The Impact of Subprime Lending Crisis on the United States Economy

Abstract

Economies all over the world have in the recent past experienced difficult times due to what is seemingly a global financial crisis that threatens to push economies all over the world in to unbearable recession. If rapid and effective measures are not put in place, the situation could soon go out of hand. This fact is already clear in the mind of many economic stakeholders. The latter are therefore working round the clock to ensure that the unfavorable situation is corrected. Many theories have been developed to explain the happenings in the economy in the recent years. The greatest stress on the economy is the sub prime lending crisis that has affected the US real estate sector and that is seen as a threat to the entire economy.

This study therefore is carried out with an objective of finding out the impact of the sub prime lending crises on the economy to the United States of America in the recent years. To aid in the research, a case of the United States economy was used. The current situation of the countries financial sector and economic recovery and investment policies between 2008 and the beginning of 2009 were reviewed and analyzed; with a bias in the US stimulus act of 2008 and the US recovery and investment act 2009. To begin with, the study set two hypotheses. One, there is a positive relationship between the sub prime lending crises and the current economic recession in the United States and also the assumption that there is a close relationship between the ineffective government financial policies in the latter years and the sub prime lending crises in the US. The study also gave literature review on the current financial sector situation in the US, the current global financial crises as well as the decline in the US economy. According to the findings of the study all the hypotheses tested positive. In addition, the study suggested areas for further research.

Introduction

In the wake of the world global economic crises, many world economies including those who are seen as the economic super powers have been adversely affected. However, the magnitude of the effect varies widely among countries. The United States of America has not been spared either. Between 2006 to until the inauguration of the newly elected president Barrack Obama, the US economy has undergone through the hardest time in history. The financial sector is one of the worst affected; having gone through a historic decline since 2006, in what is described as the sub prime lending crises. This paper therefore attempt to find out the impact of the financial and mortgage melt down crises on the economy of United States of America.

Literature Review

According to the Federal Reserve board (2007), the sub prime mortgage crises roots back 2001. However, its effects came to be noticed in 2006 exhibiting a great hike in home foreclosure, low consumer spending on housing and falling housing demands and rates that threatened to degenerate into financial crises in to the real estate industry. The International Monetary Fund gave its first ever report on a financial crises in the United States, which estimated that the sub prime lending crises could culminate to losses amounting to $ 954 billion by the year 2008 if the situation was not contained within the shortest time possible. By mid 2007 many financial expatriates had expected that the situation would have been solved but it turned out to be impossible terming the crises as unique. Unlike other similar crises, the current one had affected a non-banking financial sector thus making it difficult to contain (FRB, 2007) according to the Fed chairperson in a speech in July 2007, he warned that with the sub prime lending crises, there was an imminent housing problem noting that the prices of new homes had gone down by three percent since the beginning of 2007. He further predicted a 30% fall by 2010 if measures were not put in place to turn the situation around.

In 2006, the housing market was going through a free fall. Among the reasons attributed to the situation were the declining consumers spending on housing coupled with dismal prices on the same. This was largely expected to affect the rest of the economy probably leading to a recession in 2007 (Roalan, 2007). According to Forbre (2007) the rise in the sub prime lending rates had caused a massive increase in sub prime lending rates. As a result the rates of homes ownerships had greatly reduced. The inflation in the mortgage sector stared back in 1994. Between 1994 and 2004 the sub prime lending rate increased from 64% to a record 69.2%. Resulting to a 124% increase in the housing prices and subsequent decrease in consumer expenditure in housing.

According to the Federal Reserve board (2007) the sub prime lending crisis was caused by a number of factors. The board described several of these causes. First, the crisis was attributed to the housing bubbles. The housing bubbles are problem affecting the real estate sector which is often dismissed as insignificant or not causing too much threat. The bubbles in the US real estate sector started way back in 2001 but busted in 2006, setting a stage for the unprecedented crises that now threatens to pull the whole economy down.

Another factor blamed for the crises were very low interest rates. In response to the dot.com bubbles of 2000 and a recession that followed in the real estate sector in 2001, interest rates were hacked down from 6.5% to unthinkable 1% a move that is strongly believed to be responsible for the current situation. The low interests rates are greatly associated with high home values and subsequent reduction in home demands. As a result the sales and productivity of this sector is very low.

Rise in sub prime lending rates is also believed to have contributed greatly the sub prime lending crisis. The high rates led to high sub prime borrowing rates which in return made the home ownership rates to considerably go up. Between 1994 and 2004 for instance, the sub prime lending rates went up from 64% to 69.2% causing a hike in the home ownership rate to a historic 124%. In the same period, mortgage rates went up from 9% in 1996 to 20% in 2006 (Federal Reserve board, 2007)

Methodology

To obtain information on the effects of the sub prime lending crisis on the United States economy, a case study was used. The United States economic status from 2000 to date was keenly reviewed and analyzed to get information of the status and performance of the financial sector especially the real estate sector. In addition, the policies unveiled by the United States government in the wake of economic downturn were reviewed and analyzed and compared to ascertain their effectiveness in arresting the situation. The two policy document used in this study were, the US stimulus act 2008 signed into law on 13th February 2008 by the former US president George W bush and US recovery and investment act recently enacted by the new Obama administration.

Hypotheses

The study set two hypotheses. One, it assumed at the sub prime lending crisis in the United States had very detrimental effects to the US economy (Federal Reserve board, 2007). In addition, the 2008 stimulus package was ineffective in handling the crises making it burst to uncontainable levels. The hypotheses were tested using personal judgment and deductions from the available information.

Discussion of the Findings/conclusion

The study found out that the sub prime lending crisis had played major role in the United States economic recession. The real estate contributes to up to 11 % of the United States economy. As a result, the sub prime lending crisis which had derailed the sector was a major blow to the United States economy. According to the international monetary fund in 2007 the crises would cost the sector up to $ 945 billions in losses an amount more than the total value of the president Obama’s recovery stimulus package rolled out early in 2009. Indeed, such huge losses within a very short span of time have very adverse effect to the United States economy. In his acceptance speech, president Barrack Obama acknowledged that the sub prime lending crises had ruined the real estate sector hence it was a major contributor to economic recession and loss of employment. He intended to propose to the senate and the congress a stimulus package worth 785 billions US dollars as a move to counter the economic recession, prevent further foreclosure and save over 3.5 million jobs (LOS Angeles times Feb. 10 2009). According to the president as well as majority of the Americans interviewed by LOS Angeles time shortly after Obama’s election, the US stimulus package of 2008 was inadequate to efficiently and effectively deal with the current recession that has affected almost all sectors of the US economy.

In response to the inadequacies of the package, president Obama’s administration proposed and enacted into law within one month after coming to power, the recovery and investment stimulus package act 2009, injecting $ 787billion into the economy to turn around the US economy and put it back on track. Unlike the 2008 stimulus package, this was clear and well documented with each sector of the economy receiving a specific amount depending on the need. In the package, tax cut received about 37% package taking $288 billions, social programs and unemployment and federal spending were allocated $ 352 billions; 45% of the entire package. Specifically, healthcare was allocated $114.7 billion while education got $ 90.1 billions. It is expected that this package will succeed in turning the US economy around as well as solve the sub prime lending crises

Suggestions for Further Research

Real statistics of economic downturn caused by the sub prime lending crises.

The strengths of 2009 economic stimulus package to turn around the US economy.

Further review on the weaknesses and strengths of the 2008 economic stimulus act.

References

  1. The Sub Prime Lending Crises: Causes and Effects of Mortgage Meltdown.
  2. Chinas Confident To Overcome Situation –Chinas Stimulus Package.
  3. Chinas Applauds Obama Stimulus Package for Economic Recovery– Los Ageless Time,.
  4. Description of the Economic Stimulus Package Act Of 2008.
  5. Federal Reserve bond 2007.
  6. International Monetary Fund 2007- US Financial Report.
  7. Pay Roll Software: Stimulus Package-2009.
  8. Sub Prime Lending Crises. 
  9. US Recovery and Investment Act 2009.
  10. US stimulus act 2008.

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NerdyTom. (2021, November 15). The Impact of Subprime Lending Crisis on the United States Economy. Retrieved from https://nerdytom.com/the-impact-of-subprime-lending-crisis-on-the-united-states-economy/

Work Cited

"The Impact of Subprime Lending Crisis on the United States Economy." NerdyTom, 15 Nov. 2021, nerdytom.com/the-impact-of-subprime-lending-crisis-on-the-united-states-economy/.

1. NerdyTom. "The Impact of Subprime Lending Crisis on the United States Economy." November 15, 2021. https://nerdytom.com/the-impact-of-subprime-lending-crisis-on-the-united-states-economy/.


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NerdyTom. "The Impact of Subprime Lending Crisis on the United States Economy." November 15, 2021. https://nerdytom.com/the-impact-of-subprime-lending-crisis-on-the-united-states-economy/.

References

NerdyTom. 2021. "The Impact of Subprime Lending Crisis on the United States Economy." November 15, 2021. https://nerdytom.com/the-impact-of-subprime-lending-crisis-on-the-united-states-economy/.

References

NerdyTom. (2021) 'The Impact of Subprime Lending Crisis on the United States Economy'. 15 November.

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