Wednesday, July 21, 2010

Writing Assignment #1

Some of the elements involved in the mortgage crisis of the United States after 2007 help to explain the rise and fall of the housing market. One of the ways banks were saved from further failure was from TARP funds, which is a $700 billion troubled asset relief program, put into place by the United States government to rescue failing institutions. Also the funds were put into place in order to prevent a further sinking of the economy after the subprime mortgage crash. The fund used taxpayer money in order to rescue the banks, which came into place just as the U.S. economy was getting into trouble. TARP helped to bailout banks from their toxic assets which caused banks into bankruptcy. There was criticism on use of the TARP funds by both Democrats and Republicans, which argued on rescuing failing institutions. Now banks and credit card issuers have to repay the TARP funds used to boost their health.

An adjustable rate mortgage (ARM) is a mortgage rate that can go up or down through the life of the mortgage. The index rate is set up by the United States government depending on the condition of the economy. There are some risks with ARM as they are not for everyone. What happened to a lot of people during the housing boom is that they did not understand the risks involved or were misinformed. Since an adjustable rate mortgage can have a considerable more risk and payments can increase dramatically each year. There are certain clauses in ARM contracts that make it difficult for an individual to refinance or sell a home. A lot of homebuyers were enticed by the low interest rates provided by lenders and yet were ending up owning more than they could afford.

The consequences of the mortgage crisis were due to subprime lenders taking a risk on borrowers. A subprime mortgage caused a major crisis due to major delinquencies and foreclosures in the United States. Lenders decided to give subprime mortgages to homeowners who were less responsible and had bad credit. The more risky loans give a higher rate of return than the safer loans. Banks will insure the safer loans from risk for a small fee what is known as a credit default swaps (CDS). The result of the consequences has affected banks and financial markets around the world.

The banks went crazy with leverage and the over abusing of cheap credit. Banks sought good deals into better deals in order for them to make more money. The investors on Wall Street were using mortgages as investments in order to make more profit. The money the investors received is from the homeowners paying their mortgages. The investors put the mortgages they had invested into three different groups from risky to safe known collectively as collateralized debt obligations (CDO). A lender sells the mortgage to investment banks that turn puts it into a CDO, then sells pieces of that to other investors. This in turn made everyone happy and making money yet passed the risks to the next person or company in return.

Credit default swaps caused a lack of regulation which became a concern to regulators during the crisis. A CDS is used to cover many risks such as include defaults, bankruptcies and credit rating downgrades. The defaults of homeowners not paying caused them to go into default. That caused more houses to be for sell making the supply more than the demand. The effect was everyone going into bankruptcy, which explains how everyone is affected and the U.S. mortgage crisis flows in a circle. This is similar to how money flows and circulates in circles as well. Yet, two important factors that caused the outcome were greed and fraud during the mortgage crisis.

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