Subprime Mortgage Crisis

With the bursting of the United States housing bubble during the period 2005-2006, subprime mortgage crisis struck its roots. The default rates related to ARM as well as “subprime” were very high. Owing to competitive pressures and implementation of various government policies, high risk lending activities was encouraged. Furthermore, with the introduction of loan incentives like easy initial terms the number of borrowers increased manifold. The fact that the housing prices had also shown an escalation over the last couple of years encouraged people to take chances.

To the borrower’s utter dismay, the rates of interest showed sharp rise whereas the price of houses began to decline rather quickly. Refinancing was almost a far cry. The possibilities of refinancing at favorable terms began to appear bleak. The number of defaults as well as foreclosures escalated steeply. The easy initial terms did not last and home prices did not rise. The adjustable rate mortgage was also higher.

A cumulative effect of the above incidents gave vent to a financial crisis worldwide starting from the United States of America. Several banking, non banking institutions as well as individual investors who had taken advantage of the MBS or mortgage-backed securities lost huge sum of money estimated to be approximately USD$435 billion (17th July 2008). Central banks played their part by injecting funds into banks encouraging only eligible borrowers to avail a loan. The step was taken mainly to inject a sense of confidence among investors and debtors, a clear signal of restoring normalcy in business operations and the commercial paper markets.

Aftermath of subprime mortgage crisis

As of March 2007, the US subprime mortgage value stood at approximately USD$1.3 trillion. Subprime loans with ARM accounting for 16% (approximately) were found to be 90 days delinquent or were in foreclosure. January 2008 registered delinquency rate that had escalated by 21%. The credit crunch created a furor in the financial markets worldwide. Majority of the investors withdrew their money from risky equities and mortgage bonds. It eventually led to crisis in world food prices and oil prices. Dow Jones Industrial Average, NASDAQ and S&P 500 registered a sharp decline and entered a bearish phase. The same period also witnessed mergers and acquisitions. For instance Bank of America and Merrill Lynch underwent a forced merger amounting to USD$50 billion. Lehman brothers declared bankruptcy.

Due to subprime mortgage crisis the global banks on which United States was dependent for financing was either unable or not willing to satisfy the needs of the time. Reports suggest that banks in Japan and China hold approximately 50% of public debt of USA. The banks were reported to opt for tremendous write down.

Effect of subprime mortgage crisis on macroeconomic indicators

Following unstable financial markets, US economy slid into recession. Eventually, the major macroeconomic indicators were affected too including employment, income and production. It has been estimated that the real GDP declined for 2 quarters in 2008 and the same is expected to spill over in Qtr1of 2009. Reports suggest a loss 1.4% in real GDP during the 3 quarters.

Unemployment in United States is estimated to be escalating by 7.5% by the end of 2009. However, count of payroll job is expected to rise by 1.2 million during FY2010 after a decline of 1.1 million jobs in 2008 and approximately 1.4 million jobs in 2009.