The spread of the credit crisis

When the “housing bubble” proved constant growth, it was only a matter of time until the crisis would spread and other parts of the economy would be affected.

Since September 2007 the housing prices remained stagnant or fell. This basically means that the longer the situation remains this way, the greater will be the penalty to our future economic growth. In order to stop the Spread, Countries, Banks and other Companies, pass legislations, funding in order to support the mortgage counselling and help homeowners refinancing during this difficult period.

In December 2007, sales volume of new homes dropped by nearly 30%, compared to the previous year, this is why at the start of 2008, and the inventory of unsold new homes was at its highest level since 1981, counting nearly 10 %!
Anyhow, prices are expected to keep on declining until this excess of supply is reduced. Prices have to be stabilized in order to stop the crisis from keeping on spreading.




To start with, we have to underline the fact that if the decline of new home construction as well as the demand of housing products won’t come to an end in the nearest future, we’ll face an enormous risk of recession and stagnation if not even a fall in GDP growth.
What is important now is to focus on the re-balance concerning supply and demand of the housing market.

Moreover, financial institutions suffer a lot, as they’re primary affected by the spiralling mortgage and credit crises; banks face bankruptcy and incredibly increasing debts. In addition to this the entire financial system was threat to collapse due to a lack of transparency on parts of the market.
In order to illustrate this we could take the example of NetBank, a pioneer in Internet banking, filed for bankruptcy protection after the savings-and-loan became failed at the end of 2007. The filing in U.S. Bankruptcy Court by NetBank Inc. listed assets of $87.2 million and debts as high as $42.4 million. Federal law prohibited the savings-and-loan subsidiary from filing for bankruptcy protection from creditors like its.
This is basically why federally chartered banks cannot be reorganized and must be liquidated by the FDIC.
The bank's failure in 2007 was the result of margin compression from an inverted yields curve, fewer mortgage originations and demands to repurchase delinquent loans.
But not only banks, mortgage lenders, real estate investment trusts (REIT), and hedge funds suffered significant losses as a result of mortgage payment defaults or mortgage asset devaluation, also did stock markets and insurance companies.

Furthermore, the economy and the financial markets need to be very careful in order to prevent the liquidity crunch from spreading even further. The expansion of the crisis made the demand for MBS decline and risk premiums increase, which now led to reimprovement concerning self-regulations as well as litigation.

But not only companies are affected, the ones who suffer most are the home owners themselves, as they took large credits, and all they’ve left now is an incredible amount of debts. Additionally to the social and personal disappointment, the increasing mortgage is the main reason why homeowners are now confronted to foreclosure.

To end up with, what we can say is that this incredible bursting of the housing bubble has set in motion such a large number of economic forces, that could bring a recession in the world economy as a whole.

The causes of the credit crisis

In fall 2006, the United States were facing an extremely sharp rise in home foreclosures. The problems related to this finally resulted in a global financial crisis in 2007 and are known as the Subprime Mortgage Crisis. But what caused that crunch?

It all started in the last decade when an economic bubble was created through constant rising housing prices. The term “economic bubble” is used to characterize trade in high volumes at prices that are considerably at variance from contained value, this specific one is known as the housing bubble.
Furthermore high default rates on Subprime and many other mortgage loans, convinced many people to take higher risks. Three primary risks were involved in this crisis: the credit risk, the Asset risk and the liquidity risk. The combination of these three factors made it pretty much impossible to pay back the debts created by the declining home-prices.
Looking back, we can nowadays say that the increase in prices of housings was completely unrealistic.
As already said, investors believed in the possibility of future re-finance as the price growth seemed constant and decided to take more important credits, to purchase greater accommodations.
But not only the investors found themselves mouse trapped, also did the lenders. These were prompt to offer these riskier loans, as they believed in the continuous rise in housing value.



These graphs illustrate how the crisis evoluated since 1998, and finally became global in 2007. In 2007 neither home buyers, nor the lenders could afford to pay the incredibly high prices anymore and the money-flow broke down (see graph 1).
Basically too much loans were given, but none of the money was returned. That is when the housing crunch became a global financial crisis, which now threats to affect the whole economy. The widespread dispersion had a main impact on everyone involved. Investors as well as lenders are facing debts and bankruptcy.

The government’s role now, is to do whatever it takes in order to stop the crisis, by saving peoples homes, but mainly prevent them from an eviction from those.