The Subprime Mortgage Crisis and the US Financial System

The subprime mortgage crisis in the US, which began around 2002-03 and worsened in 2007-08, led to a significant decline in property prices, causing a cash crunch and major losses for banks. The crisis was characterized by unchecked credit growth, high levels of debt, and a lack of regulation. Many individuals took out mortgages to purchase homes or invest in real estate, hoping to profit from rising property values. However, when the market began to decline, these individuals found themselves unable to pay their debts, leading to widespread defaults and foreclosures. The resulting financial crisis led to the bankruptcy of several major financial institutions, a significant contraction in economic activity, and widespread job losses.

BUSINESS
SKILLS

ESSAY
The financial crises of 2007-2008 can be seen as a global crisis as well because it was
one of the worst since the worst depression of the year 1930. The immediate cause of crisis can
be seen in form of busting of USA housing bubble which was at its peak in the year 2004. From
the view point of Buckley (2011) the 2008 financial crisis has affected millions of Americans
and is currently one of the hottest topics still in the presidential campaigns. In recent times,
people of nation have witnessed that many major financial institutions been taken over by other
institutions, received bailouts from the local body or there exist outright of the crash. On clear
research, it was found that there were not a single reason of this crisis, it includes many things
which made this thing happened in America. One of the major financial institution in America
named Lehman Brothers Holdings Inc. which lends financial services seen a global financial
crisis and been declared as bankruptcy in the year 2008. There were other banks as well which
got bankrupted and these were Goldman Sachs, Morgan Stanley and Merrill. These all firms
were rendering their services in investment banking, equity and fixed income sale as well as
trading. Mentioned financial organization filed for Chapter 11 bankruptcy protection in
September 2008. This was the largest bankruptcy filed till date in the history of US with the
holding of Lehman of over $600 billion in the assets.
Domitrovic (2012) said that Lehman Brothers have filed for the bankruptcy with an
amount which is above mentioned in assets and also more than $600 billion in debts as well.
Lehman was the fourth largest bank in the US when it got collapsed. They were also having
more than 25000 employees who were giving productive services whole around the globe. The
major culprit of the issue were seen in the year 2003 and 2004 where the US housing and prize
of the property were at boom. Mentioned financial institution acquired five major mortgage
lenders including firms like BNC, Aurora Loan services, etc. The loan were given to customers
on the basis of the Current market price of their property. The acquisition made by the bank
earlier seen as prescient as record revenues from Lehman’s real estate were seen and there were
also fast rate in the growth of investment banking as well as the asset management. In the year
2006, firm was able to securitize around $146 billion which was exactly 10% hire which was
done in previous year. Cited organization has also marked record profit from year 2005 to 2007.
According to Grigor’ev and Salikhov (2009) the major reason of this downfall was the
reduction in the housing rate of property. These reductions were so less that the price of the

property has declined suddenly and people who had took loan from the bank were ready to sale
their mortgage property. With this, the Lehman has faced an unpredicted crisis loss due to the
subprime mortgage crisis. This loss was apparently a major result of having holding on the large
positions in the subprime as well as lower rated mortgages. In the second quarter of the year
2008, Lehman shared were closed upto 5%. After their major fall down, Barclays comes into
play and were ready to take over Lehman Brothers. Manhattan judge also approved the decision
because it was the last decision which is available in order to circulate the transactions.
Bankruptcy of Lehman’s were lead to major cause of depreciation in the price of the commercial
real estate.
Otter and Wetherly (2008) stated that there were many potential causes for the 2008
financial crises and some of them can be seen in form of market instability, decline in the
housing market and non- refund from the customers who have applied for the loan. Market
instability was the major reason and it has been caused due to different other factors. These
factors were seen in form of ability to create the new line of credit which has suddenly dried the
money flow and also the economic growth of purchasing and selling the assets. These things
happened had hurt various individuals, businesses and financial institutions very hard.
On the contrary, Chodorow-Reich (2014) said that the decline in the housing market were
one of the other reason. Each and every time when financial institution make loan, they create
new money. In order to improve and regulate their transactions, banks tend to prefer this method.
With this, they usually increase the money and debt in the economy (The 2008-2009 Financial
Crisis – Causes and Effects, 2016). With the increase in housing property in US, individuals
started applying for loans. In that around 31% were for residential property which has pushed the
rates of houses more fast as compared with wages. A further increase was seen into the
commercial property which was around 20%. With increase in property prices, people started
purchasing more of the property in order to get better return in coming future. They have applied
for the loan and tend to pay regular installments for the time period for which the loan is taken
for. From the view point of Garcia-Appendini and Montoriol-Garriga (2013) eventually the time
arrived when the debt which was there on individuals head become unpayable to pay. Lending
up of large sums of money into the property market has pushed the price of houses along with
the level of the personal debts. Interest rates were need to be paid on all the loans which banks
were making and with the debt rising more faster than income, people were not able to repay

their loans on times. Even time arrived when individuals were not having money to pay their
interests as well. With this moment, they stopped to repay their loans and banks had found
themselves in a position of going into the bankruptcy.
Moreover, Erkens, Hung and Matos (2012) said that banks were too much confident that
the individuals will repay their debt and the loan will be paid on time. So when economy started
doing worst for US, banks preferred a certain amount only for lending. There was huge reduction
in the amount of lending new loans. The major problem arise that the money which was used to
repay the loan was “destroyed” and disappeared from the national economy. This stated was
given by the bank of England. Non refunds of customers were also one of the major problem and
biggest problem for the banks. In the year 2002-03, property market in US was at boom and the
market prices as per the location were really very high. People opted for the bank loan and they
were given as per their income and also the capability of them to repay the same (Taylor, 2013).
Mortgage security has also been taken from them in front of making recovery if the installments
or loan amount did not pay.
In the year 2007-08, the rates of property significantly fall down and due to this, the
circulation of money has completely stopped even though people had money in their pocket.
Loan takers even stopped paying interest to the bank. They were ready that financial institutions
take over their property because the bank will only be able to sale the same at current market
price only. This lead into huge loss for the bank and the amount so distributed in terms of loans
were not recovered. This was the major reasons that why the banks in US were closed down.
This was the worst stage of economy in the mentioned nation. The circulation of money has
completely stopped that time around and there was a major cash crunch in the year 2007-08.
The reason why it went so worst because the US economy is built on credit and credit is
treated as one of the important tool which needs to be used wisely and precisely. However, from
last decade or so, credit was unchecked in the nation and with this it was get out of the control
(Anonymous, 2010). Thousands of the people took out loans for long years in the hope that they
will either convert the house for getting the profit or refinance the loan later at reduced rate
which will give more of the equity in their home. This equity will help them in purchasing the
new investment house. With this step, a lot of individuals will be able to get rich quickly and
every person wills to have more. People were ready to sale their houses because the rates of
property were down. This was the major situation which leads into bankruptcy of some of the

major financial institutions. People were unable to pay their debts and were ready to sale their
security which was kept in form of property for mortgage.

REFERENCES
Journals & Books
Buckley, A. 2011. Financial Crisis: Causes, Context and Consequences. Harlow: Prentice Hall.
Chodorow-Reich, G., 2014. The employment effects of credit market disruptions: Firm-level
evidence from the 2008–9 financial crisis. The Quarterly Journal of Economics. 129(1). pp.
1-59.
Domitrovic, B,. 2012. ‘The Weak Dollar Caused the Recession’ in Forbes 189(8). pp. 32
Erkens, D.H., Hung, M. and Matos, P., 2012. Corporate governance in the 2007–2008 financial
crisis: Evidence from financial institutions worldwide. Journal of Corporate Finance.
18(2). pp. 389-411.
Garcia-Appendini, E. and Montoriol-Garriga, J., 2013. Firms as liquidity providers: Evidence
from the 2007–2008 financial crisis. Journal of Financial Economics. 109(1). pp. 272-291.
Grigor’ev, L, and Salikhov, M. 2009. Financial Crisis 2008. Problems of Economic Transition
(51). pp. 35-62
Otter, D. and Wetherly, P,. 2008. ‘Chapter 9: Growth vs. austerity: The macroeconomy in a
globalizing world.’ In The Business Environment (2nd edition). Glasgow: Oxford
University Press.
Taylor, J.B., 2013. Getting off track: How government actions and interventions caused,
prolonged, and worsened the financial crisis. Hoover Press.
Online
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