The_Subprime_Paper_(final)[1]

The_Subprime_Paper_(final)[1] - Subprime Crisis The...

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Subprime Crisis 1 The Subprime Mortgage Crisis: Cause and Effect Deborah Lutz
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Subprime Crisis 2 Subprime Mortgage Crisis: Cause and Effect The central banking system in the United States is know as the Federal Reserve System (“The Fed”). These banks have a wide range of responsibilities from overseeing monetary policy to implementing specific goals such as currency stability, low inflation and full employment. Central banks also issue currency, function as the bank of the government, regulate the credit system, oversee commercial banks, manage exchange reserves and act as a lender of last resort. However, their main task is to supervise and regulate banks, implement monetary policy and steer interest rates. Any failure, deviation or miscalculation on any of the system’s responsibilities can lead to financial disaster, sometimes of global proportion. One of the best examples of a miscalculation by the banking system, along with other factors, is the subprime mortgage crisis we are presently facing. The crisis is an ongoing economic problem that began in late 2006 with an increase of foreclosures in the United States. Most of the foreclosures were on “subprime” and other adjustable rate mortgages (ARM) made to high-risk borrowers with lower income and poor credit history. The trend of rising housing prices encouraged borrowers to assume mortgages believing they would be able to refinance at more favorable terms later. Then, by 2007, housing prices started to drop in many parts of the United States and refinancing became more difficult. Also, to make a bad situation worse, ARM interest rates reset higher and defaults and foreclosures increased dramatically. In addition to mortgages, there is evidence that people are struggling to repay other debts—credit cards, auto loans and even student loans, so default rates on those are starting to rise. “That is bad news for a country that already seems on the brink of recession” (Gross, 2008 p.34). Cecala (2008), publisher of Inside Mortgage Finance explained:
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Subprime Crisis 3 As in past credit dry spells, high-risk corporations and homeowners with poor credit face the prospect of paying more for debt. But in this, the first debt drought of the 21 st century, the impact is evident in unexpected places. Due to the well-documented subprime losses and to the generally weak housing market caution has spread to the entire home-lending industry. In the Federal Reserve’s January survey, 55 percent of U.S. banks said they had tightened lending standards on prime mortgages in the past three months, while 60 percent had done so for home-equity lines of credit. Lenders are focusing the types of loans they can sell to Fannie Mae, or Freddie Mac, the government-sponsored entities that purchase mortgages meeting strict criteria. According to Inside Mortgage Finance , in the fourth quarter of 2007, 68 percent of all new mortgage debt was so-called agency debt. The upshot? Anyone who doesn’t have a big down payment or equity in their home
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This note was uploaded on 10/29/2008 for the course MG 350 taught by Professor Whitley during the Spring '08 term at Athens State.

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The_Subprime_Paper_(final)[1] - Subprime Crisis The...

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