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The Housing Market has most recently been in the headlines, for the wrong reason. This is because of the way this industry has been crushing down over the last days. Many scholars and researchers have been looking into this issue with an aim to identify what could be the major causes behind this fall. The research information that has been drafted by most of them ha been on the impact that this crushing of the housing market had on the economy as well as the downfall that led to it. In this work, I am going to analyze the previous finding of the research that has been done, take a look at the data that was provided beforehand as well as provide possible solutions that I think will be of help in reviving this Industry.
The issue of the housing market crumbling down has resulted in a fall in the economy of the United States as well. Most Americans are not willing to take the risk of going ahead to purchase a house. This fear continues even though the prices have come down to between 8000 and 6500 US dollars. Most of this worry seems to arise from the fact that most of the citizens do not have secured jobs because companies keep laying off workers day in day out. As a result, most of the people do not have a steady monthly salary that they can frankly say they depend on each month for their expenditures. The numbers of bills that have already piled up are many and they do not want to start worrying about how they are going to pay up a house mortgage again. To many of them, a new house would mean starting life afresh again. Thus, the thought of settling down and later on getting displaced simply because they could not afford to pay for the house is very disturbing.
A majority of the economists in the country tend to think that this trend that is causing a crush of the housing market is going to affect the general national economy and not should be allowed to continue. As of present, the value of the houses continues to drop from the housing market. This results in many of the owners of the houses leaving their houses to default. They do this so that they can move out of the houses while they still can so that when the value of the house completely drops from the original, they will not be the one to bear it. The widespread continuation in defaulting of the houses by the residents is raising an alarm. Economists believe that these acts are going to have major repercussions on the housing market and in the end, the economy of the country will feel the effect.
An example of real estate that is on its way to crumbling down is in Ontario, a city in Toronto. The situation in this region is really alarming and it may just end up remaining that way if there is no remedy to the cause of homeownership. The Largest real estate board in Canada which is the Toronto Real Estate Board is at loggerheads with the Toronto Land Transfer. The Toronto Land Transfer Tax has been adding an additional amount for every purchase price. It has been adding 1.1% to this price. The Toronto Real Estate Board believes that the additional costs imposed on the people of Ontario by the Land Transfer Tax have greatly affected the citizens who are interested in purchasing housing property by putting the price beyond where most of them can afford. This has resulted in making the dream of homeownership for many of them a disaster.
The effects of the Land Transfer Tax on the number of sales, and on the prices of the housing property were assessed by an institute known as CD Howe Institute. They based their research on data that was collected between January 2006 and August 2008. Their findings indicated that this new tax that is being imposed on the buyers has caused a 16 % reduction in sales. The decrease was in the number of the individual families homes that were put in the market and actually got sold after January. There was also an effect of this tax on the value of the houses. The data collected showed that there was a 1.5% reduction in the value of the houses (Wade, 2009).
When this data is analyzed, the web gets to find that in the first year alone, there will be a great decline in household mobility. In the municipality of Toronto alone, a huge number of families will not be able to move to other houses as they would wish. At least 3500 families will be stuck in their current houses. This effect does not just stop there. By these families not moving, this will mean a reduction of about 6,400 US Dollars per house, an equivalent of 8% of the initial amount on each of them. In another similar case, the state budget of Ontario harmonized 9% in this sector. This meant a reduction in the Provincial Retail Sales. There was also 5% Federal Services lay off. This was a shock to most of the people who did not expect such a thing to happen in the housing industry. The shock was because they had already been hit by a recession and were still recovering from its effects. This move made by the Ontario Budgeting committee was going to see an increase in the taxes that were being levied and it would go up to as high as 13% taxation (Wade, 2009).
People who are in support of this argue that it is important and provides a good platform for business. Currently, already five more provinces have put this into action. The government may be benefiting from these acts but the normal citizen is contemplating facing the taxations. Most of the people thus opt to remain in their current homes, because it is cheaper that way. This affects the housing market as they have got no customers in their industry and as a result, it will continue to tumble down unless something is done.
According to Ben S. Bernanke (2010) who is the chairman of the Federal Reserve System, the housing crisis is a result of the triggers and the vulnerabilities. Triggers of the economic crisis are those specific occurrences that sparked off the crushing of the housing market. The major trigger was the $1 trillion outstanding debt by subprime residential mortgages. Once the housing prices started sliding south, there were possibilities of significant losses. In 2007, Rhineland was unable to continue providing the asset-backed commercial papers it had previously been providing to finance its asset-backed securities, some of which were subprime. On 30th July 2007 IKB, a German bank, announced that it would seek the support of other German Banks including the government-owned in order to fulfill its duties. This spelled trouble in the event that the value of the Rhineland securities dropped.
Difficulties in funding by sectors similar to Rhineland worsened when investors started pulling outstand and by August, the US ABCP was at $200billion. Lenders to sub-prime mortgages also pulled out, making bank funding more expensive hence the losses incurred by these borrowers. June 2007 also saw a 'sudden stop' in collective lending to large borrowers which seemed risky like the ABCP vehicles. This led to a drop in the market price of existing loans leading to some Collateral Loan Obligations (C. L. Os) being downgraded. Confidence once exuded by short-time investors was crushed and so was the operation of the money market and other financial sectors (Bernake, 2010).
As in the case of subprime mortgages, the perceived potential losses on leveraged loans in the late summer of 2007 were significant, although not large enough by themselves to threaten global financial stability. But they damaged the confidence of short-term investors and, consequently, the functioning of money markets and the broader financial system. This aspect was, however, not large enough to cause a crisis of the magnitude witnessed in the broader economy. Vulnerabilities, which are the structural weaknesses in the monetary system and in the regulation and supervision by the government, worsened the already bad situation.
The first form of vulnerabilities was in the private sector where there was dependence on the short term funding that was unstable, leverage, derivatives and deficiencies in risk management. ABCP vehicles, mortgage firms, investment banks, and money market funds are some of the financial bodies that help with investment, other than the commercial banks and credit unions. We already discussed how these financial bodies contributed to the collapse of the housing market. There were increased risks of investors running off hence these firms accumulated liquidity by transferring their assets to the treasury. The overall price of these highly liquid assets went up while the less- liquid assets like loans lost their value.
With most firms reluctant to lend money to financial and non-financial institutions, attention shifted to Central Banks like the Federal Reserve as a 'lender of last resorts'. These Central Banks could only lend money to non-financial firms upon confirmation that the state of liquidity was getting worse. This was the case with the money market funds where the collapse of the Lehman Brothers made investors in other market funds take off. The result was liquidity hoarding despite efforts by the Federal Reserve and Treasury to mitigate the effects (Bernake, 2010). European financial firms that were guarantors to shadow banks hunted for dollar funding in the foreign exchange and wholesale market in dollar denominations. This high demand for dollars led to a currency mismatch, putting significant strain on the markets. Dollar liquidity swap agreements were set up by the Central banks to tackle this problem.
The second factor in vulnerability was a deficiency in risk management by both investors and loan issuers. There was over-reliance on credit ratings by investors, failure to upgrade their credit products from the old originate-to-distribute business model and the inability of financial firms to track risk exposures like off-balance-sheet. There was also deterioration in mortgage underwriting for subprime borrowers and commercial real estate loans. Originators of mortgages were rewarded for the quantity rather than the quality of the extended mortgages. This made it difficult to adjust the troubled mortgages as the loan securitization process was complicated and long.
Procyclical leverage trends posed another problem when the market prices went down as most people had overestimated their ability to pay back the loans they had taken. Financial institutions on their part had toughened the requirements for mortgage qualifications with down payments raising to 20 and 30 percent hence few people invested in homes. There was an increase in the debt-to-asset ratio between 2006 and 2008 hence an expected two-decade-long drop in market prices for houses. Derivatives allowed financial as well as non-financial firms to evade their risks better by meeting all the terms of the contract resulting in a few bankruptcy cases. American International Group (AIG) went over the top with their risk on credit derivatives without hedging or supplying enough capital to cover the risk. A large financial firm such as this faced impending failure. To curb such occurrences, legislation was put in place to ensure that all derivative contracts are put on foreign exchange trading or other trade markets so that they are centrally cleared.
The public sector in the United States and beyond also suffered vulnerabilities that aggravated the crisis and the slow response from the government statutory framework, supervisors and market regulators was questionable. The pre-existing gaps in the financial regulation by the state's framework were evident in lenient and shallow scrutiny of shadow banks like Clots, ABCPs, and non-bank mortgage firms. There was little or no restriction about guidelines on leverage, liquidity, risk management or risk-taking. These institutions contributed to the downfall of the hedge funds. The Securities and Exchange Commission (SEC) did not regulate brokerage firms as expected leading to the folding up of Bear Stearns and Lehman Brothers and millions of dollars in losses. Shadow banks were not obligated to submit their risk level and activities data and gathering of such information was useless as it lacked a foundation.
As if this was not bad enough, statutory supervision and regulation were all about safety and relevance of these institutions as opposed to analyzing the systemic risks involved in the market. These non-bank institutions appeared too small to pose any threat to the big banks hence were left to operate. They were, however, the first to fold up under the economic pressure. A combination of such small institutions added up to the bigger problem. The action was not taken even or partner institutions located overseas therefore when the market came down, it swept all along its path.
The divided roles in the supervision and regulation generated a discord in the system. The Federal Reserve was mandated by the Gramm-Leach-Bliley Act to suspend any supervision of the contributory regulations as much as possible, a process known as 'Fed-lite'. Issues to deal with supplementary by the national banks were forwarded to the Office of the Comptroller of the Currency while those to do with broker firms were dealt with by the SEC. This obscured one from getting a clear picture of the whole situation hence unable to arrest the problem while still in the initial stages.
Fannie Mae and Freddie Mac were housing companies financed by the government. Despite being private companies, they basked in the goodness of cost-sharing with the government hence used the extra cash to invest in other projects like acting as guarantors and offering mortgage securities. Up until 2008, they were regulated by the Office of Federal Housing Enterprise Oversight (OFHEO), a part of the Department of Housing and Urban Development. They had conflicting duties of providing housing as well as checking safety and soundness on Fannie and Freddie. Over time, the scale tipped more towards housing and Freddie and Fannie were left to do as they pleased so they amassed major risks in their portfolio such as subprime properties that had mortgage backings (Gehman 2010).
The current legislation requires supervision and regulation to be consolidated and handled by one body, the Financial Stability Oversight Council. The Gramm-Leach-Bliley Act has also undergone refurbishing to give the Federal Reserve access to the goings-on at the large financial institutions. Statutory gaps were considered to be significant in the increasing risk levels in the housing industry. They also led to the rise in the insufficient feedback of the public sector. There was an ineffective use of the existing authorities and most of the banks did not put much effort to advise the large businesses and financial organizations to tighten their internal securities.
A number of causes in the crisis pointed to the lack of protection for the consumer's interest in the market place. This was very distinct in the lending of the mortgages by the financing institutions. The Federal Reserve tried to stop this crisis by advising the institutions to protect their customers more. They went on further to lay down strong regulations for this including dealing with mortgages and the credit cards. However, the Fed did not do enough in this sector and this contributed majorly to the fall in the housing market. It was slow to identify and tackle issues regarding breaking the law and abuse of the customers in the lending of money especially the transaction that occurred outside the banking firms that are normally regulated by them directly (Gehman, 2010).
In the event of a crisis in any institution, the government always has to take action especially if this crisis poses a threat to the national economy. In the Federal Reserve, it is important that several changes be made. To be able to improve both the supervision within the financial firms and devise methods of detecting possible risks in the financial system, changes have to be made to the way the supervising is done. Federal Reserves have to be made known in the fields that directly affect the major institutes. These fields include those like economics and financial market as well as how the systems out in place by the banks when it comes to payment. There should also be supervision based on every firm on its own. This will enable the consistent management of the risks that may befall customers and also save on preventing a crisis such as this one from occurring again.
Improvements in the supervising area will go a long way toward the realization of a better outcome in the industry. Daily check-up and close examination of pending issues will enable the containment of the risks being posed to this housing sector and thus as a result, the problems will not be at large. Quicker and more effective responses from the supervising firms are going to be realized if only the firms can increase their level of centralization when it comes to the housing market. The use of both the formal and the informal ways of enabling the actions to be enforced correctly to make sure serious issues are dealt with will also be of help in preventing such a crisis from happening again.
The Issues mentioned above by the Financial Crisis Inquiry Commission have brought to light the causes, magnitude and possible measures that can be taken to manage and possibly reverse the problem. We are now better placed in identifying the warning signs bearing in mind the fact that not all cases can be prevented. A transparent and operational system in the financial industry is what we need in order to streamline the industry and provide meaningful loans to the people and businesses. While risks cannot be avoided, the guiding principles should be prudent enough. This will instill the once existing investor confidence in the market and the process of acquiring a home will no longer be so strenuous. Banks will also be able to provide flexible repayment rates for their clients. Shadow banks will also desist from hoarding liquidity (Bernake, 2010).
The government can step in and help salvage the industry by providing support for people facing foreclosure and repossession of their property. The rescue schemes will allow them to continue living in their houses and only face repossession as the very last resort. Tax-free schemes can be set up to help those who would like to own homes so that they can save easily without straining. The stamp duty that comes with owning a home should also be temporarily removed to make things easier. The whole industry will be able to recover from the recession and thrive again. All that is needed is combined effort and willingness by all stakeholders.