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Applied Economic Theory Essay

1123 words - 5 pages

Applied Economic Theory
United States Mortgage Crisis
After rising at an annual rate of nearly 9 percent from 2000 through 2005, house prices have decelerated, even falling in some markets.  At the same time, interest rates on both fixed- and adjustable-rate mortgage loans moved upward, reaching multi-year highs in mid-2006.  Some subprime borrowers with ARMs, who may have counted on refinancing before their payments rose, may not have had enough home equity to qualify for a new loan given the sluggishness in house prices.  In addition, some owners with little equity may have walked away from their properties, especially owner-investors who do not occupy the home and thus have little ...view middle of the document...

Beginning with the third year, the rate changes and fluctuates over the remaining 28 years. Typically, rates can move 2 percentage points beginning in the third year, and adjust every six months. Common cap rates are 6 points over the initial rate, which means a loan taken out at 5% can reach 11%. Many 2/28 loans contain a prepayment penalty, adding insult to injury for those who want to refinance
Sales of previously owned homes in March fell 8.4 percent from February, the group reported. It was the largest one-month drop since sales plummeted 12.6 percent in January 1989, when the country was in a housing recession. It was also 11.3 percent below the number of units sold in March 2006. The drop -- from a seasonally adjusted rate of 6.68 million homes sold in February to 6.12 million in March -- followed three consecutive months of increases in sales of existing single-family houses, townhouses, condominiums and co-ops. Those gains had led to speculation that the market was coming back after a sluggish 2006. According to the Realtors group, total housing inventory fell 1.6 percent at the end of March, to 3.75 million existing homes available for sale. However, at the current sales pace, it would take 7.3 months to get through that supply, up from 6.8 months in February. A stable market usually has a 5.5-month to 6-month supply, experts say.
Sales tumbled in every part of the country. They fell 10.9 percent in the Midwest, 9.1 percent in the West and 8.2 percent in the Northeast. In the South, which includes the Washington region, sales dropped 6.2 percent.
The federal government in 2008 created the Affordable Housing Trust Fund, which is a tax on new homes designed to help make housing more affordable. The Cato Institute holds that this fund will make housing "slightly less affordable for most people so as to make housing more affordable for a few people.” With other policies, such as reduced taxes or the waiver of land use fees, governments can subsidize the construction of new homes, hence reducing the average price. Government incentives to build more homes usually make them, all other things being equal, cheaper.
The central banks were present at the creation, as asset prices inflated and credit markets hypertrophied. Between 1997 and 2006, according...

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