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checonomics

2008 SUBPRIME CRISIS

By now the whole world has heard the story of the problems in the subprime mortgage market, which began to show up in the United States in 2007 and then spread around the world. Home prices and Home ownership had been booming since the late 1990s, and investing in a house had seemed a sure route to financial security and even wealth.

Home ownership, for all its advantages, is not the ideal housing arrangement for all people in all circumstances. And we are now coming to appreciate the reality of this, for the Home ownership rate has been falling in the United States since 2005.

What was the chain of events in the subprime crisis? Overly aggressive mortgage lenders, compliant appraisers, and complacent borrowers proliferated to feed the housing boom. Mortgage originators, who planned to sell off the mortgages to securitizers, stopped worrying about repayment risk. They typically made only perfunctory efforts to assess borrowers' ability to repay their loans, often failing to verify borrowers' income with the Internal Revenue Service, even if they possessed signed authorization forms permitting them to do so. Sometimes these lenders enticed the naive, with poor credit histories, to borrow in the ballooning subprime mortgage market. These mortgages were packaged, sold, and resold in sophisticated but arcane ways to investors around the world, setting the stage for a crisis of truly global proportions. The housing bubble, combined with the incentive system implicit in the securitization process, amplified MORAL HAZARD, further emboldening some of the worst actors among mortgage lenders.

Despite the significant strides it has made in making information available to the public, however, the SEC provides only general information regarding public securities, and only for certain kinds of securities and situations. Little information is provided about private securities, such as residential-mortgage-backed securities (RMBS). Thus no one could have evaluated the soundness of the subprime residential-mortgage-backed securities because no one outside the rating agencies could “look inside them” to really gauge the soundness of the mortgages on which they were based. Thus the stage was perfectly set for unscrupulous mortgage originators to lend to low-income people who were likely to default, and for mortgage securitizers to sell the soon-to-default mortgages off to unsuspecting investors.

High home prices made it profitable to build homes, and the share of residential investment in U.S. gross domestic product (GDP) rose to 6.3% in the fourth quarter of 2005, the highest level since the pre–Korean War housing boom of 1950s. The huge supply of new homes began to glut the market, and, despite the optimistic outlooks of national leaders, U.S. home prices began to fall in the middle of 2006. As prices declined at an accelerating rate, the boom in home construction collapsed.

Note:

Do you know how much percentage is the Residential Investment in China GDP now?

The perception that real estate prices could only go up, year after year, established an atmosphere that invited lenders and financial institutions to loosen their standards and risk default. Now the defaults are happening, massively and contagiously.

Read Note:

Catching a cold from time to time may be good to human's immune system, same as to the economic cycles to the economy itself. In the short run a sudden drop in home prices may indeed disrupt the economy, producing undesirable systemic effects. But, in the long run, the home-price drops are clearly a good thing, as it correct people's one-way-up unrealistic expectation on real estate price from time to time, and make the development of real estate industry and macroeconomy more sustainable.

Before the crisis is over, real price drops from recent historic peaks amounting to 40% to 50% or more may well come to pass in some cities or sectors. Such price declines will severely test our economic institutions. The relatively slight price declines already recorded have thus far produced a crisis of mortgage defaults for only a small portion of the universe of mortgage holders, and the impact to date on the financial institutions that issued, insured, or held these mortgages may be minor compared to the damage that may yet unfold.

Read Note:

Sometimes, intentionally slow down to test the self-adjustment mechanism of the market may be a wise move to take, the only thing stop people from doing it may be the leadership may not be willing to see the slowdonw in his or her own term, which leave it to a MORAL HARZARD again, i.e. it's a good thing that needs to be done yet most people want it to be done in other peoples' term.