Collapse of the U.S. sub-prime mortgage lending Market explained through The Kindleberger-Aliber-Minsky Paradigm
In this paper we examine the stages of the recent sub-prime mortgage financial crises through the models of the Kindleberger and Aliber paradigm from their book “Manias, Panics, and Crashes: A History of Financial Crises” and its aftermath. Kindleberger and Aliber’s paradigm is adapted from Hyman Minsky’s idea where events leading up to a crisis begins with a type of “displacement,” a type of outside shock to the macroeconomic system. The KAM model explores the three stages in which a financial bubble crisis is formed, fueled, and then popped. The Mania, also ...view middle of the document...
Technology also aided in the financial innovations in the housing market, simplifying ways for the bank to hand out it’s loans. It has become easy for someone to browse properties with the click of a button and view a nearly infinite number of properties within one sitting (Kindleberger and Aliber, 2011).
As for the government, the change of the tax laws to reduce taxes and specifically the Taxpayer Relief Act of 1997 passed by the Congress paved way to the idea of “flipping” properties. The Taxpayer Relief Act of 1997 allowed profits to be exempted from taxes, up to $500,000 per married couple, if the home was owned and used as a principle residence. Removal of the capital gains tax encouraged home buyers to engage in “flipping” their homes. The buyer would own the house for a short period with the sole intention of selling it very quickly for a higher price, thereby gaining a significant profit without much effort and by using very little of his or her own money as an investment (TAXPAYER RELIEF ACT OF 1997 - U.S. Government Printing ). The KAM paradigm distinguishes this as an initial key component to the cause of the mania.
The KAM model applies to all aspects of the subprime mortgage crises. From the development of the bubble, through the legal, economic, and political aftermath. Kindleberger explains that the credit cycle is closely followed by the business cycle given that initially an external shock will boost the economy for example the rise of the internet. Venture capitalists and banks pours money into the new boom and the overflow of wealth reaches other markets such as real estate. Investors would buy securities thinking that there is no limit to the amount the asset prices could gain. Investors had the belief that they can flip their properties for profits within a short period of time. When the prices have gone too high on real estates and no buyers are available, the borrowers default on their loans. As large waves of loans are unpaid, the banks then decide to stop handing out their credits and so the credit system is entirely frozen (Kindleberger and Aliber, 2011). It becomes a vicious cycle since no one can afford to buy real estate without borrowing money, and the sellers could no longer find themselves a buyer.
THE U.S. SUB-PRIME MORTGAGE
A prime mortgage in the U.S. is a home loan offered by the bank to whom they...