Tuesday, October 30, 2012

Could the US Mortgage Crisis Have Been Prevented?

The blows of debt have made us witness the hardest financial times which at the same time introduced us with several debt relief firms and debt consolidation programs. Nevertheless, it made us a victim of certain financially declining processes like foreclosures, bankruptcy and mortgage crisis of course. We have perhaps known all ifs and buts, pros and cons of the recent mortgage crisis but somewhere the information is yet to be gathered completely. The year when it all started in was 2007 when the economy watchers failed to realize the sheer magnitude of the subprime mortgage and the perfect storm of bad events that could soon follow. . First, banks were not as worried about the credit-worthiness of borrowers because they could sell the mortgages on the secondary market. Second, unregulated mortgage brokers made loans to people who weren't qualified. Third, many homeowners took out interest-only loans to get lower monthly payments. As home prices declined and mortgage rates reset at a higher level, these homeowners could neither pay the mortgage nor sell their homes for a profit, and so they defaulted. Fourthly and most importantly, mortgages were repackaged as mortgage backed securities by banks which were further re-packaged by bank technicians into high risk and low risk product bundles. Now, the computer programs were so complicated that no one really understood what exactly was in each product bundle or how much of the bundle had subprime mortgages. When times were good, it didn't matter, and everyone bought the high risk bundles because they gave a higher return. As the housing market declined, however, everyone knew that these products were losing value but, since no one other than the computer programs understood them, the resale value of the products was unclear. By March 2007, it appeared that these hedge fund housing losses could threaten the economy. Throughout the summer, banks became unwilling to lend to each other, afraid that they would receive bad MBS in return. No one knew how much bad debt they had on their books, and no one wanted to admit it. If they did, then their credit rating would be lowered, their stock price would fall, and they would be unable to raise more funds to stay in business. The stock market see-sawed throughout the summer, as market-watchers tried to figure out how bad things were. As a result, the housing market dropped due to this liquidity problem and panic gripped the financial market. However few things could have prevented this mortgage crisis from happening. The first would be regulation of mortgage brokers, who made the bad loans, and hedge funds, which used too much leverage. Secondly, an early recognition of this credibility problem by the federal government could have prevented the situation if the same would have bought the bad loans. To some extent the financial crisis was also caused by the financial innovation that outstripped human intellect. The potential impact of new products, like MBS and derivatives, were not understood even by the technicians who created them. Apart from that even some good regulations could have softened the downturn but the greed for new products could not be avoided.

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