Case Analysis
I. Background of the Study
The global financial crisis of 2007-2008 is one of the most serious financial crisis
considered by many economists. One of the major contributor on the occurrence of the
said event is the collapse of US housing market in 2007-2008. Before this year US
economy seems resilient to financial crisis.
It was noted that years before the crisis US experience housing bubble which
reached its peak on 2006. In 2000s investors in the US and abroad, looking for low-risk,
high-return investments, started throwing money at the US housing market thinking that
they will be able to get high interest rate from home owners’ payment of mortgage. Since
the Federal Reserve brought down the interest rate on treasury bills at very low rate,
these investors thought that housing market is a better way of investing their money.
Mortgage back securities are created when large financial institution securitize
mortgages. Investors gobbled on these mortgages securities and since it gives a very
high return on investment, many investors think that it is safe to bet on buying more
mortgage backed securities. Home prices begun to go up and lender investors thought
that they are in the safe side since even on worse case scenarios when a home owner
defaults on mortgage they could still sell the house to other potential buyer for more
money. Back then mortgages are only offered to individual with good credit standing
making mortgages a prime investment. Credit rating agencies gave a lot of mortgage
backed-securities AAA-ratings - the best of the best. Investors became desperate to buy
more of these securities and lenders tried to create more of them.
In order to create more mortgage backed securities lenders lower their standard
on providing mortgages to public. Sub-prime mortgages were created which provide
mortgages to low income earners, no stable job, no assets and people with poor credit
standing. Middle income borrowers seeks mortgages for a larger house that they can’t
afford to pay. Lenders failed to verify the background of some creditors. Mortgage
brokers earns large commissions in facilitating these transactions. At these situations,
mortgage securities become risky investment but investors kept on putting their money
because they trusted the credit ratings. While the investors kept on putting their money
on US housing market the price of houses kept on going up. Because of lax lending
requirements and low interest rate housing prices kept on going up. These makes the
mortgage securities more attractive to investors. The situation resulted to housing
bubbles or rapid price increases tendency to burst. People cannot afford to pay their
expensive houses or keep up with their ballooning mortgage payments. Borrowers begun
defaulting which put more houses on the market back on sale but there were no buyers.
Since there are plenty of supply for houses and very low demand, home prices go down.
As prices fell, some borrower had more mortgage payable than the prices of the house.
For these reason some stopped paying leading to more default and pushing the price of
the houses down further. Big financial institutions stop buying subprime mortgages.
By 2007 some big lenders declared bankruptcy. Investors started losing money
on their investments. Credit default swaps or insurance against mortgaged backed
securities like AIG sold millions of dollars of insurance policy but without money to back
up when things went wrong. Since these credit default swabs were also turned into other
financial securities when things turn bad the entire financial system fall down. Some
major financial player declared bankruptcy while other forced into mergers and other
where bailed out by the US government. On the onset of panic, the stock market crushed.
The US economy experienced recession.
II. Time Context
The problem was experienced by US economy on 2007-2008 when US housing
market collapsed. The collapsed of the housing market brought drastic problems to
economy resulting to bankruptcy of some big financial institutions and crushed of the
stock market.
III. Viewpoint
Investors put their money on the US housing market securities thinking that it will
yield higher returns from mortgage interests. Also, considering the houses as collateral
these securities are thought to as a safer form of investment. Investors were confident to
invest in these forms of securities because of good credit rating and high return on
investments on its earlier years.
IV. Statement of the problem
Due to lower standards on providing loans to mortgaged borrower and increasing
investment on housing market securities, the prices of the houses increased rapidly. Due
to rapid increased on prices of houses, people cannot afford to pay the expensive houses
or keep up on the ballooning mortgage prices. Borrowers begun defaulting on payment
which causes high supply of houses in the market with very low demand. This caused
dropped on prices of houses and losses on investments. This situation resulted in
bankruptcy of some big financial institution and in the end US economy recession.
V. Objective
Temporary Objectives
o To stop other financial institutions from declaring bankruptcy as a result of
collapsing housing market securities.
o To stop panic among investors due to incurring farther losses on their investments
in housing market securities.
o To help home owners on possible foreclosure of their houses due to default on
mortgage payments.
Permanent Objectives
o To recover from economic recession and rebuild the economy.
o To provide secured methods of investment to possible investor.
VI. Area of Consideration
Strengths
o Large amount of investment in mortgage securities came in due to high
return on investment at lower risks.
o Lower interest rate for loans in financial intermediaries making funds
available for potential business investments.
o Good investment rating encourages more investments.
Weaknesses
o Low standards on granting loans to sub-prime mortgages.
o Concentration of investments in housing market due to high interest on
mortgage payments.
o Very low interest on other securities like treasury bill which discourage
investors from putting their money on these types of investments.
Opportunities
o With the fall of housing market, the price of houses become very low. It
gives an opportunity for citizens to purchase their own house at minimal
cost.
o There is a big opportunity for other investors to grant loans at minimal
interest to other financial institutions who suffer from the financial crisis.
This will give potential income to possible lenders and on the same time this
will give fund for financial institution to restructure and continue its
operation.
Threats
o With the fall of housing market, the price of houses become very low. It
gives an opportunity for citizens to purchase their own house at minimal
cost.
o There is a big opportunity for other investors to grant loans at minimal
interest to other financial institutions who suffer from the financial crisis.
This will give potential income to possible lenders and on the same time this
will give fund for financial institution to restructure and continue its
operation.
VII. Alternative Course of Action
The following recommended actions can be taken by the government in order to
addressed the situation.
o Provide government funds to be loaned to financial institutions like banks which
were affected by the situation but has the potential to recover in order to support
their operations until they were stable again. Loan should have very small interest
rate in order for it not to give extra burden on the firms.
o The government can buy some of the houses foreclosed since the price is very low
and offer it to public for mortgage at a reasonable price on a long term period of
payment or on terms that is appropriate to financial capability of potential buyer.
o The government should find a way to regulate different type of investments.
VIII. Recommendation
A financial crisis should be handled immediately as soon as signs arises in order
for it not to escalate and cause more problems to the economy. The government should
find ways to regulate different investments. Upon occurrence of the crisis, the first thing
the government should do is to stop the panic that arises. Emergency funds for such
situations should be part of internal budget of the government
IX Conclusion and Detailed Action Plan
