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1) What was the state of the housing/real estate market leading up the crisis? After?
The housing market before the crisis experienced a large-scale boom. Interest rates were highly attractive for consumers, and the demand tended to increase dramatically. During 1997-2006, the average house prices increased to around 124%. The savings rates decreased, and many consumers preferred to finance their debts from second mortgages as they expected prices to continue rising; however, the dynamics of savings cannot explain the whole process (Cachanosky, 2010). By the middle of 2008, the average prices had declined by around 25% in comparison with the peak level. More than 20% of the US homes had lower market value than the amount of the mortgage loan (Hellwig, 2008). It seems that speculative borrowing during the boom led to such a significant decline during the recession.
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2) Were other markets affected as well? If so, how?
The Subprime Mortgage Crisis significantly affected other markets as well. The major impact was observed in financial markets as they reflected the general investors’ expectations. During the boom, the shadow banking system experienced considerable growth. Consumers were widely involved in speculative operations and steadily increased their borrowing operations. However, the real estate prices began falling, and the scope of banking and financial sectors declined as well, because investors tried to reallocate their resources in order to minimize losses associated with over-optimistic initial invstments. During the boom, housing was considered the most efficient investment option because the prices in this sector tended to rise at much higher rates than in other industries. Correspondingly, during the recession, alternative markets (such as precious metals) experienced growth as investors tried to select more stable assets.
3) What group(s) were ultimately responsible for causing the crisis and how did their actions contribute to the problem?
The main responsible groups included the government, the banking system, and consumers. The government was partially responsible because it substantially decreased the regulation of financial institutions. Moreover, it implemented several policies encourage “affordable” housing such as those introduced through the Community Reinvestment Act (Hellwig, 2008). The banking system is also responsible as it proposed affordable but not market interest rates to consumers. As a result, their indebtedness increased. Consumers and homeowners are responsible because they have been widely involved in speculative operations. It led to a much deeper recession than could occur otherwise.
4) Identify at least 4 major stakeholder groups (e.g. mortgage holders, banks, etc.) that were directly affected by the outcome and discuss how they were affected.
The first stakeholder group is mortgage holders. They were negatively affected as they misunderstood the dynamics of the market and increased their indebtedness. When the prices collapsed, they suffered losses and financial difficulties. The second stakeholder group is banks. They were affected in two different ways. During the boom, they obtained extra-profits and were able to expand their operations. During the recession they suffered losses, but the net effect depended on the actual strategy of a given bank. More conservative banks were more sustainable in the long run (Bianco, 2008).The third stakeholder group is financial dealers. They experienced a considerable growth of demand for their services during the boom but were negatively affected in the following stage. The fourth stakeholder group is gold dealers. They experienced the opposite influence: the demand for their services was minimal during the boom but increased during the subsequent recession.
5) Using the concepts you have learned in this class, how do you think such a crisis can be avoided in the future? Be specific - discuss the roles of the involved groups you identified.
In order to avoid such crises in future, it is necessary to affect the incentive structures of all parties involved. In particular, the government should minimize its monetary expansion. The banking system should not use credit expansion as a source of obtaining higher short-term profits (Demyanyk & Van Hemert, 2008) Mortgage holders should understand the risks of speculation and adopt more conservative policies as moral hazard is present in all modern crises (Dowd, 2009). Financial and other specialists should respond to the existing market demand and be oriented on the market price signals. In this way, the existing risks may be minimized.
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