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Recently, news in the United States have been swirling around the economic meltdown that the country is experiencing. The financial meltdown triggered by the collapse of the subprime mortgage market and the ensuing tidal wave of economic downturns have been discussed so much that the effects has been one of the issues being seen as a major point of policy for the incoming United States president. For most people, we don't know how a sector in the market could trigger such a violent reaction in the economy and affect almost al parts of the world. What is a sub prime mortgage and how does it affect the United States and the world's economic structure?
Sub prime Mortgage: Defining the entity
It was held that a symbol of one's prosperity consisted in the ownership of one's own home (Souphala Chomsisengphet and Anthony Pennington-Cross, 2006). Many inpiduals focus so much attention on acquiring their own home given the difficulty in buying one (Chomsisengphet & Pennington-Cross, 2006). The recent innovation in the mortgage market is the introduction of the sub prime lending structure (Chomsisengphet & Pennington-Cross, 2006). This new market, encompassing inpiduals who take on loans for their housing purchases at significantly higher risk rates, is inclusive of potential buyers who have less than sterling credit payment records (Eric Rosengren, 2007). Mainly due to the person's bad payment history, usually these persons would be denied the loan for the purchase (Rosengren, 2007).
People who have a had a history of failed credit ratings would not be able to avail of loans in the standard mortgage loan arena, would be able to avail themselves of loans through the sub prime market (Chomsisengphet & Pennington-Cross, 2006). Perceived benefits of this type of lending activity would be a greater number of people owning homes and the increased chances fore wealth generation (Chomsisengphet & Pennington-Cross, 2006). But with this gain are connected risks (Chomsisengphet & Pennington-Cross, 2006). In its very basic form, one could define sub prime lending as lending money at very steep costs (Chomsisengphet & Pennington-Cross, 2006), no questions asked (Nicholas Von Hoffman, 2007).
The Effects here and abroad
Many industrial leaders, including tycoon George Soros and organizations like the International Monetary Fund view the crisis, which started in August 2007, as one of the most severe economic meltdowns since the Great Depression (Hui Tong and Shang-Jin Wei, 2008). Not only is the meltdown evident in the U.S housing market, but it also seems to be affecting the other economic areas as well (Insurance Journal, 2008). For the housing market, the visible effects are the dip in the price tags of homes, restrictive credit environments, and resets of interest rates for home loans (Insurance, 2008). This in turn results in the homeowners unable to finance their loans, and an inability to sell off their homes (Insurance, 2008).
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This drive to achieve the “American Dream”, so to speak, of acquiring one's own home through the sub prime mortgage scheme, instead resulted in the new homeowners' selling off their homes, sweeping away much of their financial resources (Rosengren, 2007). Not only is the “disease” prevalent in the direct arena of homeowners and potential investors in the housing sector, but has also spread to other sectors of society as well (Insurance 2008). Increased instances of losses in the residential market, snowballing pressures in the commercial real estate sector, loans by students and car purchase loans-all have been affected by the crisis in the United States (Insurance 2008). On top of this, the increasing amount of foreclosures, combined with a weakening dollar, has suddenly created a “homeless” sector comprised of people suddenly forced out of their homes, unable to recoup their lives in the ensuing fallout (Subprime Mortgage Plan & Resources, 2008).
How sick is the economy abroad?
The global economic structure will continue to feel the effects of the United States sub prime mortgage collapse (The Earth Times, 2007). According to Angel Gurria, OECD Secretary General, the full strength of the crisis in the United States has not reached its peak, and will continue to linger in the years to come (Gurria, 2007). He (Gurria) avers that the banking industry will be the hardest hit by the American financial meltdown (Earth, 2007). Banks, like financial institutions in the Kingdom of Saudi Arabia, have expressed optimism that they will receive minor hits with regards to their exposure to the ongoing credit crisis, but have already enacted safeguards for their banks (Khalil Hanware, 2007).
It is also likely that the “wait and see” attitude adopted by some financial and business concerns in the Kingdom with regards to the intentions of investors in Saudi companies (Hanware, 2007). Across the world, Germany has just embarked on a bail out plan for one of its banks heavily exposed in the United States subprime collapse (Frank Hornig, Lothar Pauly and Christian Reiermann, 2007). Germany had been “afflicted” with a type of the subprime collapse that sent the bourses in Japan and New York to nosepe (Hornig, Pauly and Reiermann, 2007).
As has been stated, the effects of the subprime crisis in the United States will inevitably spread. How much will it spread and at what costs are the things that continue to be dodging answers (Von Hoffmann, 2007). But in the United States, the influx of the “homeless” will proceed at a steady pace and the effects of the crisis still draws vague answers (Subprime, 2008). It is still to soon to know who and what were affected by the crisis (Wharton School, 2008).
- Chomsisengphet, S., Pennington-Cross, A. (2006, January/February). The evolution of the subprime market. Federal Reserve Bank of St. Louis Review, Volume 1, pp. 31-56 http://research.stlouisfed.org/publications/review/06/01/ChomPennCross.pdf.
- Earth Times, The. (2007, November 15). OECD warns of subprime mortgage effects set to linger. The Earth Times Business. http://www.earthtimes.org/articles/show/142474.html
- Gurria, A. (2007, November 15). OECD warns of sub prime mortgage effects set to linger. The Earth Times Businesshttp://www.earthtimes.org/articles/show/142474.html
- Hanware, K. (2007, September 6). US sub prime mortgage crisis affects Kingdom. Arab News http://www.arabnews.com/?page=6§ion=0&article=100849&d=6&m=9&y=2007
- Hornig, F., Pauly, L. & Reiermann, C. (2007, August 10). Bad debts: American mortgage crisis rattles German banking sector. Spiegel Online Global Financial Crisis http://www.spiegel.de/international/business/0,1518,499160,00.html
- Insurance Journal. (2008, June 12). Analysts: insurers equipped to weather sub prime mortgage crisis. Insurance Journal National News http://www.insurancejournal.com/news/national/2008/06/12/90915.htm
- Rosengren, E. S. (2007). Subprime mortgage problems: research, opportunities and policy considerations. Retrieved November 4, 2008, from http://www.bos.frb.org/news/speeches/rosengren/2007/120307.htm
- Subprime Mortgage Plan & Resources. (2008). 2007 US sub prime mortgage crisis effect & global impact-responding to sub prime mortgage crisis. Retrieved November 4, 2008, from http://www.subprimemortgageplan.com/Subprime_Mortgage_Crisis_Global_Impact.php
- Tong, H., Wei, S.J. (2008). Real effects of the sub prime mortgage crisis: is it a demand or a finance shock-IMF working paper. Retrieved November 4, 2008, from http://www.imf.org/external/pubs/ft/wp/2008/wp08186.pdf.
- Von Hoffmann, N. (2007). Sub prime mortgage blues. The Nation Banks & Banking http://www.thenation.com/doc/20070319/howl
- Wharton School-University of Pennsylvania. (2008). Could tremors in the sub prime mortgage market be the first signs of an earthquake? Retrieved November 4, 2008, from http://knowledge.wharton.upenn.edu/article.cfm?articleid=1664