Case Study on Mortgage Crisis
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Subprime mortgage crisis which still has its impact on the global economic condition as huge global capital market valuation was lost in the year 2008-2009 due to this crisis which erupted from United States and led its impact on the economic conditions of all countries (Crandall, 2008). Majorly, the subprime mortgage crisis has made significant negative impact on the economy condition of United States, United Kingdom, European countries as well as in Asian countries. The subprime mortgage crisis has taken its shape from the year 2006 when the well known investing firms of United States ease their lending norms for providing loan to sub-prime customer (low income group people) for buying real estate property. The particular decision was taken with the thought that prices of real estate property rises continuously which will enable them to earn more revenues (Demyanyk and Hemert, 2008). Till the year ending 2006, the housing and real estate market grew but eventually after the year 2006, it started depleting because the interest rates of mortgages are increased which make the things difficult for subprime customers to repay the loan installment amount and because of that reason, they started selling homes. However, the increase in supply of homes decreased the prices of homes severely which did not bring enough money to the subprime customer to repay the mortgage loans and because of that reason, they made defaults in repayments loans. Now, as the prices of homes already decreased in the market and demand was also depleted to the major extent, banks could were not able to raise money from the auctioning process. This has resulted in increasing the non-performing assets and debts of investment banks which they could not able to recover from the market. This led investors and banks to bear huge financial loss which ultimately wipe out 50% value in the capital market as investors started losing hopes from the banking and financial institution. The particular crisis brought slowdown in the economic growth is such a way that many countries are still struggling in reviving the economic and financial condition (Calomiris, 2011). The major effects which subprime mortgage crisis brought on economic condition of US and UK are decreasing the purchasing power of consumers, high unemployment, shortfall of money supply in the economy, high debts of banks, insolvency, increase in non-performing assets, decrease in value of equity, fall in currency value in foreign exchange currency market and falling of demand of real estate. In addition to this, banking sectors, financial institutions and real estate firms suffered with a major loss (Gerardi and et.al., 2007).
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There were many banking and investment firms like Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley which suffered with a huge loss and this has resulted in selling their physical assets to repay the debt. Moreover, the financial service firm Lehman Brother declared itself as bankrupt as it did not have money to repay its debts (Lehman Brother, 2008). Till the year 2008, the entity was known to be as 4th largest investment banking firm in United States but when the subprime mortgage crisis raised in United States, the firm filed the Chapter 11 bankruptcy protection as most of its clients declared themselves as insolvent which increased the assets' loss of firm (Lehman Brother, 2008). Many economist says, the main reason for which subprime crisis emerged was because of blind financial practices of financial institution and investment banking firms like Lehman Brothers and Merrill Lynch which gave loans for housing to subprime customers who were not having good credit worthiness and financial track record with regard to repayment of loan (Demyanyk and Hemert, 2008). However, many economists of the world blames credit rating agencies of United States for emergence of subprime mortgage crisis as they gave high ratings to Mortgage Backed Securities without any proper evaluation that whether it is given to prime and sub-prime customers or not. Due to inappropriate ratings, investment banks sold the Mortgage backed securities to the investors who were not known about to whom the loan or mortgage had been provided by the bank (Kulikowski, 2007). Critics said that the credit rating agencies who have the role to give proper ratings to the firms and their MBS might have adopted faulty practices as they would have got good commission from the investment banking firms. The author Michael Simkovic stated in his research paper that credit rating agencies had proper knowledge about the process of rating of subprime related securities which was inaccurate but they did it to gain monetary benefits from the investment banking firms (Simkovic, 2011).
Thus, in the view of this perspective, the present thesis is prepared to get more in-sight knowledge and information about the happening of 2008 subprime mortgage crisis which led its severe impact on US, UK and Global economic condition. The main purpose for conducting this research on the particular topic is to examine whether it is fair and justifiable to blame the credit rating agencies for the emergence of subprime mortgage crisis which ultimately led to the global financial crisis . Apart from that, efforts would also be put forward to understand the different causes for which subprime mortgage and the financial crisis occurred that brought a huge loss of monetary for the financial institution as well as investors (Tong and Wei, 2008). In the study, appropriate suggestions and recommendations is also provided with the help of which such type of crisis or situation can be eliminated and dealt in effective manner. It is true that many studies have been done in the past with respect to the related topic but the fact should not be ignored that each study has brought new in-sight information and findings that were related to subprime mortgage crisis (Crandall, 2008). Thus, in the present study also, considerable efforts are being imparted to bring constructive information and findings that were related to the subprime mortgage crisis. Furthermore, the study would provide information and knowledge about if there is any requirement to revive the responsibilities and accountability of credit rating agencies so that no such financial crisis would occur in future which has happened in the year 2008 (Demyanyk and Hemert, 2008).
Up to this point, it was detailed about the subprime mortgage crisis and contemporary nature of the present study. Apart from that, the research objectives or questions which would be addressed in the current study is also detailed. Now, in the next chapter, review of past literature is done to understand the findings and conclusions that are related to the research topic which are drawn by several authors in their studies. Further, review of literature is also done to carefully examine the viewpoints and opinions of different authors with respect to subprime mortgage crisis.
Review of literature is considered to be as important part in a study. In the particular section, a researcher list out all the past studies related to the topic in order to understand the findings and conclusions which were drawn previously. In addition, to this a researcher also undertakes review of literature to understand the view points and opinions of past authors who had conducted studies related to the topic. Review of past literature helps researcher in identifying the research gap in the past studies. The identification of research gap leads the action of researcher towards setting of research objectives for its own study (Kuada, 2012). Thus, by seeing this importance and significance of literature review in a research, the present study also attempted a sound review of literature in order to develop comprehensive understanding related to Subprime mortgage crisis which severely affected the economic condition of all the countries of the world. In the underneath literature review, efforts has been put to understand the evolution, causes, impacts of Subprime mortgage crisis (Kim and Kim, 2011). Apart from that it also has been studied about the policies and practices which were adopted by US and other countries' government to deal with the particular financial crisis.
The evolution of Subprime mortgage crisis is complex to define as different economist and authors had given their different statements and definition about the evolution of Subprime crisis. However, it was understood by getting knowledge and information from the statement of US President George W. Bush who had given on September 24, 2008 in which the crisis had already surpassed in worsening the global economic condition in which US and UK economies were highly affected (Chong, 2011). The US Presided said in his statement that “The problem of financial crisis which US is witnessing today it is not emerged in a day or in a year but it has developed over a long period may be more than a decade” (President's Address to the Nation, 2008). “The situation of financial crisis started emerging from the time when the foreign investors started investing huge amount of money in US banks. In particular time period banks lending interest rate was also low which made things easier for American to get loans with utmost ease and convenience.” Mr. Bush further said in his statement that “Easy loan access along with wrong assumption about increment in the values of mortgage home loan created the situation of bad decision from the side of banks, investors, rating agencies and American citizen too (Chihi, Selmi and Boujelbene, 2012). Further, former US President George Bush also admitted that there were many mortgage home lenders who sanctioned the loans to the customers without doing any proper credit worthiness analysis and their abilities to repay the amount. Several economists stated in their research papers on the topic Subprime mortgage crisis that banks gave loans to Subprime American with a view that the value of mortgage home would increase in the future (Record stock market falls in 2008, 2008). On the other hand the people who took loan for buying of home with the assumption that they would sell the home in future on higher price and repay the loan amount to the banks on which they would also earn a good margin but all things went futile as the complete assumption and process of secularization of securities backed by mortgage home loans were wrong or baseless from the side of lenders or financial institutions who were involved in that (Goda and Lysandrou, 2014).
The author Demyanyk (2009) said in his study that there were also involvement of some credit rating agencies in the happening of Subprime mortgage crisis as they gave high and safe ratings to the mortgage backed securities which were being allotted to Subprime customers. Thus, they didn't give high risky or negative grading to such securities due the assumption that the prices of home would continue rising in future which was completely vague (Demyanyk, 2009). On the other hand, the Amadeo (2015) said in his study that the evolution of Subprime crisis started after the year 1998 in which people were having high tends towards investing in real estate over stock market as they were getting high returns (Amadeo, 2015). This tend or high demand of people towards real estate or housing increased the prices of housing and real estate. The author Shirai (2009) further said the particular trend continued till the year 2006 as during the period the banks lending rate was also low. However, after the year 2006 banks increased their lending with a view that the interest rate would be the same in coming future and the prices of real estate would also grow as it has been increasing for last 8 to 9 years (Shirai, 2009). However, things went in other way as Federal Reserve increased the lending rates to curb excess credit money supply in the economy and then things started ruining as people couldn't repay the increased loan installment amount which ultimately heighten-up the non performing assets of banks and their debt obligation to investors (Tong and Wei, 2008).
Global financial system is the most integral component of the world. The capital markets all over the globe are witnessing a high level of depression because of arising of bankruptcy threats from highly capitalized stocks. Global financial crisis began initially is now regarded as global economic crisis (Barangayrp, 2008). The destruction in the global demand leads to a massive job crisis. Different types of financial crisis have become a sign of concern for country, economists, political leaders, managers, companies etc. Many financial institutions are having the bad taste of it. Due to crisis all economies around the globe have been affected adversely (Bulow, Geanakoplos, and Klemperer, 1985). It is also affecting the purchasing power of individuals and life style patterns all over the world are changing. Before taking the study further, it is imperative to identify what type of financial crisis can have an impact on economy. So different types of financial crisis which can occur in the economy are as follows:
Banking crises - When a bank faces a condition under which depositors performs the action of withdrawal, this is called bank run (Chari and Kehoe 2004). Generally banks lends all the money which they receive in deposits hence it is difficult for them to pay back all deposits on immediate basis. Bank may come under the situation of bankruptcy, resulting in loose of money for all depositors unless they are covered by deposit insurance. Condition under which bank runs are widespread is regarded as systematic banking myths (Eichengreen, 2004). Sometimes in the absence of ban run also, banks are forced to lend because they concern that they have insufficient funds available. This phenomenon is called credit crunch.
Speculative bubbles & crashes – Financial asset such as stock, displays a strategy or a bubble, when its price exceeds the present value of the future income. Most of the market participants buys assets in the expectation that they will sell it later at higher price (Kindleberger and Aliber 2005). Instead of buying it for the income it will generate this could be confirmation that there is a presence of bubble. There is also a risk of crash in asset prices in case if there is bubble. Market participants will choose to buy only if they see others also buying and when they decide to sell the price falls (Laeven and Valencia 2008). Although it is difficult to say that whether prices of an asset actually equal its fundamental value, hence it is also difficult to identify reliable bubbles.
International financial crisis – The situation under which a nation who maintains fixed exchange rate, is forced to decrease the value of its currency due to a speculative attack, it is knows as currency crisis (Naija, 2009). Sovereign default is another type of international financial crisis under which a country is incapable of paying its sovereign debt. Devaluation and default could be identified as voluntary decisions of the government and often taken as involuntary results of a change in investor sentiment. It leads to decrease in capital inflows and increase in capital flight (Nwachukwu, 2009).
Wider economic crisis – There are wider economic crisis also such as recession, stagnation, etc. When a country suffers from negative Gross Domestic Product for two or more quarters is known as recession (Ryan, 2008). A very lengthy period of recession is called a depression and a long period of negative growth is known as economic stagnation. These aspects impact much more than the financial system, hence they are not usually regarded as financial crisis (Dooley and Hutchison, 2009). Some of the economists have argued that many recessions have been caused in large part because of financial crises.
The severe impact of Subprime mortgage crisis had upturned every aspect or elements of US and global economy. There was no stones which were not turned by Subprime mortgage crisis. The study of the author Simkovic (2011) reveals that Subprime mortgage crisis hugely affected the stock market which demonstrates the economic condition of a country. The particular crisis had steeply deepened down the market valuation of equity market of US, UK and other countries like India. Further, in this regard the author stated that the Subprime crisis affected the economies of those countries which were highly dependent or related to US. In other words, the economies of that countries were highly affected which were having huge volume of international trade with US (Simkovic, 2011).
In the year 2007, a study was published in which the author Gerardi and et.al. stated that Subprime mortgage crisis taken the jobs of millions of Americans and the people of other nationals from the countries United Kingdom, Italy, Philippines and India (Gerardi and et.al., 2007). The author Crandall (2008) said the people who were doing outsourcing work of US companies became unemployed for long period. Nonetheless, the unemployment risen not only with respect to outsourcing companies but also with all the companies. In the study, it was also concluded that the Subprime mortgage crisis taken the inflation on surge in US which decreased the purchasing power of consumers as the prices of products started increasing due to rise in interest rate (Crandall, 2008). The author Calomiris (2011) said after the crisis, it was become very difficult for the American to earn and live their livelihood.
The study of the author Goda and Lysandrou (2014) gives evidence that many cases related to suicides and attempt of suicide by equity investors came in light due to Subprime mortgage crisis. The suicide cases increased among the investors who lost major proportion of their chunk amount in US (NASDAQ) and Indian (BSE and NSE) stock markets. Further, the study also found that the people who invested large portion of their surplus fund in mutual funds also incurred huge financial loss as they could not get any capitalization on their amount invested (Goda and Lysandrou, 2014).
According to the author Chihi Selmi and Boujelbene (2012) the Subprime mortgage crisis had increased the risks like credit risk, liquidity risk, systematic risk, counter party risk, asset price risk which brought significant negative effect in the market as well as in the sentiments of investors (Chihi Selmi and Boujelbene, 2012). This negative impact had left long negative impression in the minds of investors and because of that reason investors becomes more risk averse in investing their surplus fund in equity market. In the year 2009, the author Shirai conducted a study on “ The impact of Us Subprime Mortgage Crisis on the World and Asia”. In the particular study, the author identified number of impacts by analyzing the movements cross-border capital market. The author stated in the study that the main reason for which the 2008 recession came and hit the global market was because of Subprime mortgage crisis in which the banks like Lehman Brother become bankrupt (Shirai, 2009). The author further concluded in his study that the particular crisis had severely hit the exchange rates, GDP and international trade i.e. imports and exports of most of the countries. The study of author Kim and Kim (2011) gave sound evidence that the Subprime mortgage crisis, decreased the world stock market by almost 50%. According to the reports, the global economy approximately lost 30 trillion wealth due to the recession which came due to Subprime mortgage crisis (Kim and Kim, 2011). On the contrast, the study of the author Goodhart and Lim (2011). laid down the fact that the Subprime mortgage crisis made very difficult situation for the large as well as small and medium organization to borrow money on debt from banks or to take money from the investors or shareholders or angel investors (Goodhart and Lim ,2011). Apart from this, the 2010 report of Federal Reserve published the information that the figure foreclosure has not been decreasing even after the passing of 2 years of happening of Subprime mortgage crisis. In the report, it was included that people who got mortgage loan for buying of home are continuously losing their homes since Subprime crisis. The report gave information that in the year 2.25 million foreclosure occurred which would be the same in the year 2011 and 2012 (Calomiris, 2011). Thus, the report concluded that it become serious concern for the American government as large number of people has lost their homes which is their main asset to live their life (Independent Foreclosure Review, 2015).
In the year end 2008, BBC News reported news that 2008 was the year in which record stock market fall was seen due to recession which was backed by Subprime mortgage crisis. In the published article it was reported that the 2008 was the year in which the all the countries saw huge financial turmoil and economic slow down as stock markets were being hit severely due to financial crisis. In the article, it was reported that the FTSE 100 Index of Britain recorded 31.3% steep fall down and the same thing was seen in the stock index of Paris and Frankfurt. Further, it was identified that the stock market of Shanghai was among the list of countries whose stock market crashed in severe manner (BBC News, 2008). The published information revealed that the Shanghai Stock Market of China deepen down by 65% which was the highest loss in Shanghai Stock Market. The Shangai Stock Market lost almost $3 trillion due to 2007-08 financial crisis. In addition to this, the Dow Jones of New York fell by almost 34% in the year 2008 due to financial crisis that occurred due to Subprime mortgage crisis of US. Several economists said that this was the highest fall in down in Dow Jones after the year 1931. The Japan stock market index, Nikkei dropped by almost 42% that means 42% of the market valuation of equity shares of Japanese companies erased due to recession which was backed by Subprime mortgage crisis ((BBC News, 2008). From the secondary information available on Trading economic website, it was identified that the stock market of India i.e. BSE SENSEX and NSE NIFTY also decreased by almost 50%. In the beginning of the year 2007, the SENSEX was stand above 20000 points but in the mid of year 2008 the stock index slipped below 10000 points. Moreover, in the beginning of the year 2009 it touched 7500 points. Thus, the Indian stock market also severely affected due to the impact of US Subprime mortgage crisis which created recession in the global economy. Above the all, the NASDAQ stock market of US, was at 14000 points in the beginning of the year 2007 which slipped to 6400 points in the first quarter of the year 2009 (Trading Economic, 2015). Thus, by seeing this data, it can be anticipated that at what extreme level the Subprime mortgage crisis had affected the stock market of different countries which ultimately reflected their worsen economic condition.
If something bad like subprime crisis happens, it does not take too long to identify who is to blame for it. In the above crisis, there was not any single individual or entity on which the blame can be put on (Dick-Nielsen, Feldhütter and Lando 2012). So there can be many factors responsible for such type of financial crisis, these can be explained as follows:
The lenders - Mortgage originators that are the lenders can be highly accused for creating such type of issues. It was the lenders who granted money to people having poor credit and a high risk of default. Interest’s rates became low, when central banks filled the market with high capital liquidity (Eichengreen, Mody Nedeljkovic and Sarno 2012). It also broadly depressed risk premiums as investors sought riskier opportunities to reinforce their investment returns. At that moment lenders feel that they have got ample of capital to lend and there was an increased desire to undertake additional risk to enhance their investment returns. For the protection of lenders, demand for mortgages was increased and further housing prices were increasing because there was an substantial drop in interest rates (Gerardi, Lehnert, Sherlund and Willen, 2008). Hence lenders identify subprime mortgages with low amount of risk. Under it, the rates were low, the economy was healthy and people were making their payments.
Homebuyers – Along with the lenders, category of home buyers can also be accused for crisis. Many of them were confronting with high amount of risks by purchasing expensive houses which are not affordable (Santos, 2010). These purchase deals were happening on the basis of non-traditional mortgages that rendered low introductory rates and minimum initial costs such as “no down payment”. They were eagerly waiting for price appreciation which could have given them the benefit of refinancing at lower rates and withdraw the equity from home for use in other spending (Phillips and Yu ,2011). Although all happened completely opposite of that which was expected. Despite of continued appreciation, the prices dropped rapidly damaging the bubble of housing for home buyers. Leading to that, many homeowners prove to be incapable of refinancing their mortgages to lower rates, when their mortgages reset.
This is because no equity was being created because of the price fall (Acharya and Merrouche 2012). Hence they have to reset their mortgage ate higher rates in deliberate manner, which was not affordable for many. Many homeowners were simple forces to default on their mortgages. In the desire of catching more subprime borrowers, the mortgage brokers or lenders may have given the indication that no risk was associated with these mortgages and the cost were not that high (Hesse, Frank and González-Hermosillo, 2008). Although at the end of day many subprime borrowers simple assumed that they could not simply afford mortgages. Intensifying the situation, lenders and investors of securities backed by these defaulting mortgages suffered. Lenders lost their funds on defaulted mortgages because they remained left with the property whose values was less than the amount loaned originally (Blackburn, 2008). The losses were large enough to drive in towards bankruptcy in some cases.
Investment banks – The increased use of secondary mortgage market by lenders increased the number of subprime loans which lenders could originate. Lenders just simple sell off the mortgages in the secondary market and collected the originating fees, despite of maintaining the originated mortgages on their books (Davidson, 2008). This resulted in generation of more capital for lending and this leads to increase in more liquidity. The snowball started creating momentum. Creation of assets which combines the mortgages with security, resulted in lot of demand for these mortgages. The security was known as collateralized debt obligation (Ackermann, 2008). In this process investment banks would buy the mortgages from lenders and securitize these mortgages into bonds which were sold to investors through the mode of CDOs.
Rating agencies - Rating agencies were also held responsible for financial crisis. There was lot of criticism about rating agencies, underwriters of the CDO and mortgage backed securities that includes subprime loans in their mortgaged pools (Kregel, 2008). According to the experts these rating agencies must have predicted the high default rates for subprime borrowers. It is expected that they should have given lower ratings to these CDOs as compared to “AAA” rating given to the higher quality tranches. If the rating was done better, less number of investors would have bought into these securities and the losses would not have been so bad (Barangayrp, 2008). However some thinks that conflict of interest between rating agencies is the cause behind the crisis. The argument is that rating agencies were forced to offer better ratings so that they can continue receive service fees or they run the risk of the underwriter going to a different rating agency. Nevertheless it is difficult to sell a security in case if it nor rated (Bulow, Geanakoplos and Klemperer, 1985). No matter what the criticism says about the relationship between underwriters and rating agencies, the things is they were simply bringing bonds to market on the basis of market demand.
Not only individuals were affected by the subprime crisis but its also affected the firms in different industries. There was a impact on sales, revenue, profits, productivity etc. Financial crisis lead to a great impact on different types of business industries.
Automotive industry – The global crisis did not have an impact on automotive markets in developing countries, except for automotive exporting nations like South Africa, Mexico, Thailand etc. In the year 2009, automotive production and sales have declined across the board in Global South (Chari and Kehoe, 2004). The key market turned around in the end of the year. Firms in the automotive industry responded with traditional crisis management. Government also launched traditional stimuli packages for that purpose. It affected the manufacturing of auto mobiles as there was huge decline in number of cars, vehicles etc. It ended the purchasing power of the consumers (Eichengreen, 2004).
Impact on insurance sector – Global financial crisis has not had a major impact on the Life Insurance sector. It is due to complex guidelines framed by IRDA on solvency margins. Further industry companies have to follow the investment norms (Kindleberger and Aliber 2005). Domestic life insurers are subjected to solvency needs which stipulate them to hold a minimum solvency ratio of 150%. It reflects that life insurance companies remain well capitalized at all point of time.
Aviation industry – There was a fall in demand in Aviation industry. Synergy can be seen between global economy and demand for air transportation. It is believed that in any economic downturn civil aviation is the one which will be most suffered (Laeven and Valencia 2008). The demand for air transport in the industry is of pro-cyclic nature. Further there was reduced capacity of the firms in the sector. Many of them deferred delivery of new aircraft, undermining the outlook for production at makers (Naija Lo Wa, 2009).
There was a increase in price of fuel and operating costs. It has significantly impacted the level of net profit. A fall in the profitability growth of the companies was also noticed. After that a fall in employment level was also noticed. It was mainly due to factors like outsourcing, increasing share of LCCs (Low Cost Carriers) etc and due to substitution of technology in labour activities like ticketing, luggage processing etc (Nwachukwu, 2009). Low Cost Carriers are described as the airlines which provide no-frills flights for which passengers pay low fares. It is mainly characterized by low ticket distribution costs, increased aircraft utilization, common fleet type, use of secondary airports etc (Ryan, 2008).
Information technology – There was a high impact on the information technology sector also. The financial crisis affected the profits, growth, etc of the industry. There was a decrease in sale of IT gadgets such as mobile phones, laptops, computers etc (Dooley and Hutchison 2009). Financial crisis has emptied the pockets of people and people have no money to buy these sort of things. IT companies which were listed on stock exchange encountered with decrease in the prices of shares. It was a tough time of information technology sector. Hence it can be said that subprime crisis hugely impacted the business sectors (Gerardi, Lehnert, Sherlund and Willen 2008).
India is one of the fastest and dynamically growing economies of the world. The country was also the victim of subprime mortgage crisis occurred in 2008. The immediate impact of financial crisis was felt when Indian stock market started falling. In the month of October 2008, 250,000 Crores was wiped out on a single day. There was a losing of 1000 points on the Sensex on that day before regaining 200 points. There was an intraday loss of 200 points. A huge withdrawal was noticed from the side of Foreign Institutional Investors and participatory notes. There was an impact on different industries also. Reduction in demand in the OECD nations affected the gems and jewellery industry. Handloom and tourism sectors were also affected. Many employees in jewellery industry lost their jobs due to global economic turndown. The volume of exports was dropped down by 4.6% in the year 2007-08. Exports were also affected as manufacturing sectors such as leather, textile, gems etc were hit hard due to slump in demand in US & Europe. Exports dropped down by 9.9% in November 2008. There was exchange rate depreciation also as with the outflow of foreign institutional investors; Indian rupee was depreciated approximately by 20% against US dollar. It created huge panic among the importers. Talking about the Inforamation Technology sector, majority of the revenue in the sector comes from US and it contributes about 5.5% towards India’s total export. Hence it was expected that software companies will be impacted a lot. It can be said that Financial or Subprime crisis was shear consequences of greed. It shows the failure of capitalist market economy. However Indian economy would be able to withstand the crisis without any major difficulty but the crisis is still causing havoc across the globe.
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UK again was the major sufferer of the financial crisis. The imports and exports were decreased by 20% because the sterling exchange rate got depreciated by 700 points until the end of 2009. Due to low amount of imports & exports, the companies started receiving less order which in turn resulted in lay off of employees. Along with that some of the firms confronted with possibility of becoming bankrupt also. Unemployment rate increased swiftly and people started to cut out their spending and could not afford to high mortgage loan. Borrowers faced the condition of defaulting the contracts. Banks and mortgage intermediary was unable to suffer the loss either. Some banks have to ask for help from the government who agreed to perform bailout plans and making them public by purchasing their stock. Government also used monetary policy as a weapon of quantitative easing to save the market. The investors lose their interest when they realize that government is rescuing the banks and house agents. They do not have enough confidence to make investment in UK. There was a great impact on house prices also In the recent years the house prices reached very high and reached an unprecedented level till 2008. The mortgage markets become profitable and attractive to banks due to emerging trend of unbrokensies in property values since the deregulation. Lenders were giving loan which were more than size or seven times of borrowers real income in actual. They were also more than the face value of their underlying properties. This overshadowed the high amount of risk along with the property market. Unemployment rate was on top as large numbers of graduates were not able to find job and they faced the most competitive recruitment market. British Exchange rate decreased sharply from the end of 2007 until 2009. There was a large fall in retail sales, massive firms went to bankruptcy. Financial sector is one of UK’s core industries and when crisis happened the financial system suffered a crushing blow.
Financial crisis also affected in parts of China, although China was able to maintain high economic growth. The crisis multiplied through a number of channels. Many Financial institutions in China had invested heavily in securities linked to the US real estate market. These investors suffered huge losses. These investors generated a general flight to safety which resulted in large capital outflows from many emerging market economies that had few direct connections with the US real estate market. China proved to largely resistant to such capital and wealth flow effects. Foreign direct investment in China decreased at the beginning of financial crisis. Nevertheless there was a global financial impact that did not operate directly through capital flows. The crisis carried a impact on economic outlook and risk attitudes across the globe and China was not immune. Earlier before the crisis extreme hopefulness had affected many markets across the globe and China’s stock market was no exception. China has enjoyed a stock market boom, like in many other nations and witnessed fivefold increase between 2005 and 2007. Such level of growth makes the market capable of facing the bad news. China was able to maintain high growth due to strong fiscal position, a high level of foreign exchange reserves, limited international capital flow etc,.
Research methodology gives understanding and knowledge to the user or readers about the way or manner in which the researcher has conducted the study. In the research methodology section, a researcher makes attempt to give significant amount of information about the methods and techniques which he or she has adopted to complete the study in required manner which is directed towards achievement of research objectives. In the past studies, several authors had said that a research study would be conceived or seen half or incomplete if the researcher would not mention or give detail about the research methodology which he or she has used in conducting the research (Jonker and Pennink, 2010). The proper mentioning of research methodology shows the researcher has carried out the study in proper and defined manner and on the basis of that the outcomes of the study are considered effectual (Diment, 2012). Thus, by seeing this significance of research methodology in conducting of a research, thus in the present study proper and accurate research methodology has been followed to demonstrate the methods and techniques which are used for accomplishing of the determined research objectives (Forzano, 2011).
In the research methodology, the fundamental thing which demonstrated is about the knowledge and understanding of the researcher about the research topic. This section comes in research philosophy. Research philosophy depicts the thinking of researcher while carrying out the study. A researcher adopts research philosophy on the basis of his understanding about the chosen research topic (Mathur, 2005). If the research has sound knowledge and information about the chosen topic then he selects positivism research philosophy whereas when or she doesn't have enough knowledge and information about the study then the researcher adopts interpretivisim research philosophy. Several authors says, a researcher selects research philosophy on the basis of nature and type of the study (Diment, 2012). For example if the study is of objective in nature then positivism research philosophy is adopted by the researcher and if the study is of subjective type then interpretivsim research philosophy is considered. The present study is carried out by following positivism research philosophy as the study is objective in nature and the researcher was having substantial amount of knowledge and understanding related to the chosen topic (Kuada, 2012). Here, the knowledge and information about the topic was also gained by studying past literature which were related to Subprime mortgage crisis. Here, as the study was of objective type so numerical data was collected and evaluated.
A research approach defines what the researcher wants to do from the study whether he or she wants to make generalization or to make deduction from the generalization to address or to apply set theories to the specific thing. There are basically two types of research approach i.e. inductive and deductive from which a researcher adopts one on the basis of research philosophy or objective of the study (Goodhart and Lim, 2011). The present is completed by using deductive research approach. Here, with the help of particular research approach, constructive findings and conclusion has drawn with respect to the determined research objective about the extent to which whether it is fair to blame the credit rating agencies for the occurrence of Subprime mortgage crisis which created severe financial crisis in the world. In the present study, deductive approach is selected because the numerical data is collected and analysed by using qualitative analysis technique (Kuada, 2012). Thus, by adopting the particular research approach it would be concluded that whether it is justifiable to blame credit rating agencies of US for occurrence of Subprime mortgage crisis. In addition to this, conclusion has also made with regard to whether or not it is always advisable to blame for the nature of the global financial crisis as it exists today.
In the above, it was mentioned that positivism and deductive approach has used in the present study because of objective and quantitative nature of the study. Now, the research type gives exact information about the type of research. The research types are categorized into two- quantitative type and qualitative type. The present study can be expressed as quantitative type because numerical or quantitative data is collected and analyzed by adopting required techniques and methods (Jonker and Pennink, 2010). With the help of information about research type in research methodology chapter, a reader or user instantly gets an idea about the type of study the researcher has conducted. Academic authors Forzano (2011) says that it is always good to do quantitative research as it provides sound evidence and justifies the result. Thus, by keeping this aspect in mind, the study is made by adopting quantitative research type (Forzano (2011).
Research design demonstrates the attempts or efforts the researcher has made in finding of the results and outcomes in align with the research objectives. The selection of research design for the study shows the structured plan the researcher has adopted in deriving prolific findings and conclusion related to the study. In other words, through research design, a researcher gives information about the kind of study it intended to do like exploration, evaluation, explanation, prediction etc. The broad classification of research design is done into three: exploratory research design, descriptive research design and casual relationship research design. The present study is conducted by adopting exploratory research design (Mathur, 2005). The particular research design is selected because in the study quantitative analysis of numerical data has been done. The other reason of selecting exploratory research design is that here it would be determined whether it is fair to blame credit rating agencies of US for the 2008 financial crisis. In addition, by using the particular research design various factors and variables would be identified that led to the creation of Subprime mortgage crisis which ultimately brought severe financial crisis or recession in the economy.
Data collection is the most imperative dissertation. It is a very sensitive part hence it has to be handled with care. It is very important that data is to be collected from valid and authentic sources (Creswell, 2013). It is evident that there are two types of data primary data and secondary data. Primary data is collected for the first time and is very fresh & new in nature. This type of data becomes secondary on getting used once by someone (Diment, 2012).
For this research study, primary data has been collected from investors, bank employees, credit rating agencies employees, insurance firms, investment bankers. It has been collected through the method questionnaire (Mathur, 2005). Questionnaire approach is appropriate because it helps in gathering the data in appropriate manner with high level of accuracy. While secondary data has been collected from sources such as books, journals, newspapers, articles, internet data etc related to the subject of subprime mortgage crisis.
Researcher can face different types of accessibility issues while this research study. There may be problem is accessing the participants. The primary data will be collected from different categories of people such as investors, banks, insurance employees etc (Forzano, 2011). A lot of time can be consumed in reaching to the participants. Further he can face issue of lack of resources such as money, content, time etc.
Sampling is an activity which aids in making the data collection work easier. It is related with selection of appropriate respondents for the research who can provide valuable data. Researcher has the option of selecting two types of sampling techniques probability and non-probability (Goddard and Melville, 2004). For this study, purposive sampling has been applied which is a part of non-probability techniques. This sampling approach has been applicable because data is to be collected from people of a specific characteristics. For this study data is required to be collected from people who have the knowledge of stock market or who shares a connection with stock market. Hence this sampling approach is appropriate (Jonker and Pennink, 2010). Further it is also imperative to select an appropriate sample size for the study. Here primary data has been gathered from 50 respondents.
Data analysis is another stringent section of the study. Evaluation of data helps in producing meaningful outcomes for the research. Data can be analysed in qualitative as well as quantitative manner (Kuada, 2012). For this research work, quantitative tool like SPSS has been used for data analysis. SPSS is one the best tool for representing the data in quantitative manner.
There are certain limitations associated with every research. There may be a limitation related to reaching the respondents who will provide the primary data. It is very important that data is to be collected from valid and authentic sources. Researcher may not be able to discover ethical sources for the study (Merriam, 2009). Limitations may also arise during survey process. It can be difficult to derive responses from every participant.
In the study, many constructive information and facts were identified which were backed by findings from past studies and also from the primary research. From the thorough review of past literatures on subprime crisis it was identified that there were number of factors which created the Subprime mortgage crisis. In the present study, it was discovered that the main causes which triggered the subprime crisis were improper lending practices of lenders, wrong ratings of CDO’s by credit rating agencies and improper securitization of asset backed securities by the investment banks. Further, from the present study it was identified that the credit rating agencies was equally responsible like lender and investment bankers for the emergence of Subprime crisis. The particular finding has not been discovered in any past studied and thus here it is determined that credit rating agencies has active role in triggering of subprime mortgage crisis that led to the creation of 2008 financial crisis which brought high negative impact on the global economy with respect to increase in unemployment, wiping out of market valuation of investors wealth, increase in inflation, industrial break down, hampered economic growth and increase in foreclosure. The other flooring information which was discovered from the present study is that the current economic condition of US and other countries have been improved considerably as now the stock index of all countries are moving up and economic growth of all the countries are also steering up. Thus, on the basis of analysis and findings of the research, it can be finally concluded that the credit rating agencies were the equally responsible like lender and investment bankers for the occurrence of subprime crisis. In addition to that, the study also gives evidence that the global economy has been improved at certain level after the passing of 7 years of subprime mortgage crisis. However, there are also some segments or areas like stock markets, investor sentiments, real estate of US, US banking sector and employment which are still taking time for the improvement as they were severely affected from the occurrence of subprime mortgage crisis.
From the above study it can be concluded that If something bad like subprime crisis happens, it does not take too long to identify who is to blame for it. There are lot many factors which can be made responsible for the crisis. In case of subprime crisis, lenders, homebuyers, investors, investing bank, rating agencies etc were blamed for the damage. Lenders granted money to people in the context of poor credit and high risk of default. Lenders regarded subprime mortgages with low amount of risk. Homebuyers were also responsible as they were buying expensive homes at that moment in the expectation that prices will increase in future. Rating agencies provided higher ratings to collateralized debt obligations which resulted in losses for the investors.
Further it can be concluded that global crisis did not have an impact on automotive markets in developing countries, except for automotive exporting nations like South Africa, Mexico, and Thailand etc. Pharmaceuticals sector was also not affected by subprime crisis because no matter what the situation is people will not compromise with their health. Industries which were affected by the crisis were aviation, information technology, etc. There was a great fall in demand in aviation sector and prices of fuel and operating costs got increased.
It can be said that credit rating agencies can be equally put blame able for subprime mortgage crisis. It is evident from the fact there was a lot of criticism about rating agencies, underwriters of the CDO and mortgage backed securities that includes subprime loans in their mortgaged pools. It was expected from the agencies that they should have given lower ratings to these CDOs as compared to “AAA” rating given to the higher quality tranches. If the rating was performed appropriately, less number of investors would have bought into these securities and the losses would not have been so bad. At last, from the report, it can be suggested that the cr Thus from the report can be suggested that the crisis like subprime mortgage crisis can be avoided by following stringent monetary policy and making improvisation in the provisions of credit rating agencies.
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