China stands on the top waves of financial crisis
Name: Li Yanping Student ID: S08074
Research paper supervisor:Dr.Sekou Conde
Minzu University of China
2008-2009 Academic Year
Abstract: In 2008, financial crisis, firstly happened in American, spreads to other countries in the world, it results in an earthquake in global financial market, and almost all countries suffer great lost in this crisis. The financial crisis formed by the housing market bubbles named sub-prime crisis, it had caused large financial institutions collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. China also have great challenges in this crisis, china’s real estate market, imports and exports, medium and small enterprises, migrants workers had suffered a tremendous impact in this crisis. China had confidents to tackling financial crisis and many of the measures had taken to cope with the economic crisis.
Key words: sub-prime crisis; economic recession; influence to china; economic stimulus
1.Introduction of the Financial Crisis of 2008
In Feb.13th of 2007, HSBC Holdings increased $1.8 billion bad debt provision for the mortgage loans he issued, the risk of mortgage loans began to emerge out. In March, U.S. Mortgage Bankers Association released a report, calming that credit market emerge crisis. In April 14th, New Century Financial Corporation went bankruptcy. Then, the crisis dispersed to the derivative market whose basic assets were subprime loans, many banking institutions, mortgage companies have been involved in sub-loan crisis, the United States financial services industry began to decline. The outbreak of the sub-loan crisis is only the beginning of the financial crisis, followed by a series of knock-on effect caused, U.S. recession had begun. Bad debts and loans in banking institutions increased, dollar value began to decline, in September, 159,000 jobs were lost, bringing the monthly average to 84,000 per month from January to September of 2008.The famous investment bank Lehman collapsed, Goldman Sachs, Morgan transformed into bank holding companies, those events let the investment banks to be the past history. Since then, financial crisis began to spread to other countries in the world.
The Subprime Crisis Explained
A) The context of Subprime Crisis
Sub-prime loan is the loan to high risk customer. At the beginning of 1998, the prices of technology companies run up in stock and it was called “tech boom.” This boom collapsed in early 2000, leading to the so-called “tech wreck” in the stock market, a collapse in spending on technology and a mild recession in 2001. [1]
To prevent this situation worsen and to stimulate economic growth, Alan Greenspan started to dramatically drop interest rates. From the graph blow we can see that interest rates are very low after 2002. [2]
Spurred by low interest rates, mortgage lenders in the U.S. started turning to lower income households. They were inspired to do so by the introduction of “securitization” of mortgages –investment firms bundled large numbers of mortgages were together and sold to banks and other investors instead of keeping mortgages on their books and relying on homeowners to pay them down. Since lenders were no longer caught in if the homeowners taking out the mortgages defaulted, lending standards were not so rigid across the board. This led to “subprime” mortgages .Because the lender didn’t stay on the mortgages, there was little real concern about borrowers’ ability to repay the mortgages. Meanwhile, the government made lots of political support that would allow lower income households to own home and get their American dream. Almost every possible rule was unrigged to give lower income households access to financing insured by government agencies Fannie Mae and Freddie Mac. The customers no longer worried about the traditional barriers to buy a home – houses were offered with low or no down payment and no closing costs. Rules were changed, so lenders could select their own for the mortgage ,they didn’t have to set the home value using government appointed appraisers– as a result, lots of cases have materialized of inflated and sometimes fraudulent appraisals. Large mortgage lenders focused on the subprime market sprung up. [3]Many investment institutions competed to increase provide mortgages to people whose incomes were low, a home’s value could be obtained via a mortgage steadily went up – At last, borrowers could get a mortgage for 100% of the appraised value. Because the low payments, renters were inclined to purchase homes and acquired mortgages they could never hope to afford. These home buyers did so in the hope that housing prices would go up enough that by the time the higher rates kicked in they could either sell their house for a profit or cash in on the gains through loans against their home equity [1]. All of these factors together led to a boom in lending to “subprime” borrowers who would not have qualified for mortgages. In large part due to the elevated demand from unqualified buyers who came into the market and from people buying homes way beyond their means, the early part of this decade saw housing prices increase at an accelerated rate – in what turned out to be a mini bubble.
Beside the consumer’s action, a lot of investment bank went into action. Using
large amounts of debt, investment vehicles were created offering premium interest rates to financial institutions and other investors who bought them. Another contributor to the problem is bond rating agencies dramatically misread the risk
in these derivative instruments, giving some of them their highest rating of AAA. some insurance companies, such as AIG sold insurance against these mortgages defaulting – as it turned out, some of the firms that sold the insurance did not have enough funds when called on to back up mortgages that ran into trouble.
Because the escalation of mortgage lending and the packaging of these mortgages, profits by financial institutions rose dramatically. For the reasons of concerning developed about the economy overheating, the Federal Reserve Board raised interest rates to slow the economy down in 2006. In response, the housing market started to slow as well - as the rate of borrowing went up, the large volume of new houses coming on stream pushed down prices and increase in defaults on mortgages appeared. Throughout 2006, U.S. housing prices continued to decline, leading to an increase in mortgage defaults. Just the followed graph says: Form 2001 to 2006, the housing price always increased, but, since then, housing prices started to get down.
Source：Office of Federal Housing Enterprise Oversight
To the beginning of 2008, the drop in housing values had led to a growing level of mortgage delinquencies. In some markets, prices declined by 30% to 50% compared to the same time the year before. In the summer of 2008, rising mortgage defaults caused the near collapse and the nationalization of two massive U.S. mortgage lenders – Fannie Mae and Freddie Mac. In September, financial crisis accelerate. Three of the largest U.S. financial institutions changed enterprise type –Bank of America acquired Merrill Lynch, AIG required a bailout by the Government and Lehman Brothers was allowed to collapse entirely.
In totally, the whole reason of financial crisis in American can explain as follow [4]:
Credit expansion
Interest rates decline rates rise, bubbles break
Asset price bubbles
Outbreak of financial crisis
To stimulate economic growth, U.S. Federal Reserve Board dramatically drops interest rates, it leads the credit expansion and asset price bubbles. As concerns developed about the economy overheating, the Federal Reserve Board raised interest rates, as followed, the housing bubble break, a lot of financial institutions went bankrupt, financial crisis outbreak.
B) The influence to American’s economy
American stepped into financial crisis in 2008; it was suggested by several important indicators of economic downturn.
1）Rise in unemployment
United States Department of Labor report that its unemployment rate rose to 6.1%, the highest in five years. Jared Bernstein, economist at the Economics Policy Institute in Washington, said: “The unemployment rate jumped to 6.1 percent in August, its highest level in five years, as the erosion of the job market accelerated over the summer”. [5] Employers cut 84,000 jobs last month, more than economists had expected, and the Labor Department said that more jobs were lost in June and July than previously thought. So far, 605,000 jobs have disappeared since January. The unemployment rate, which rose from 5.7 percent in July, is now at its highest level
since September 2003[6].
From: United States Department Of Labor
As we can see, with the growth of inflation, the rate of unemployment is declining from 2004 to 2008.
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