Subprime Mortgage Crisis in the United States

Paper Info
Page count 7
Word count 2505
Read time 9 min
Subject Economics
Type Essay
Language 🇺🇸 US


The sub prime lending is the practice of making loans to borrowers who do not quality for market interest rates due to factors that are considered such a income levels which are low, the size of down payment, there credit history and the employment status. Such people can be helped through this practice because they are not able to attain those standards that are set so that they can qualify to get loans from banks and other financial institutions. The estimate that is made to the US sup prime mortgage is about $1.4 trillion and about 17% of sub prime loans which have adjustable rate mortgages. (Mike, 1999)

Essay Body

The mortgage crisis is an economic problem that is taking place in US which is seen through the liquidity issues in the banking systems which has caused the closure of several banks in the country. This crisis began with the bursting of the US housing bubble and the high default rates that took place in the sub prime and other adjustable rates of mortgages which made risks to the borrowers with low income of leading to the credit history that was faced prime borrowers. The loan incentives and the long term trend of rise in prices of the houses encouraged the borrowers to assume the mortgages with the belief that they could refinance later with better prices.

When the housing prices started to decrease then it became hard for them to refinance and the defaults and foreclosure activity raised as the ARM interest rates became high. There was an estimate in 2007 by economist that showed that there was a bout $ 2000 billion sub prime defaults that was recorded during that time. The credit lenders were the first people who were affected by the difficulties that resulted. This is because the borrowers were not willing to make payments. The major banks and other financial institutions in the country were affected as there was a report of about $ 170 billion and many of the mortgage lenders had passed the rights to the mortgage payments and related credit risk was given to a third party investors which had to pass through the mortgage backed securities and the collatorized debt obligations. The corporate, individual and the institutional investors who held these securities faced losses as the value of the mortgage assets had declined.

The stock markets in many countries were also affected which led to their decline. This meant that the financial problem was greatly affecting these countries and the individuals at large were affected. With the dispensation of the credit risk and the unclear affect in the financial institutions then this caused many lenders to reduce their lending activity of raise the interest rates of the loans that were given to the people this had the implication that the people who had low income were affected as they could not afford the loans because of the rise in interest rates. The ability of the corporations to get funds through there issuance of commercial papers was affected meaning that these corporations could not get funds and lend to individuals as it was expected. This crisis is mainly consistent with a credit crunch and the liquidity concern drive the central banks around the world to take action so that they could provide loans to many banks in order to have encouragement of loans to worthy borrowers and to re invigorate the commercial paper markets. (Martha, 1997)

The sub prime crisis affected the economic growth this is because they were few or more expensive loans which led to the decrease in the investment that were done to businesses and consumer spending which lead to the effect in economy. The changes that took place in the housing market affected the people this is because there was decline in a new house construction and the rise in housing process meaning that there was a down ward pressure that was exerted to the economy. With the interest rates and the large number of the sub prime ands other ARM changes in the country then there was need for legislators in the country to take action so that they could reduce this effect in the country. A systematic program, which was meant to limit the interest rates adjustments, was to be implemented so that the effect could be reduced.

The lenders and borrowers who were facing this default were encouraged to cooperate to enable the borrowers top stay in their homes. The risks to the economy, which was created by the financial crisis in the market and housing downturn, were the factors that had to be considered so that they could become up with information that could lead to the change in economy of the country. The reasons that led to this crisis were complex and the need for understanding and managing of the ripple effect through the world wide economy changes which affected the government, businesses and the investors. The crisis was attributed to a number of factors, which include: there was the inability of homeowners to make the mortgage payments available for all due to the loss of employment or healthy related issues. This meant that the people were greatly affected which led to effects been faced by the homeowners. (Kurt, 2006)

There was poor judgment by the borrower or the lender this was because they had no clear information, which led to making of uncertain judgment on which loans to borrow. There were the inappropriate mortgage incentives such as the buy downs and the short fixed term adjustable rate mortgages which was affected by the rising in the mortgage rates. There was the decline in home prices which affected the refinancing this is because with low prices then it meant that it was not possible to get loans for refinance therefore the problem was advanced on the financial institutions. With the innovations made in securitization then it was thought that the risks which were related to the inability of the home owners to meet their mortgage payments then there was the need to have distribution of this and the categories of the risk include: the credit risk which is a risk that is transferred to the third party investors and the rights of the mortgage payments have been repackaged into a variety of complex investment means like MBS.

The exchange that will exist for one to buy this MBS and assume the credit risk then the third party investors receive a claim on the mortgage assets and the cash flow which will become the event of default. In the case of the asset price risk then the MBS and the CDO asset valuation is complex and is related to the fair value of accounting where the valuation has to be derived from both the collectivity of sub prime mortgage payments and the existence of a valuable market in which these assets are sold. The rise in mortgage delinquent rates will affect the demand in which the demand for the assets will reduce and this effect will affect the banks and other financial institutions. The liquidity risk this is the case in which the companies have a high reliance on the short term finding of markets for cash to operate. (Jose, 1990)

The companies will require the short-term loans by issuing the commercial papers and pledging the mortgage assets in exchange. This will mean that such companies will not be able to get the loans because the banks and other financial institutions do not offer such services leading to effects been faced by the borrowers and lenders. The country party risk where the major investment banks and other financial institutions have positions in credit derivative transactions and some of these transactions serve at a form of credit default insurance. These types of risks have high impact to the financial institutions and banks, which will lead to problems been faced by the lenders and borrowers as the assets will not be readily available to them. The crisis is caused by the housing down turn in which the sub prime borrowing is seen as the main contributor to the increase in the home ownership rates and the demand of housing.

The home ownership in US has increased by about 65% in 1994, which means that this demand is helpful to the fuel housing price increase and the consumer spending. The American prices increased by more than 100% where some homeowners used the increase in property value to refinance their homes with the low interest rates and take out the second mortgage against the value added to use the funds for the consumer spending. The over building that occurred during the boom period led to increase in foreclosure rates and the unwillingness of many of the home owners to sell their homes at this reduced market prices which had significant increase in the supply of housing inventory therefore the sales volume of new homes dropped as few people were willing to sale homes. The excess supply of home inventory placed the significant down ward pressure on prices and with the decline in prices the more homeowners were at a risk of default and foreclosure. This problem could be solved with the further decline in prices of house until there would be excess supply of home been reduced to measurable levels. Another cause is the role of borrowers where by with easy credit combined with the assumptions that are made to houses then it will mean that there will be need which will encourage the sub prime borrowers to obtain ARM. (John, 2000)

Once the housing prices start to decline then it will mean that the refinance will be difficult and the borrowers will not be able to borrow loans. Some of the home owners will be unable to refinance and begin to default on loans the reason is because the loans will be set at a high interest rates were few people will be able to offered therefore it will not be possible to get the loans and the payment amounts will be affected. This will have the implication that with high interest rates then many of the borrowers will not be able to borrow loans and this will affect the economy of the country, as money with will be limited. There is the role of financial institutions in which the lenders are been forced to increase their borrowing to high-risk loans to high-risk borrowers. This will imply that if the risks are high then the borrowers will be in fear of getting such loans, as they are harmful to them because they will have to be repaid with high interest rates. This will lead to reduction in the sub prime loans that are offered to the people as the loans are affected by high risks. With the borrower facing the high risks then the lenders have been able to offer high-risk loan options and incentives, which means that the sub prime will be affected and will affect the borrowers. This will have the indication that if the institutions do not know their role then they will affect the borrowers and this will lead to effect in the economy of the country. (Alice, 2000)

There is the role of securitization, which is the structured finance process in which the assets and other financial instruments are acquired and offered to third party. This will mean that there will be many parties involved and this will affect the process of giving of this finance, as the loans will be at high risks of facing the default. This will mean that there will be rise in the third party investors who have effect to the sub prime mortgage and this will lead to global credit crisis been affected. The role of mortgage brokers who are not involved in lending of their own money but act in between the owner and the borrower. These brokers should know their role and play their part in the Riggs manner so that they don not affect the supply of loans to the borrowers. If the brokers profit from the home loan then it will mean that the borrowers will not be able to repay their loan and this will lead to effects been faced by the financial institutions, which will affect the economy of the country.

There is the role of government and regulators which should be considered because if the government does not know what is expected to do in the issuing of loans by the financial institutions then it will mean that they will lead to problems been faced but the people and the economy at large will be affected. The retrenchment is affecting the lending activity in which the lenders will not have well experienced people to keep them informed this will mean that it will not be possible to know how to issue these loans meaning that problems will occur which will lead to few borrowers as they are in fear of the risks that face the financial institutions this will lead to the economic crisis been faced and the country will have high changes of poverty.

This problem should be solved within the shortest time possible so that the borrowers can get their loans without the fear of facing the risks and this will change the economy of the country within the shortest time possible. Throe is need for the market correction in which a real estate bubble type is economic bubble which should take place in the local or the real estate markets so that there can be rapid valuations of real property like housing and this has to be done until the relative income levels are reached. The changes need to be made in the price to rent ratios so that they can be affordable by many people with low interest rates will lead to many people been able to afford the loans that are supplied by the financial institutions. After the collapse of the sub prime mortgage then there was need for innovations been made so that there could be production of new products that could be able to respond to the market changes these innovations were in terms of loans and niche credit that was given to the immigrants and this brought the right correction in the market and the economy of the country changed a lot after the innovations that were done. (Alex, 1990)


Sub prime is very important method that can be used so that it can bring about balance in the country this is because if the low-income earners are able to get loans in the financial institutions then it will lead to the change in living standards of these people. This will mean that the economy of the country will change as desired as they dependency ratio will be reduced and the risks that people fear to get loans will be reduced as each institutions will play its part in assuring the borrowers that they are safe and they can get the loans at affordable interest rates.


Alex, P. (1990): the economic out look in US. Economic and policy consequences.

Alice, K. (2000): the changes that are required in the sub prime. Department of consumer affairs.

John, Y. (2000): sub prime encountering problems in US. California department of real estate.

Jose, P. (1990): sub prime effects in economy. Center for responsible lending.

Kurt, S. (2006): how to overcome the sub prime mortgage crisis. Unbreakable darkness of banking.

Martha, L. (1997): the financial solutions. Federal deposit Insurance Corporation.

Mike, Y. (1999): solutions to better economic growth. California department of financial institutions.

Cite this paper


EduRaven. (2021, November 4). Subprime Mortgage Crisis in the United States. Retrieved from


EduRaven. (2021, November 4). Subprime Mortgage Crisis in the United States.

Work Cited

"Subprime Mortgage Crisis in the United States." EduRaven, 4 Nov. 2021,


EduRaven. (2021) 'Subprime Mortgage Crisis in the United States'. 4 November.


EduRaven. 2021. "Subprime Mortgage Crisis in the United States." November 4, 2021.

1. EduRaven. "Subprime Mortgage Crisis in the United States." November 4, 2021.


EduRaven. "Subprime Mortgage Crisis in the United States." November 4, 2021.


EduRaven. 2021. "Subprime Mortgage Crisis in the United States." November 4, 2021.

1. EduRaven. "Subprime Mortgage Crisis in the United States." November 4, 2021.


EduRaven. "Subprime Mortgage Crisis in the United States." November 4, 2021.