2007 Financial Crisis Can It Happen Again

The 2007 financial crisis is the breakup of trust that occurred between banks the yr earlier the 2008 financial crunch. It was caused by the subprime mortgage crisis, which itself was acquired by the unregulated use of derivatives. This timeline includes the early warning signs, causes, and signs of breakdown. It also recounts the steps taken by the U.Southward. Treasury and the Federal Reserve to prevent an economical collapse. Despite these efforts, the financial crisis withal led to the Cracking Recession.

Fundamental Takeaways:

• The subprime mortgage crisis started in 2007 when the housing industry's asset bubble flare-up.
• With the previous years' increasing dwelling house values and depression mortgage rates, houses were bought not every bit places to live in, but as investments.
• Government entities like Fannie Mae and Freddie Mac guaranteed mortgages, even if they were subprime or those lent to people who wouldn't normally qualify for loans.
• Since the financial industry heavily invested in mortgage-backed derivatives, the housing industry's downturn became the fiscal industry's ending.
• The 2007 financial crisis ushered in the 2008 Bully Recession.

February 2007: Homes Sales Height

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In February 2007, existing domicile sales peaked at an annual rate of five.79 million. Prices had already begun falling in July 2006, when they hitting $230,400. Some said it was considering the Federal Reserve had just raised the fed funds charge per unit to 5.25%. In January 2007, new homes prices peaked at $254,400.

Even though each calendar month brought more bad news about the housing market place, economists couldn't agree on how dangerous it was. Definitions of recession, conduct market, and a stock marketplace correction are well standardized. The aforementioned is not true for a housing market slump.

The research did show that price declines of 10%-xv% were plenty to eliminate nearly homeowners' equity. Without equity, defaulting homeowners had little incentive to pay off a firm they could no longer sell.

Economists didn't think prices would fall that far. They also believed homeowners would take their homes off the market before selling at such a loss. They assumed homeowners would refinance. Mortgage rates were only half those in the 1980 recession. Economists thought that would exist enough to allow mortgage holders to refinance, reducing foreclosures. They didn't consider that banks wouldn't refinance a mortgage that was upside down. Banks wouldn't accept a house as collateral if it were lower in value than the loan.

February 26, 2007: Greenspan Warns of a Recession, only the Fed Ignores It

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On February 26, onetime Federal Reserve Chairman Alan Greenspan warned that a recession was possible later in 2007. A recession is two consecutive quarters of negative gross domestic production growth. He also mentioned that the U.S. budget deficit was a significant business organisation. His comments triggered a widespread stock market sell-off on February 27.

On February 28, Fed Chairman Ben Bernanke's testified at the House Budget Commission. He reassured markets that the United states of america would go on to benefit from another year of its Goldilocks economic system.

On March two, 2007, the Federal Reserve Bank of St. Louis President William Poole said that the Fed predicted the economy would grow 3% that year. Poole added that he saw no reason for the stock market place to turn down much beyond electric current levels. He said stock prices were not overvalued every bit they were before the 2000 turn down.

March 6, 2007: Stock Market Rebounds Subsequently Worst Week in Years

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On March six, 2007, stock markets rebounded. The Dow Jones Industrial Average rose 157 points or i.3% after dropping more than 600 points from its all-time high of 12,786 on February 20.

Did that mean everything was okay with the U.S. economy? Non necessarily. For one thing, the stock market reflects investors' behavior about the time to come value of corporate earnings. If investors retrieve earnings volition become up, they volition pay more than for a share of stock. A share of stock is a piece of that corporation. Corporate earnings depend on the overall U.Due south. economy. The stock market place so is an indicator of investors' beliefs about the state of the economy. Some experts say the stock market is a six-month leading indicator.

The stock market also depends on investors' beliefs about other investment alternatives, including foreign stock exchanges. In this case, the sudden 8.four% drop in People's republic of china's Shanghai index acquired a global panic, as investors sought to cover their losses. A big cause of sudden market place swings is the unknown effects of derivatives. These permit speculators to infringe money to purchase and sell large amounts of stocks. Thanks to these speculators, markets can decline suddenly.

For these reasons, sudden swings in the U.S. stock market can occur that is no reflection on the U.S. economy. In fact, the market upswing occurred despite several reports that indicated the U.S. economic system was doing more poorly than expected.

March 2007 - Hedge Funds Housing Losses Spread Subprime Misery

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By March 2007, the housing slump had spread to the financial services industry. Business organization Week reported that hedge funds had invested an unknown amount in mortgage-backed securities. Unlike mutual funds, the Securities and Substitution Committee didn't regulate hedge funds. No ane knew how many of the hedge fund investments were tainted with toxic debt.

Since hedge funds employ sophisticated derivatives, the impact of the downturn was magnified. Derivatives allowed hedge funds to borrow money to make investments. They did this to earn higher returns in a expert market place. When the marketplace turned southward, the derivatives then magnified their losses. In response, the Dow plummeted two% on Tuesday, the second-largest drib in two years. The drib in stocks added to the subprime lenders' miseries.

April eleven, 2007 - Fed Ignores Alarm Signs, Stock Market Disapproves

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On Apr eleven, 2007, the Federal Reserve released the minutes of the March Federal Open Market Committee meeting. The stock market place dropped 90 points in disapproval. Worried investors had hoped for a decrease in the fed funds rate at that meeting.

Instead, the Fed was worried more nigh inflation. It ruled out a return to expansionary monetary policy anytime soon. Lower interest rates were needed to spur homeowners into buying homes. The housing slump was slowing the U.S. economy.

Apr 17, 2007: Assistance for Homeowners Not Enough

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On Apr 17, 2007, the Federal Reserve suggested that the federal financial regulatory agencies should encourage lenders to work out loan arrangements, rather than foreclose. Alternatives to foreclosure included converting the loan to a fixed-rate mortgage and receiving credit counseling through the Middle for Foreclosure Alternatives. Banks that worked with borrowers in depression-income areas could have received Community Reinvestment Act benefits.

In addition, Fannie Mae and Freddie Mac committed to helping subprime mortgage holders keep their homes. They launched new programs to help homeowners avoid default. Fannie Mae developed a new attempt called "HomeStay." Freddie modified its program called "Habitation Possible." It gave borrowers means to get out from under adaptable-charge per unit loans earlier interest rates reset at a higher level, making monthly payments unaffordable. These programs didn't help homeowners who were already underwater, and by this time, that was nigh of them.

April 26, 2007: Durable Goods Orders Forecast Recession

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The business printing and the stock market celebrated a 3.4% increase in durable goods orders. This result was better than the 2.4% increase in Feb and much better than the 8.viii% refuse in Jan. Wall Street celebrated because information technology looked like businesses were spending more on orders for machinery, reckoner equipment, and the like. It meant they were getting more confident in the economy.

Comparing the orders on a year-over-yr ground told a different story. When compared to 2006, March durable goods orders declined by 2%. This decline was worse than February's twelvemonth-over-year decline of 0.iv% and January'sincrement of ii%. In fact, this softening trend in durable goods orders had been going on since last April.

Why are durable goods orders and then important? They correspond the orders for big-ticket items. Companies will concord off making purchases if they aren't confident in the economy. Even worse, fewer orders mean declining product. That leads to a drop in Gdp growth. Economists should have paid more than attention to this attribute of this critical leading indicator.

June nineteen, 2007: Home Sales Forecast Revised Down

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The National Association of Realtors forecast dwelling house sales would fall to half-dozen.18 million in 2007 and half dozen.41 million in 2008. That was lower than the 6.48 million sold in 2006. It was lower than the NAR'south May forecast of 6.iii million sales in 2007 and 6.5 million sales in 2008.

The NAR too predicted the national median existing-domicile price would decline past 1.3% to $219,100 in 2007. It thought prices would recover past 1.7% in 2008. That was ameliorate than May'southward forecast of a low of $213,400 in the first quarter of 2008. It was still downwards from a high of $226,800 in the second quarter of 2006.

August 2007: Fed Lowers Charge per unit to four.75%

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In a dramatic activity, the Federal Open Market Commission (FOMC) voted to lower the benchmark fed funds rate a half-bespeak down from 5.25%. This reduction was a bold move since the Fed prefers to adjust the rate by a quarter-point at a time. It signaled an changeabout in the Fed's policy. The Fed lowered the rate two more times until information technology reached 4.25% in December 2007.

Banks had stopped lending to each other considering they were agape of beingness defenseless with bad subprime mortgages. The Federal Reserve believed lower rates would be enough to restore liquidity and confidence.

September 2007: Libor Rate Unexpectedly Diverges

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As early as August 2007, the Fed had begun extraordinary measures to prop upward banks. They were starting to cutting back on lending to each other considering they were afraid to become stuck with subprime mortgages as collateral. Equally a result, the lending rate was rise for short-term loans.

The London Interbank Offered Rate (LIBOR) rate usually is a few tenths of a point above the fed funds rate. Past September 2007, it was almost a full indicate college. The departure of the historical LIBOR rate from the fed funds rate signaled the coming economical crisis.

October 22, 2007: Kroszner Warned Crisis Non Over

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Federal Reserve Governor Randall Kroszner said that, for credit markets, "The recovery may be a relatively gradual process, and these markets may non expect the same when they re-emerge."

Kroszner observed that collateralized debt obligations and other derivatives were and so complex that information technology was difficult for investors to make up one's mind what the existent value should be. As a result, investors paid whatever the seller asked, based on his sterling reputation. When the subprime mortgage crunch hit, investors began to doubt the sellers. Trust declined, and panic ensued, spreading to banks.

Kroszner predicted that the collateralized debt obligation (CDO) markets would never return to health. He saw that investors couldn't define the price of these complicated financial products. Everyone realized that these complicated derivatives, which even the experts had problem understanding, could critically damage the country's finances.

In October, existing-home sales fell 1.2% to a rate of 4.97 million. The sales step was the lowest since the National Association of Realtors began tracking in 1999. Domicile prices fell 5.1% from the prior twelvemonth to $207,800. Housing inventory rose at1.9% to 4.45 million, a 10.8-month supply.

Nov 21, 2007: Treasury Creates $75 Billion Superfund

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Treasury Secretary Henry Paulson convinced three banks, Citigroup, JPMorgan Chase, and Banking company of America, to gear up upwardly a $75 billion superfund. BlackRock managed the superfund for buying distressed portfolios of defunct subprime mortgages. The fund would provide liquidity to banks and hedge funds that bought the nugget-backed commercial newspaper and mortgage-backed securities that lost value.

The U.Southward. Treasury backed the superfund to ward off further economical decline. The goal was to give the banks plenty fourth dimension to effigy out how to value these derivatives. Banks would exist guaranteed by the federal government to accept on more subprime debt.

December 12, 2007: Fed Announces TAF

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Lowering the fed funds rate wasn't plenty to restore banking company confidence. Banks were afraid to lend to each other. No i wanted to get caught with bad debt on their books at the terminate of 2007.

To keep liquidity in the financial markets, the Fed created an innovative new tool, the Term Auction Facility (TAF). It supplied short-term credit to banks with sub-prime number mortgages.

The Fed held its offset 2 $20 billion auctions on December 11 and December 20. Since these auctions were loans, all coin was paid back to the Fed. TAF didn't price taxpayers anything.

If the banks had defaulted, taxpayers would have had to pes the neb as they did with the Savings and Loan Crisis. It would have signaled that the financial markets could no longer function. To preclude this, the Fed continued the auction program throughout March 8, 2010.

TAF gave banks a gamble to unwind their toxic debt gradually. It also gave some, similar Citibank and Morgan Stanley, a chance to find additional funds.

Dec 2007 - Foreclosure Rates Double

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RealtyTrac reported that the rate of foreclosure filings in December 2007 was 97% higher than in December 2006. The total foreclosure rate for all of 2007 was 75% college than in 2006. This growth means that foreclosures were increasing at a rapid rate. In total, ane% of homes were in foreclosure, up from 0.58% in 2006.

The Center for Responsible Lending estimated that foreclosures would increase past 1-two one thousand thousand over the next 2 years. That's because 450,000 subprime mortgages reset each quarter. Borrowers couldn't refinance as they expected, due to lower home prices and tighter lending standards.

The Center warned that these foreclosures would depress prices in their neighborhoods by a full of $202 billion, causing 40.half dozen meg homes to lose an average of $5,000 each.

Abode sales barbarous 2.2% to 4.89 million units. Habitation prices barbarous half-dozen% to $208,400. It was the 3rd price drop in four months.​

The housing bosom caused a stock market correction. Many warned that, if the housing bust continued into spring 2008, the correction could turn into a carry market, and the economy could endure a recession.

2008 Financial Crisis Timeline

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The crisis in cyberbanking got worse in 2008. Banks that were highly exposed to mortgage-backed securities soon found no ane would lend to them at all. Despite efforts by the Fed and the Bush Administration to prop them upward, some failed. The government barely kept ane stride ahead of a complete financial collapse.

Ofttimes Asked Questions (FAQs)

How exercise you prevent financial crunch from recurring in the future?

In the aftermath of the fiscal crisis, Congress passed the Dodd-Frank Wall Street Reform Deed. This comprehensive legislation sought to strengthen the financial system. Its provisions included new financial regulations and oversight frameworks, such equally prohibiting many banks from prop trading.

Who went to jail for the financial crunch?

Kareem Serageldin pleaded guilty to conspiracy charges in 2013 for his function in the financial crisis. The judge sentenced him to xxx months of imprisonment. Hundreds more than were convicted for fraud related to how bailout funds were spent.

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Source: https://www.thebalance.com/2007-financial-crisis-overview-3306138

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