rate to the record low level, loosing lending standards, and the “housing syndrome” of most U.S citizens as well.

During this period, buying a house in the U.S was quite easy. The partial payment required to be made was only about 20% of the house value (Yuliya Demyanyk and Otto Van Hemert, 2008) and the remaining could be paid within 20 years or even more. Additionally, due to a very low interest rate at this time, after purchasing the house the buyer inclined to rent it out and then make a use of the rental fund to meet his required schedule for a bank instalment loan. Afterwards he sold for profit when realizing the house price was high enough.

The market is always affected by the principle of supply and demand. As the purpose of buying houses was not reserved for residential but for commercial use or investment tools it was likely that over time there would have been an excess supply for housing if houses had been continuously built up for sale. (Figure 1). Simultaneously, the U.S. banks, due to profits, were willing to make loans to those who even had bad credit backgrounds in order to enjoy interest payments. Additionally, interest rates had witnessed a continuously increasing tendency, which in turn triggered home loans to go up dramatically. Many borrowers were unable to pay their loans while their houses were also not easy to be sold as before because the U.S. housing market faced up with an ice age.

As can be seen in Figure 1, the U.S. housing supply increased sharply from the second half of 2005, which was considered a consequence of the “too liberal” home loan process of U.S. banks. 

     (Figure 1)

Source: Bill Hampel, Mike Schenk, and Steve Rick (2008). 'The U.S. Mortgage Crisis - Causes, Effects and Outlook Including Suggested Credit Union Responses' .

As mentioned above, during the period the U.S. housing market falling into the freeze period, spenders who bought houses for commercial purposes were unable to sell them (Figure 2), while housing demand experienced a sharp decline (Figure 3), both of which led home loans to rise dramatically. By this time, banks started to recognize a steady increase in bad debts. The number of bad debts and defaulted borrowers climbing exposed banks themselves to hardship times with huge losses.  

     (Figure 2)

     (Figure 3)

Source: Bill Hampel, Mike Schenk, and Steve Rick (2008). 'The U.S. Mortgage Crisis - Causes, Effects and Outlook Including Suggested Credit Union Responses' .

More than that, bad loans were turned into securities that were then divided into sub – spices to be traded on the stock market. By this way, although the U.S. sub-prime housing mortgage crisis occurred in America its impacts spread to New Zealand, Germany, France, Australia, Japan, etc. because they also got involved in trading such securities. 

Thus, the housing sub-prime mortgage crunch happened in America was because of banks’ lending standard deduction for home loans with high risks and banks’ securitized loans. 

                  ....What were consequences of this crisis???...

...Keep an eye on my blog...

...You will have an answer in my next post :)...

(2) - Sub-prime housing mortgage 

                                 
                             ...What is this???

Before going to discuss more the actual circumstances of the U.S. credit crisis (specifically the U.S. sub-prime housing mortgage crunch), let me start off by talking a bit about the definitions  of ‘Sub-prime housing mortgage’ terms. 

The Federal Bank and thrift Supervisory Agencies said “Sub-prime refers to the credit characteristics of individual borrowers. They characterize sub-prime borrowers as those who display, among other characteristics, (i) a previous record of delinquency, foreclosure, or bankruptcy, (ii) a low credit score, and (iii) a debt service-to-income ratio of 50 percent or greater.” (Rajdeep Sengupta and William R. Emmons, June 2007). Hancock et al. (2005) also attempted to classify sub-prime mortgages according to credit scores and loan-to-value ratios. As can be seen in the table below, if the credit score is equal to 580 (or lower) and the loan-to-value ratio is below 80% or between 80-90%, this segment is defined as sub-prime lending. As long as the ratio is more than 90% it also refers to sub-prime mortgages. (Click here for more details).

Source: Hancock, Diana; Lehnert, Andreas; Passmore, Wayne and Sherlund, Shane M. “An Analysis of the Potential Competitive Impacts of Basel II Capital Standards on U.S. Mortgage Rates and Mortgage Securitization.” Basel II White Paper No. 4, Board of Governors of the Federal Reserve System, 2005.

Sub-prime housing mortgage, which is one kind of sub-prime mortgages, saw a strong development in the early 21^st century and even became an industry in the USA (Yuliya Demyanyk and Otto Van Hemert, 2008). (Click here for more information). It means that such a kind of mortgages became a type of business with lots of profits not only for lenders (banks) but also for speculative investors. In addition, a special thing here is that most banks and credit institutions in America lending under this form accepted security by assets created from borrowed capitals. Thus, we can realize that the risk in this situation is very high as housing often falls into ice cycles. 

                                       

                                         See you in my next post...

Jonathan Mann on Subprime Mortgage

Please find attached the video offering you a simple explanation of the U.S. sub-prime mortgage crisis.

ENJOY fun way, LEARN more & DON'T hesitate to share your thoughts!

(1) - Why the U.S. credit crisis interests me???

It cannot be denied that global finance was suffered much from the sub-prime home mortgage crisis of 2007 in America. The World Bank and the International Monetary Fund had never stopped warning against severe consequences and spill- over impacts of the crisis in global scope. Not only did the market witness heavy losses in the U.S. financial institutions but the severe impacts of such a crisis were also observed on banking systems (especially commercial banks) of other economies such as Europe, Japan, etc. Real consequences of the U.S credit crunch could be seen of wide range from the U.S. economic growth rate and operations of business to the global effects on international investment capital flows particularly and the world's economic growth rate generally. 

From my point of view, exploring causes, actual situations and consequences of the U.S credit crisis would be creating a basis to financial institutions in particular and the government in general in order to strengthen their management ability and ensure safety requirements for assets and the stability of the domestic market.

In my next few posts, I am going to talk more about causes and effects of the U.S. crunch on the basis of real circumstances.