The Housing Crisis By Frank Elliot At Isnare.com Ezine Articles

The day after signing the $787 billion economic stimulus package, President Obama unveiled his housing plan which involves a hefty $75 billion to help prevent about nine million Americans from losing their homes. This is a sign that underscores the urgency of solving the economic crisis. The President made the announcement in Arizona, which is on of the states hardest hit by foreclosures. The housing problem is viewed by many as the source of the economic crisis. The President believes that housing crisis, the financial crisis and the broader economic crisis are interconnected and by solving the housing problem, the economy might recover.

Nearly 27% of the 52 million homeowners in the U.S. with a mortgage owe more on their mortgage than their homes are worth right now. The president's plan is aimed at helping borrowers in that predicament, and those who are in danger of foreclosure.

The main cause of the mortgage crisis is the subprime mortgage. According to Wikipedia "subprime lending is the practice of lending, mainly in the form of mortgages for the purchase of residences, to borrowers who do not meet the usual criteria for borrowing at the lowest prevailing market interest rate". The criteria can be the borrower's credit score, credit history and others. If the borrower becomes delinquent in making payments to the loan provider, the lender will take possession of the property. This process is called foreclosure.

The US mortgage market is estimated to be $10,000 billion. 13% of which is the subprime market. This is a huge amount and has a bearing on the economy the subprime market share of the United States GDP is 9%.

Why did financial institutions support giving subprime mortgages? Prior the crisis, government policies and competitive pressures had encouraged higher risk lending practices. Also in addition, loan incentives such as easy initial terms and the long-term trend of rising housing prices had encouraged borrowers to think that they can afford the loan. But that is not the case, sometime in 2006 to 2007, interest rates started to increase and housing prices started to drop. This made refinancing a mortgage difficult, resulting to an increase in defaults and foreclosures.

Lenders alone are normally responsible for the mortgages they issued. But it is possible for the lender to sell the right to receive the payments on the mortgages through securitization. These are called mortgage backed securities (MBS) and collateralized debt obligations (CDO). Those involved in MBS and CDOs can also insure against credit risk by buying credit defaults swaps (CDS) which guarantees that the bond principal and interest would be paid in full. Most of the mortgages have CDS, when the foreclosures started, the holders of mortgage backed bonds demanded to be compensated for their losses. The sellers of credit default swaps like AIC, Lehman Brothers, Merrill Lynch, and Wachovia did not have funds to realize these guarantees.

This is what brought down the US financial giants which cascaded through the banking, lending and the whole US economy and finally the world. The US mortgage crisis prompted governments worldwide to implement their own economic stimulus and their respective central banks to cut interest rates. These actions are designed to stimulate economic growth and inspire confidence in the global financial markets.

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