Sub Prime Crisis

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In the year of 2008, the entire economy is facing up what has been called the worst financial crisis since the Great Depression which is the sub-prime mortgage crisis. This crisis began with the collapse of United States sub-prime mortgage and the reversal of the housing boom. As of March 2007,the value of U.S. subprime mortgages was estimated at $1.3 trillion, with over 7.5 million first-lien subprime mortgages outstanding. Approximately 16% of subprime loans with adjustable rate mortgages (ARM) were 90-days delinquent or in foreclosure proceedings as of October 2007, roughly triple the rate of 2005. By January 2008, the delinquency rate had risen to 21% and by May 2008 it was 25%. The U.S. mortgage market is estimated at $12 trillion with approximately 9.2% of loans either delinquent or in foreclosure through August 2008. Subprime ARMs only represent 6.8% of the loans outstanding in the US, yet they represent 43.0% of the foreclosures started during the third quarter of 2007. During 2007, nearly 1.3 million properties were subject to foreclosure filings, up 79% versus 2006.

This ongoing increase in foreclosure risk occurred when mortgage industry pushed loans with more generous terms in order to extend home ownership rates which was stagnant in year 1990 or to make home-buying more affordable. It has an adjustable interest rate called a “2/28” that features semi-annual interest rate adjustments after a two-year fixed-rate period which is often a discounted or “teaser” rate, so the rate adjustment can lead to a significantly higher payment. Because of the resulting payment shock, these loans are sometimes referred to as “exploding ARMs.” This allows the homeowner to pay just the interest (not principal) during an initial period. Still another is a "payment option" loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal. Further, an estimated one-third of ARM originated between 2004 and 2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment. It has also limited documentation of borrowers’ loan qualifications owing to various risk factors, such as income level, size of the down payment made, credit history, and employment status. Lenders even offer the "No Income, No Job and no Assets" loans, sometimes referred to as Ninja loans. In 2005 the median down payment for first-time home buyers was only 2%, with 43% of those buyers making no down payment whatsoever. Thus, increasing mortgage fraud too. And, it starts with low initial payment enticing borrowers but at the same time costly fees and prepayment penalties associated with predatory loans also strip equity, making it harder for borrowers to refinance and forcing them into foreclosure more quickly.

From that, housing market boom which is an another cause for the crisis. Easy credit, combined with the assumption that housing prices would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages they could not afford after the initial incentive period. It fueled housing price increases and consumer spending. Americans spent $800 billion per year more than they earned. Household debt grew from $680 billion in 1974 to $14 trillion in 2008, with the total doubling since 2001. During 2008, the average U.S. household owned 13 credit cards, and 40 percent of them carried a balance, up from 6 percent in 1970. But, once housing prices started depreciating moderately in many parts of the U.S. about 15.8% as of May 2008, refinancing became more difficult. Some homeowners were unable to re-finance and began to default on loans as their loans reset to higher interest rates and payment amounts. And, this is expected to continue declining until inventory of surplus homes is reduced to more typical levels.

Another is speculation in real estate where Keynesian economist Hyman...
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