How a ‘perfect storm’ led to the economic crisis
The U.S. economy is clearly in a terrible state. It is less clear how it got here.
Opinions vary on when and where the story begins, but many experts trace the origins of the current economic situation in the housing bubble, which came earlier in this decade.
House prices jumped to a rate of over 6 percent in 1999 and has grown quickly and steadily turned into a decade, according to a recent study by the Brookings Institution.
“In the mid 1990 house prices … a real gone through the continuous wave of 2005 that the residential real estate is not only a great investment, but it was also widely perceived as a very safe investment,” the Research has said.
Prices eventually moved “out of line with fundamentals such as household income,” and they formed the bubble, the study said.
There were two development trends in this period that contributed to the housing bubble, experts said.
Federal Reserve Board to combat recession and the 2000-01 economic impact of the September 11 terrorist attacks today began drastically cutting interest rates.
So it was very easy to borrow money, especially if you want to buy a house.
Meanwhile, global investors – have a lot of cash by the global economic boom in the 1990s and ’00s – were in search of the U.S. economy to make even more money.
“You have a group of people that get rich by leaps and bounds,” said Peter Rodriguez, an economist at the University of Virginia. “And they liked the idea of parking money in the biggest, the safest in the world economy.”
Enter mortgage-backed securities.
Wall Street has tried to link investors with rich booming housing market with the help of complex financial instruments.
These tools – such as mortgage-backed securities, we have heard a lot – made it easier for investors to transfer funds to the housing market, which is fed to the spiral surcharge, said Rodriguez.
“It really began to take it’s own life, when people saw how much money they could make,” he said. “In a short time, all goes down the pace of this train.”
So how do these mortgage securities, and what role do they play?
Let’s say there are three potential buyers of homes in the neighborhood. Local bank grants mortgage loans to all three, and then bundles up mortgages and selling a big pile Wall Street firm, such as the now bankrupt Lehman Brothers.