The Mortgage Crisis in a Global Economy

Everybody’s talking about the mortgage crisis, in which risky mortgages were bundled together by Wall Street and then sold to investors who borrowed heavily themselves in order to buy them. The collapse of this investment system could cause a recession in the United States, but what about the rest of the world? 

The U.S. is a major player on the world’s economic stage and when our economy begins to crumble, it sends international markets reeling. For example, markets in Hong Kong, Taiwan, Mumbai, and Singapore have all dropped. But why? Because banks and investors in these places (and all over the world) invested millions in U.S. subprime-mortgage-related bonds and are experiencing major losses. 

But according to traditional economic theory, interconnected global markets should make the world economy more stable, since the risk is spread more widely, but this isn’t necessarily the case.

This has implications for foreign governments as well as ordinary consumers. People who are having trouble paying their mortgage can no longer call their local bank to renegotiate because their mortgage is being held by an investor thousands of miles away.

Global recession?

But some, including Japanese Prime Minister Yasuo Fukuda, don’t think the U.S. housing slump will cause a global recession. Fukuda says the situation is under control and seems to agree that the U.S. Federal Reserve Chairman Ben Bernanke has taken appropriate steps to curb the situation. The Federal Reserve has cut interest rates twice in the last two months in order to make it easier for banks and their customers to borrow.

But many others say the mortgage crunch is going to get worse before it gets better. Analysts predict weaker home sales, less consumer spending, and an increase in foreclosures.

Borrowing from home

Many people were using their homes like ATMs, getting cash out of them to buy other things. But now that housing prices have dropped, people don’t have the extra equity to borrow off of and are spending less, much less.

According to former Federal Reserve Chair Alan Greenspan, Americans spent $310 billion a year between 2004-2006 that was pulled from residential real estate via home equity lines of credit and refinanced mortgages. Since consumer spending accounts for 70 percent of economic activity in the United States, even a slight dip in home borrowing takes a lot of money out of the flow.

This year, home equity withdrawals are down 15 percent, lowering consumption. A fall of 2 percent in consumption would be big enough to trigger a recession. 

Further, trade deficits with China and Japan make Americans vulnerable to the possibility that foreigners could stop purchasing American debt, which would make the dollar even weaker and force the fed to raise interest rates.  Some say the best way to avoid this is for Americans to save more and spend less. Others, like Robert Kuttner, co-editor of The American Prospect and former chief investigator for the Senate Banking Committee, say that federal government should regulate Wall Street more carefully and put the breaks on this sort of unsteady borrowing.

Kuttner gives voice to the public feeling that government should do something to both manage the buying and selling of risk as well as prevent unscrupulous lending practices in the future. The economy is global, but individuals look for a “solution” to the subprime mortgage crisis to their national and even regional governments. There is no global government.

WomenMatter will continue to track the debate about both the causes and the possible fixes to these serious problems.

What do you think?

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