Managerial Economics In Global Environment: Are We Heading Toward Another Subprime Mortgage Crisis? Essay.

Theoretical economic concepts according to the article

Discuss about the Managerial Economics in Global Environment.

US housing sector crisis is one of the most dared crisis that the world economy has ever faced since the great depression of 1929 (Kumhof et al. 2015). Due to the subprime mortgage crisis, record reduction in the housing price has been prevailed in the US economy for almost 6 years (Summers 2015).  With successive stimulus package and through policy reforms, US government has gauged the situation largely; however, according to the purview of the economists, the country is yet to face another GFC like situation.  Through this report, an economic article “Are we heading toward another subprime mortgage crisis?” published in CNN will be discussed from the perspective of various economic tools like supply and demand, scarcity, elasticity and comparative advantage. The report is meant analyse and understand the language and tools of economic analysis of a contemporary economic news article and find out how economic tools are used in economic news reports.

The selected article highlights the US subprime mortgage situation, where it has portrayed the pre 2006 and present situation with through the analysis of difference in key economic factors. The report has pointed that the US economy is presently facing gap in the demand and supply due to rise in price and substantially ineffective demand (Poole, 2018). In addition to this, the report highlights that though there is governmental presence to support any market failure in present day, lack of principal in the market economy is yet to bring in crippling blow to the economy. This would not only affect the comparative advantage that the US housing enjoys at present days, moreover hamper the US insurance sector too. Lastly, it is important to highlight that the report argues lack of active participation of the Fed and rise in rate of interest in successive quarters is aimed to encourage foreign investment, however volatility is constraining the same from moving in. It will not only hamper the US economy in future but also can bring in another financial crisis within coming years.

The chosen article is based on the economic theories like supply and demand, elasticity, trade and comparative advantage. From the idea of distortion in the housing price and housing demand promote that there is certain demand and supply gap in the US housing market (Glaeser and Gyourko 2018). Besides this, the article also highlights that though there is rise in price of the houses, yet the supplies hasn’t increased as much it should be. In addition to this, it can also been traced from the article that during 2000 to 2006, housing price of the US market is one of the lowest in the developed nations, that provided it comparative advantage and it has sourced much needed foreign investment in the housing sector (Wagner and Wied 2017)). It has lead to raise the price further and ultimately turn into subprime mortgage bubble.

Economic discrepancies of the article

From the figure 1, it can be seen that over the year since 1991, Housing price of US has been rising since 2006, and then it started to fall. This depicts that, within the period of two decades, US housing demand has also rose substantially to support the price rise and once there is market volatility, price started to fall (Ferrero 2015). Since 2013, price started to rise again, however it fails to penetrate the market as effectively as pre 2006 condition (Poole, 2018).

Financial crisis of the US was mainly originated from the lack of market discipline owing to the presence of huge private investment. Excess supply of the foreign investment lead to rise in the infrastructural development and on the other hand subprime mortgage took undue advantage of this development. Due to lack of presence of government in the housing sector, price of the houses started to sky rocket and once the subprime mortgage bubble busted, it lead the insurance firms become bankrupted (Mian and Sufi 2015). As a counter measurement, Fannie and Freddie invested $200 billion in the market to prevent the failure of the Bear. Dodd-Frank Wall Street Reform was introduced by the Obama government and by the end of 2010; Consumer Protection Act came into force (Culp 2015). According to the xxx, Federal Housing Finance Agency was developed by the US government in order to win the confidence of the domestic mortgage industry through allocating $300 billion fund for the 400,000 homeowners (Markham 2015). From the economic terms, these reforms can be considered as the government expenditure, which can enhance the aggregate demand effectively to introduce growth in all the sectors. In this regard it is also important to mention that, reduction in the foreign investment in the housing sector due to volatility in the market has hampered the comparative advantage of the US housing sector. Thus, government was forced to reduce the credit score from 660 to 630 to provide loans (Agarwal et al. 2015).

According to the economic theory of supply and demand, if there is rise in price, then it would lead to fall in quantity demanded (considering that the good is normal good), where as the producers will be willing to produce more output at the enhanced price rate (Azevedo and Leshno 2016). This can create the excessive supply and lead to fall in the price again.

Comparing the US housing market with the supply and demand theory, it can be seen that though there is rise in price in present day, number of houses available are falling (Keyens 2016). From the figure 3, it can be seen that the housing market of the US is lacking in supply though there is rise in price as shown in the figure 2 above. According to the figure 3, it can be observed that most of the reputed cities in the US have only 1 house to sale among total available houses, though there is rise in price. This contradicts the basic law of supply and demand.

Conclusion

Analysing the market condition from the scare resource perspective, it can be seen that housing being a normal good is inelastic in nature (Atalay et al. 2016). According to the law of elasticity, if a there is rise in price of normal good, then it will hamper the consumption slightly compared to inferior and luxury good (Harrison 2016). However, considering the case of US housing market, it can be seen that rising price of the affordable housing has effectively reduced the demand of the houses. Kripke (2018) highlights that, maiden buyers of the houses in US has fallen from 40% to 30% during last decade due to rise in price of the available houses.

Conclusion:

Above discussion has portrayed that with rise in the cost of houses in the US economy, and the affordable housing lobby backed by the Fed is again leading the US economy on the verge of destruction. Housing price is enhancing day by day and the gap between the supply and demand is falling apart largely. With reduction in the capital flow in the US economy it is ought to face another financial crisis. Presently with stimuli to the rise in price due to the US backing in the affordable housing project, the economy is yet to face another breakdown because credit rating is low that has stopped the capital inflow and volatility in the market is another factor that can lead to deterioration of the situation.  

Reference:

Agarwal, S., Chomsisengphet, S., Mahoney, N. and Stroebel, J., 2015. Do banks pass through credit expansions? The marginal profitability of consumer lending during the great recession.

Atalay, K., Barrett, G. and Edwards, F., 2016. Housing wealth effects on labour supply: evidence from Australia. Mimeo, University of Sydney.

Azevedo, E.M. and Leshno, J.D., 2016. A supply and demand framework for two-sided matching markets. Journal of Political Economy, 124(5), pp.1235-1268.

Culp, C.L., 2015. OTC-Cleared Derivatives: Benefits, Costs, and Implications of the'Dodd-Frank Wall Street Reform and Consumer Protection Act'.

Ferrero, A., 2015. House price booms, current account deficits, and low interest rates. Journal of Money, Credit and Banking, 47(S1), pp.261-293.

Glaeser, E. and Gyourko, J., 2018. The economic implications of housing supply. Journal of Economic Perspectives, 32(1), pp.3-30.

Harrison, J., 2016. Law and Economics in a Nutshell. West Academic.

Keynes, J.M., 2016. General theory of employment, interest and money. Atlantic Publishers & Dist.

Kripke, P. (2018). Are we headed for another housing collapse?. [online] New York Post. Available at: https://nypost.com/2017/09/02/are-we-headed-for-another-housing-collapse/ [Accessed 18 Mar. 2018].

Kumhof, M., Rancière, R. and Winant, P., 2015. Inequality, leverage, and crises. American Economic Review, 105(3), pp.1217-45.

Markham, J.W., 2015. A financial history of modern US corporate scandals: From Enron to reform. Routledge.

Mian, A. and Sufi, A., 2015. House of debt: How they (and you) caused the Great Recession, and how we can prevent it from happening again. University of Chicago Press.

Poole, W. (2018). Are we heading toward another subprime mortgage crisis?. [online] CNN. Available at: https://edition.cnn.com/2017/03/14/opinions/risk-of-another-housing-crisis-poole/index.html [Accessed 18 Mar. 2018].

Summers, L.H., 2015. Demand side secular stagnation. American Economic Review, 105(5), pp.60-65.

Wagner, M. and Wied, D., 2017. Consistent Monitoring of Cointegrating Relationships: The US Housing Market and the Subprime Crisis. Journal of Time Series Analysis, 38(6), pp.960-980.