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Financial Crisis and Current Real Estate Market

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Financial Crisis and The Real Estate Market

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Causes of the 2007-2009 Financial Crisis

The financial crisis which began in year 2007, otherwise called the global financial crisis is considered by business analysts and global economists to have been a terrible economic time in history. The state of the economy during the financial crisis compares to the 1930’s Great Depression. The financial crisis initiated in the United States with worthless mortgage loans and then spread out to infect global economies. The collapse observed particularly in subprime mortgages was the immediate cause of the decline in the 2008 financial sector. In September of 2008, the Dow Jones Industrial Average dropped by five hundred and two points following the bankruptcy of large investment banking company, Lehman Brothers. Although worthless subprime mortgages directly impacted the financial crisis, there were many other factors that contributed to the collapse in the banking system. Factors include: government regulation and lack thereof in expanding the number of home owners, inaccurate assessment of risk due to banks manipulating bond ratings, and global monetary policies.

        In year 1938, congress developed Fannie Mae and its purpose was to encourage commercial banks to issue more mortgage loans. The motivation for those banks to issue more mortgage loans was a reduced risk because Fannie Mae repurchased those same loans. In 1970, congress created Freddie Mac for another increased home ownership reason. In 1995, both Fannie and Freddie Mac were ordered by the Department of Housing and Urban Development to expand homeownership. They directed forty two percent of their financing on mortgages to borrowers with low to moderate income, which was a risky move. Previously it was required for mortgage loan borrowers to put down a minimum payment of twenty percent. The 20% requirement discouraged borrowers with less income to purchase. To highly encourage home purchases, Fannie Mae decided to implement a new minimum requirement of only three percent. This allowed for individuals with lower credit scores and less income to purchase homes. In year 2000, the amount of low income people targeted to buy homes increased from 42% to 50%. In the same year Fannie Mae introduced the “American Dream Commitment”, which served to again increase homeownership among individuals who previously could not do so. Following in Fannie Mae’s footsteps, Freddie Mac launched the “Catch the Dream” program two years later; this program focused on outreach. In year 2004, the amount of lower income people targeted were increased yet again from 50% to 56% (Friedman, 2010). Approximately 40% of those sub-prime mortgage loans issued were backed by government-sponsored enterprises. In year 2006, those same individuals who were highly targeted, began defaulting on their mortgage loans. The problem was that individuals were getting into mortgages that they could not afford. By 2008, the government sponsored enterprises that served to back up those loans paid out over 382 billion dollars to bailout Fannie and Freddie Mac. (Friedman, 2010). Since Fannie Mae and Freddie Mac had a government sponsored status, they were able to receive that bailout unlike privately held investment banks such as Lehman Brothers which issued mortgage backed securities (MBSs). The MBSs were bad assets that became a liability in which Lehman Brothers and other issuers could not afford (Friedman, 2010).  

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