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Current market crisis Essay

The existing crisis which has already covered the economy and numerous markers is often referred to as subprime mortgage problem. The current decline of the securities industry is merely a consequence, knit directly with the original issue of the fall of the United States housing system, which has passed through several stages, exposing market players and the government to new challenges and difficulties. Primarily, it is important to understand the roots of the crisis, which consist in the boosting of the American housing.

Given that with the beginning of the new millennium, the population’s income has risen dramatically, all financial institutions, eligible to provide housing loans, began to accept increasingly more critical moral hazards, i. e. began to lure those borrowers who were not qualified enough for such a huge loan. The frequency of principal-agent problem cases had also grown substantially. In economics, “the principal agent problem treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent” (Fukuyama, 1995, p. 54).

This model can be easily applied to the relationship between borrower and financial institution, in which the former conceals certain information about their spending plans and current financial situation and therefore are more

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likely to fail to return the loan. The popularization of housing loans subsequently caused the decline of risk premiums: “A study by the Federal Reserve indicated that the average difference in mortgage interest rates between subprime and prime mortgages declined from 2. 8 percentage points in 2001, to 1. 3. percentage points in 2007” (Lahart, 2007, p. 12).

Thus, given the spread of the loans, financial institutions needed lower risk premiums and were less selective in defining eligible borrowers. As a result, the numerous “risky” customers at certain time exhibited the careless behavior financial institutions intrinsically expected, but given their number and the total amount of loans the borrowers failed to manage, several financial entities became insolvent immediately. Due to the three-decade-long tendency for securization of assets, the securities (especially those supported by mortgage) of most entities have been falling over the last year.

It also needs to be noted that the securities were overestimated, i. e. their monetary price did not reflect their true value. Again, it is important to return to the situation with the growing number of borrowers, associated with moral hazard. Due to the fact that lenders were jeopardizing their financial stability by serving such customers, they naturally needed to safeguard themselves by “transferring” the potential risk into the monetary price of securities.

In 2007, such capital as mortgage-backed securities appeared to investors extremely attractive and beneficial, given that they were growing in price muck quicker as compared to bonds issued by the players of other markets, not involved into mortgage sphere. The trend for such disproportionate growth contravened with the efficient-market hypothesis, which states that “financial markets are informationally efficient, or that prices on traded assets, e. g. stocks, bonds , or property, already reflect all known information” (Fukuyama, 1995, p. 97); as a result, correction finally began and appeared inexplicable to most parties involved, probably, even to financial institutions which were barely capable of anticipating the climax of “hazardous behavior”.

Finally, globalization, which managed to cover the world’s market over the last two decades, also resulted in the international spread of the securities crisis.

Most stock markets are currently falling, and central banks of the main states, similarly to the Federal Reserve, are trying to manage the inflation, directly related to the devaluation of securities, though curbing the amount of money available to citizens. As a result, the purchasing capacity of investors and ordinary citizens is decreasing. Reference list Lahart, J. (2008). Egg Cracks Differ in Housing. Wall Street Journal, 13 July, p. 16. Fukuyama, F. (1995). Trust: The Social Virtues and the Creation of Prosperity. London: Hamish Hamilton.

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