(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 :)...
