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Sub-prime Crisis

Sub-prime Crisis

Introduction

In2000, Phil Gramm, a senator from Texas, entered the senate and made an argument concerning the importance of deregulating certain financial instruments that lead to the deregulation of the use of mortgage-backed securities (MBS) and collateralized debt obligations (CDO). This action paved the way for the sub-prime crisis that rocked the nation in 2008 (American Casino, 2009). Once the sub-prime crisis in America was on its peak, it also affected financial markets in the UK. It was later discovered that the UK financial market followed similar patterns of deregulation, when it comes to sub-prime mortgages and the emergence of financiers that saw great opportunities in making profitable investments in the use of risky but highly valuable MBS and CDOs. As a result, both countries suffered irreparable harm due to the deregulation of the aforementioned financial instruments. However, the same effect was not seen in Australia due to the peculiarities that surround the housing market in the country.

The Sub-Prime Crisis

The sub-prime crisis was rooted in the deregulation of the housing market. When the MBS and CDOs were deregulated, the US government made it easier to trade MBS and CDOs through the global market. In other words, the deregulation of these financial instruments lifted several restrictions, thus giving traders an easier way to dispose of the said securities. These financial instruments were aptly called mortgaged-backed securities, because the money that was invested into the said papers was plowed back into the housing market. In other words, the banks used the investment to loan more money to those who were seeking to acquire new homes or to refinance their existing mortgages. In theory, this was a sound financial investment, because the houses and the properties werecollateral for the loan. However, it must be emphasized that there is a reason why this type of mortgages is called sub-prime. These loans are riskier, because they are given to people with a higher tendency to default on their borrowings.

The deregulation of the mortgage-backed securities created a significant cash flow to US banks, which enabled bankers to loan more funds to those who needed them. As a result, it created a housing bubble, or an artificial increase in the growth of the housing market. Consequently, it fueled greater demand for the MBS and the CDOs.

With regards to the bank, or the lenders, they realized that they could make more money if they increased the number of borrowers under their portfolio. As a result, due diligence was not applied when it comes to lending money to people that upon closer examination do not have the capacity to pay back the money they owed. This triggered the sub-prime crisis, because when borrowers defaulted on their loans, the investors and the general public realized the true value of the MBS and CDOs.

The Case of Australia

There were two major features of the Australian housing market that was instrumental in shielding the country from the impact of sub-prime mortgage crisis. In fact, the same pattern of deregulation and market collapse did not occur in the country, because the investors and the homeowners did not behave like their counterparts in the United Kingdom and the United States. The first one was the attitude of the Australians with regards to home ownership. Second, it was the unique practice of compartmentalizing the role of land developers and home builders.

The settlement that emerged in the coastal areas of Australia was a testament to the need for building houses in lands that are not susceptible to the wrath of naturee. As a result, one can find clustering of homes in a particular area, whereas on large plots of land across the country there are no houses. Thus, there was no incentive for land developers to create dwellings, subdivisions, and condominiums all over the country in the anticipation that people will move there because of the need to have their own space. Without a doubt, Australians, like the rest of the global population, would love to have home ownership, but there are other factors to consider. In addition, Australians prefer homes that they could expand, and the concept is called wrapping additional improvements into a particular property (Burke & Hulse, 2010). Thus, the sought after properties are those that are found in suburbs and rural areas. There was less attractiveness for homeownership with properties that are found in claustrophobic areas in urban centers. As a result, there is a significant number of Australians that are renting rather than own houses. Furthermore, the most sought after properties are those that enabled homeowners to build single-detached dwellings.

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Another important feature is the separation of roles of land developers and home builders. It was the responsibility of the land developer to choose the best site to construct dwellings. Land developers are also responsible for taking care of the legal requirements, such as those related to zoning laws and others. However, after subdividing the land into appropriate lots, the home builders come in as a separate entity and construct houses for the homeowners. In countries like the United States and the United Kingdom, the land developer and the home builder are one and the same. Thus, there is room for speculation as land developers are often compelled to build more houses and condominiums in anticipation of greater demand.

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