2008 Mortgage Crisis in the United States

The US mortgage crisis was the beginning of the financial and economic crisis all over the world, and touched almost every country. What was the cause of the collapse? What were its real consequences? Let us examine in more detail the answers to these and some other questions.

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What was this crisis

The US mortgage crisis is a collapse of the economy and the real estate market, manifested in the form of a sharp increase in non-payment of mortgage loans with increased risks. Accompanied by the withdrawal of residential and commercial real estate lenders (banks and credit organizations).

In terms of the level of decline, the mortgage crisis is compared to the Great American Depression of the 1930s. There are indeed similarities: excessive speculation on the stock exchange and the absence of a corresponding reaction from the controlling and state authorities to the existing facts of crisis.

The very essence of the crisis in general terms is as follows:

  1. The rise in prices for apartments and houses significantly exceeded the level of inflation in the country, which led to the emergence of artificial demand (in the United States there was a “housing boom”).
  2. This boom was financed with the help of “cheap money” or mortgages with minimal interest rates, as well as through the issuance of secondary mortgage loans (re-loan for already mortgaged property).
  3. The economy involved a mechanism of uncontrolled growth in housing prices and sales, which was the key cause of the “inflating bubble” in the real estate market.

As a result, the market became too rich and, as a result, real estate prices began to fall. As a result, US banks increased interest rates on mortgage loans with floating interest rates. These conditions have become the reason for the impossibility of fulfilling one’s obligations to creditors by a significant share of borrowers (especially those in the high risk zone). Clients became debtors, and the property was put up for auction at a cost lower than the initial one.

In September 2008, the level of housing prices fell by more than 20%.

Conclusion: All these factors led to a series of the largest bankruptcies in the history of US banks, insurance, investment and other financial institutions and caused the global recession of the world economy.

World schedule

Chronology of events

In the time interval, the 2008 US mortgage crisis did not occur on one day, or even on one year. Chronologically, the events leading up to it can be presented as follows:

  1. 1999 – 2006

During this period, the real estate market in America experienced an unprecedented rise in construction. In fact, over 7 years, prices soared almost 7 times. Also, during the Bush presidency, a number of legislative measures were adopted, providing tax incentives and jobs in construction corporations. Profit tax on the sale of housing was reduced, which also contributed to the growth in demand for new construction.

The steady growth of the real estate market was accompanied by an increase in the volume of issuing non-standard mortgage loans or subprime loans, when the level of mandatory requirements for borrowers was significantly reduced. That is, loans were received by high-risk individuals who already have a negative credit history. The greed of bankers who sought to increase their incomes by any means was to blame.

In addition, the real estate market at its peak attracted investors and speculators, whose main goal was to extract maximum profit. Asian and Western capital poured into America, whose investors invested in relatively safe instruments – securities secured by real estate (CDO).

  1. 2006 (middle).

In mid-2006, the growth of the real estate market stopped, a glut occurred. More and more borrowers were not able to service their mortgage loans. By the end of 2006, this figure was about 10% of the total number of loans for housing. Refinancing loans was impossible to achieve – banks no longer issued cheap loans. Began a massive alienation of mortgage housing by banks.

  1. 2007 – 2008

In 2007, the mortgage bubble burst. The fall in real estate prices has become critical, which was the result of a long chain of bankruptcies of the largest American banks, hedge funds, insurance and investment companies that have lost huge sums. In 2007, about 25 banks declared bankruptcy. The CDO market has also collapsed.

All further events are already facts of the general economic crisis in the USA, which then spread throughout the world due to the inherent globalization.

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The causes of the mortgage crisis in the United States

The reasons that contributed to the growth of the mortgage crisis in the US, you can list a lot. However, many experts agree that the main ones are the growth of foreign investment in the economy and the change in legislative regulation of the banking system. Consider them in more detail.

Growth in foreign investment and its impact

The period 2002-2005 characterized by a sharp increase in foreign investment – mainly due to China. This is due to the rise in prices for oil and related hydrocarbons. Here there are 2 theories explaining the relationship of the impact of foreign investment on the crisis:

  1. According to 2004 data, America’s balance of payments deficit was about 6% of GDP, that is, Americans consumed more than they produced, and at the same time they spent more than they earned. A logical way to balance this balance is to attract foreign investment.
  2. The attraction of external capital was made by increasing the level of consumption in the USA. If exports fall, you can attract investments with loans from foreign manufacturers.

The first theory is based on the assumption that foreign investment poured into the country due to excessive mass consumption and created a mortgage crisis. The second states that external capital appeared and reached such a scale due to excessive consumption.

Conclusion: Both theories blame third countries on the US mortgage crisis, not on the internal causes and actions of the authorities and control authorities.

Growth in foreign investment

Changes in legislative regulation of the banking system

As early as 1982, the law “On parity in alternative mortgage lending” was passed, which allowed lenders who are not related to federal banks to issue a mortgage with a floating rate.

During this period, new types of mortgage loans appeared: with floating interest, with the possibility of choosing the size of the monthly payment, with the repayment of the debt at the end of the loan period by a large amount, with only interest paid at the beginning of the loan term, etc. All of them gradually pushed the usual mortgage with a fixed interest rate and installments.

The use of new types of mortgages has led to their abuse due to the lack of appropriate legal regulation.

In the future, banks lobbied for a law called “Gremma-Licha-Bliley” or, in a different way, “Law on Modernization”, which gave them the right to create commercial holdings and at the same time engage in investment, commercial and insurance activities.

In practice, banks attracted funds from the public and immediately invested them in high-risk instruments, while insuring themselves. It was given almost complete freedom of action.

 Sub-standard lending, its types and impact

The construction boom in the United States and the steady rise in house prices have created huge competition between banks. Among the key tools in the fight for customers and an increase in lending, they use lower interest rates and the issuance of subprime loans.

Sub-standard lending provides for a significant reduction in requirements for potential borrowers. Credits began to be issued to customers from high-risk groups. In addition, the client could choose the most suitable method of settlement with the bank:

  • a loan with a floating interest rate (the rate is fixed for the first few years, and then the bank has the right to raise it);
  • the choice of a specific payment option (for example, the borrower himself could set a reasonable amount for the monthly payment with the subsequent transfer of unpaid interest to the loan body);
  • payment of most of the debt to the bank at the end of the loan period.

That is, virtually any American without income and any assets could get a mortgage expensive real estate, the cost of which is not comparable with its creditworthiness. These banks themselves called such loans “junk”, as everyone understood that they would not be returned. The main task was to issue them, because the banks received a huge profit from the sale of debt securities.

Building

Derivatives speculation

Due to the sharp increase in the volume of mortgage lending, a new mechanism for securitization or risk mitigation on the non-return of such loans was formed, or simply their financing. The bottom line is to turn debt into securities or derivatives.

The most widespread among derivatives in the United States in the period of the beginning of the mortgage crisis were swaps. The turnover of such instruments was colossal – only according to the data for the summer of 2008, the volume of operations was about 600 trillion US dollars.

The derivatives themselves were provided with new securities, others were issued for them. Thus, the creation of derivatives, synthetic securities, endless emission, their growth in geometric progression provoked a regular collapse – the bubble, which has nothing to it, burst.

In order to maximize profits, the largest hedge funds and investment companies have conspired with leading rating agencies, which deliberately assigned excessive ratings and investment attractiveness of even “junk” securities.

What are its consequences and impact on the global economy?

Mortgage crisis in the US 2007-2008 became the flywheel of further economic events affecting the entire global economy. The key consequences for America are:

  • alienation and bidding of more than 1 million real estate objects pledged under mortgage agreements (by mid-2011);
  • bankruptcy and huge losses of the country’s largest banks, hedge funds, insurance and investment companies (bankruptcy of Lehman Brothers, Bear Stearns, Bank of America bought Merrill Lynch investment bank, termination of investment activities by giants Goldman Sachs and Morgan Stanley);
  • a decrease in the value of production assets by more than 20% (2007–2008);
  • loss of the real estate market, according to approximate estimates, amounted to more than $ 5 trillion (the market is not growing to this day);
  • reduction of retirement savings and personal savings of Americans in the total amount of over $ 8 trillion.

The crisis worked on the principle of “domino” and pulled the construction sector, engineering, services, etc.

Thousands of families were no longer able to service mortgages and left their homes to banks. Entire streets and neighborhoods died out.

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Implications for Russia

Our country has not experienced such large-scale consequences as in the United States. However, the crisis still affected Russia. The main blow fell not on the sphere of mortgage lending, which at that time was at the stage of its development, but mainly on the financial sector.

Many leading banks were in a depressing position and turned to the state for help. Among them are Svyaz-Bank, VTB, KIT-Finance and others.

Capitalization of the largest companies fell by ¾ in autumn 2008, and gold and foreign exchange reserves by 25%. Banks again faced the distrust of the population and the outflow of deposits. The flight of investors has become an additional stimulation of a significant reduction in the financial stability of many banks in the Russian Federation and their bankruptcy.

The financial crisis also triggered a natural decline in prices for oil and accompanying products. There were serious problems with attracting investment in this sector and the completion of projects already started.

The growth rate of the Russian economy has significantly decreased – by about 4 percentage points for 9 months of 2008 compared to the same period last year.

In almost all areas of the economy, a decline was traced.

The crisis in Russia

Conclusions on the outcome of the crisis for the world economy and the Russian economy

After some time, the main conclusions can be drawn from the 2008 global and Russian crisis:

  1. The mortgage crisis in the United States and the subsequent economic recession around the world are the result of human action. It was the people who ignored the danger signals, did not consider the risks, and chased the super-profits. State and financial regulators also did not take proper actions, but only contributed to the formation of poor-quality mortgage portfolio and inflating the derivatives market.
  2. The crisis has revealed weak points and holes in the legislation of many countries. Many housing and tax reform projects and incentives are still under development and approval.
  3. Active actions of US government agencies were taken only in September 2008, when the crisis was already in full swing. Time to mitigate the negative effects was missed. Government spending on overcoming the effects of the crisis, according to the data at the end of 2009, is estimated at $ 11 trillion.

As for the situation in Russia, despite the global integration, it is unique. Our crisis began with the crisis of the private sector, which was triggered by excessive borrowing in shock conditions, namely from the outflow of capital, foreign trade and a significant tightening of external lending conditions.

The complete dependence of the Russian Federation on the prices of oil and other hydrocarbons in their fall and the volume of exports led to the strongest blow of the global crisis in our country. Key measures taken by the Government of the Russian Federation to overcome the crisis were aimed at strengthening the financial system, including pouring capital into the banking system and providing liquidity in the form of subordinated loans.

The policy of the Central Bank has tightened, starting in 2009, mass cleanings began in the banking sector for the inconsistency of credit and financial institutions with the stated indicators and the quality of the policy.

The 2008 US mortgage crisis led to the collapse of the real estate market, the stock market crash and was the beginning of a general economic recession. The bankruptcy of the largest banks, investment companies and hedge funds, a sharp decline in the welfare of the ordinary population, the withdrawal of a million objects of collateral real estate, as well as the penetration of the crisis into all sectors of the economy were its key consequences.

There are many reasons for this, but the main two are a sharp increase in foreign investment in the American economy and legislative acts that have contributed to the development of a speculative bubble. All this led to the fact that at one moment he burst.

Read more about the mortgage market and mortgage lending in Russia, read on.

We are waiting for your questions. Write in the comments, how did the US mortgage crisis affect you? What do you think about the possible mortgage crisis in Russia in connection with the total reduction in rates and the construction boom?

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