M2 Dynamic Discussion
I think the demand for more safe income by interest through mortgages, the lax policies of the government for these loans, created the 2008 economic crisis. Due to the increase demand for a safer (backed by real estate) return on investment many investors flocked towards mortgage investment vehicles. These were not as safe as proposed because the criteria for lenders was almost nonexistent and anyone (even terrible credit) could get a mortgage. This made many homeowners over borrow on their mortgages which in turn made them default on them. This was not only the governments fault, it was also because many banks worked within that system to maximize return by selling ultra high risk mortgages.
What really caused the Great Recession. (2021). Berkeley.Edu. https://irle.berkeley.edu/what-really-caused-the-great-recession/
https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp
Subprime mortgage crisis
12 days ago
Dear Doctor Ferguson and Colleagues, Amadeo, K. (2021) states the lack of regulation on the use of derivatives caused the subprime mortgage crisis resulting in the 2007 financial crisis.
Time to time, the market creates bubbles, which burst at some point. I understand market bubbles bursts by themselves should not be a problem; a burst is an adjustment expected in financial markets.
However, the economists did not expect the house price would fall enough to bring homeowners into default. They had wrong perceptions of the market situation, and did not consider the banks would not refinance a mortgage which has a collateral with lower value than the loan (The Balance, 2021).
In addition, nobody knew the size of toxic debt in the hedge funds investments, which use sophisticated derivatives. These derivatives provide high returns, but also magnify losses in downturns (The Balance, 2021).
Furthermore, some economic signs (as lower durable goods consumption) were not observed. Since the banks were afraid of lending to each other, not to be caught with subprime mortgages, the Fed lowered the rate to bring more confidence and liquidity. It was needed some extraordinary measures and the recovery was slower. Fed Governor Kroszner mentioned that before the subprime mortgage crisis the derivatives were so complex that it was difficult to establish their real value. A fund sponsored by Citigroup, Bank of America and JPMorgan Chase was created to bring liquidity to banks with distressed portfolios, as requested by Treasury Secretary Paulson. The housing burst brought a correction in the stock market. Despite the efforts, banks and financial institutions with high exposition to mortgage backed securities could not find loans to hold themselves, and some ended up failing. In 2008 there was a great recession (The Balance, 2021).
References:
The Balance. 2021. Heres How They Missed the Early Clues of the Financial Crisis. [online] Available at: [Accessed 9 September 2021].
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