57431174 the Sub Prime Crisis the Crisis of Over Spending

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The Crisis of over-spending

and over-supply


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United Nations Human Settlements ProgrammeNairobi 2011


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Te Global Urban Economic Dialogue SeriesTe Sub Prime Crisis: Te Crisis o Over-Spending and Over-Supply

First published in Nairobi in 2011 by UN-HABIA.Copyright United Nations Human Settlements Programme 2011

HS/069/11EISBN (Series): 978-92-1-132027-5ISBN(Volume): 978-92-1-132363-4

Disclaimer

Te designations employed and the presentation o the material in this publication donot imply the expression o any opinion whatsoever on the part o the Secretariat othe United Nations concerning the legal status o any country, territory, city or areaor o its authorities, or concerning the delimitation o its rontiers o boundaries.

Views expressed in this publication do not necessarily reect those o the UnitedNations Human Settlements Programme, the United Nations, or its Member States.

Excerpts may be reproduced without authorization, on condition that the source is indicated.

Acknowledgements:

Director: Oyebanji Oyeyinka

Chie Editor and Manager: Xing Quan Zhang

Principal Author: Xing Quan Zhang

Contributors: Oyebanji Oyeyinka, Ananda Weliwita, Asa Jonsson

English Editor: om Osanjo

Design and Layout: Victor Mgendi

Cover Photo : Donald R. Swartz/Shutterstock


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Urbanization isone o the mostpowerul, irreversibleorces in the world. Itis estimated that 93percent o the utureurban population

growth will occur inthe cities o Asia and

Arica, and to a lesserextent, Latin America and the Caribbean.

We live in a new urban era with most ohumanity now living in towns and cities.Global poverty is moving into cities, mostly indeveloping countries, in a process we call theurbanisation of poverty.

Te worlds slums are growing and growingas are the global urban populations. Indeed,this is one o the greatest challenges we ace inthe new millennium.

Te persistent problems o poverty andslums are in large part due to weak urbaneconomies. Urban economic development isundamental to UN-HABIAs mandate.Cities act as engines o national economicdevelopment. Strong urban economiesare essential or poverty reduction and theprovision o adequate housing, inrastructure,education, health, saety, and basic services.

Te Global Urban Economic Dialogueseriespresented here is a platorm or all sectorso the society to address urban economicdevelopment and particularly its contributionto addressing housing issues. Tis work carriesmany new ideas, solutions and innovativebest practices rom some o the worlds

leading urban thinkers and practitionersrom international organisations, nationalgovernments, local authorities, the privatesector, and civil society.

Tis series also gives us an interestinginsight and deeper understanding o the widerange o urban economic development andhuman settlements development issues. It willserve UN member States well in their quest

or better policies and strategies to addressincreasing global challenges in these areas

Joan ClosUnder-Secretary-General, United Nations

Executive Director, UN-HABIA

FOREWORD


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CONTENTS

FOREWORD III

CONTENTS IV

LISTS OF BOXES, FIGURES AND TABLES VII

INTRODUCTION 1

The Breakdown of the Global Financial System 3

Excessive Public Spending and Excessive Growth

of Government 3

THE CAUSES OF THE SUB PRIME CRISIS 3

Total US Federal Obligations Far Exceed the GDP

of the Whole World 5

Oversupply of US Dollars Distort Real Economy 6

Oversupply of US Dollars Making Financial Institutions

Lowering Lending Criteria 7

Oversupply of US Dollars Contributing to the Soaring

of Housing Prices 7Deregulation Opens Door for Sub Prime Lending 9

Reckless Lending of Financial Institutions 10

The Role of Mortgage Brokers in Promoting Loans

to Sub-prime Borrowers 10

The Role of Securitisation in Expanding Subprime Mortgages 11

Over-emphasis of Homeownership and Lack of Oversight

Driving Riskier Lending 11

Rapid Increase of Subprime Mortgages Leading toCredit Crunch 12

IMPACTS OF THE SUB PRIME CRISIS 15

The Broken Dream of Homeownership 16

Impact on Remittances 16

Impact on Foreign Direct Investment 17

Impact on International Trade 17

Oversupply of Currencies Distorts the Real Economy

and the Welfare of People 18

The Rapid Increase of Unemployment 19

REFERENCES 23


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LISTS OF FIGURES

v

Figure 1: Public Debt in USA 4

Figure 2: Rapid Increase o Federal Government Debt rom a Long-Term Perspective. 5

Figure 3 Huge Trade Decit Shows the Imbalance o Production and Consumption in USA 5

Figure 4: Depreciation o US Dollar to Gold 6

Figure 5: Housing Price Increase over the Previous Year 7

Figure 6: Infation-Adjusted Housing Prices in USA 8

Figure 7: Housing Prices vs. Owner-Equivalent Rent in USA 8

Figure 8: Sub Prime Mortgage Market Growth and Share o Total Mortgage Market 10

Figure 9: Projected State Foreclosure Rates or Sub Prime Loans 13

Figure 10: Housing Price Changes in USA 15

Figure 11: Properties with Foreclosure Activity in USA 16

Figure 12: The Importance and Fall o Remittances 17

Figure 13: Growth o International Trade and World Gross Product 18

Figure 14: Geographic Distribution o Unemployment Rates in USA in 2009 20

Figure 15: Uneumployment Rates or Workers 25 Years and Older, by Education in USA 21


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INTRODUCTION

Te sub prime crisis reers to the collapse osub prime mortgage markets in USA dueto the sharp rise in oreclosures beginningin 2006 and led to the ailure, merger andgovernment bailout o leading Americannancial institutions and enterprises such asBear Stears, AIG, Fannie and Freddie, Merrill

Lynch, Citi Group, Lehman Brothers and etc.Te sub prime crisis triggered a nancial crisis

which rapidly spread to other countries aroundthe world and became a global nancial crisisin 2008. It aects every country and everyonethrough the global nature o the nancialsystem.

In late 2008, the global nancial crisis beganto aect the real economy and triggered aglobal economic crisis. It resulted in the worstglobal economic recession since the GreatDepression o 1920s and 1930s. Te sub primecrisis is basically the crisis o the overspendingo governments and individuals beyond their

nancial capacities. It is the crisis o over-consumption. It is the imbalance betweenconsumption and production. It is the resulto consumptionalism. Tis report examines thecauses o the sub prime crisis and the impacto the sub prime crisis and that o the globalnancial crisis caused by the sub prime crisis.


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The Breakdown of the GlobalFinancial System

In July 1944, a new international monetarysystem was agreed upon at the United NationsMonetary and Financial Conerence held inBretton Woods, New Hampshire, USA. Te

system was based on xed exchange rates and acommon standard. In the 19th and early 20thcenturies, the role o monetary standard wasplayed mainly by gold. Te value o currencies

was benchmarked against a xed weight oprecious metal. A country with a decit inits balance o payments would make up theshortall with sales o some o its gold reserves,

with a concomitant reduction in its moneysupply.

Te Bretton Woods system adopted a goldexchange standard whereby one ounce o themetal was worth a xed USD35.00, a ratethe US government promised to maintain.ogether with chronic US external decits,this system established the hegemony o theUS dollar in the global nancial system, whereit became the near-exclusive reserve currency.However, the US government ound it

increasingly difcult to meet its commitments.

In the post-war decades, the USA acted asthe main engine o world economic growth,importing more goods and services thanit exported. Te resulting sureit o dollarsaround the world was the near-exclusive sourceo international liquidity. Te problem wasthat i dollar supply was perceived as excessive,condence in the currency became weaker,

and so did its gold peg. Ater a successiono currency crises in the late 1960s, the USgovernment on 15 August 1971 unilaterally

lited the xed peg between the dollar andgold. Te liting o the gold exchange standarddiscipline triggered an era o uncontrolledprinting o US dollars, leading to quickination and eective devaluation (the dollarhad lost about 100 per cent o its value againstgold by 1972).

Excessive Public Spendingand Excessive Growth ofGovernment

For many years, many countries have beenadvocating or market principles and smallgovernments. But their practices or what theyactually do are oten dierent rom what theypreach. For example, public spending has soared.Government does not reduce public spendingbut rather increases it disproportionately. Inthe USA, it increased about ve old in the lasttwo decades. Te outstanding public debt inUSA stood at around USD 10 trillion in 2008.Te US government spends excessively. TeUS Government aced huge decit (Figure 1and 2). However, the US government tried to

solve the problem by repeating the cause o theproblem. Tat is to solve the decit problemsby borrowing more money and creating moredecits. Tis is why a ormer EU chairmancritises the approach o over-spending andrecently warned that urther public excessivespending is not a solution, rather a way tothe hell. Recent debt crisis in Greece, Spain,Iceland, Portugal and Italy has more clearlydemonstrated the problem o excessive public

spending.President Obamas budget blueprint would

THE CAUSES OF THE SUB PRIME CRISIS


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THE SUB PRIME CRISIS: THE CRISIS OF OVER-SPENDING AND OVER-SUPPLY

raise a total spending to USD3.9 trillion in2009, an increase o nearly 32 percent. Tis isthe highest level since World War II. In the nextve years, his plan would double the nationaldebt. In 10 years, the debt would triple. Many

would argue that the US government and theUK and EU had no option but to rapidlyincrease government spending and to bailout the banks whose reckless lending and use

o dubious nancial derivatives brought theproblem in the rst place. But it will ultimatelylead to the overburden and depreciation ocurrencies, which aects the aordability ogovernments and shrinkage o peoples wealth

due to currency depreciation and could lead toanother wave o crisis sooner or later.

FIGURE 1: Public Debt in USA (in USD)

Source: Generated rom http://www.savingsbonds.gov/govt/reports/pd/histdebt/histdebt_histo1.htm


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Compared to 1929, the US ederal governmentdebt is 625 times larger. Starting late 1960s, anupward trend emerged, then accelerating in theearly 1970s. In the meantime, the householdincomes (adjusted or ination) ceased rising

or two and a hal decades and real incomes ellor ull-time employed male workers. Tis alsomakes household savings more difcult due tothe decline in real income.

Te government share o the economyaccounts or 61 percent and is larger than theprivate sector in the USA. It equates to 6.7months per year o a workers income neededto cover government spending and regulations

- 5.2 months to cover government spendingand another 1.5 months to cover mandatedregulatory compliance costs. Te ederalgovernment spending was growing much asterthan the nations economy in USA. Not onlythe government is getting too big in termso expenditure and sta but it is also morecentralised rather than decentralised.

Te government spending has 800 percent o

increase in the ederal share o the total economyin USA, which increased rom 3 percent to 28percent. Even though the ederal government

grows aster than state and local governments,the State and Local Governments still growincredibly. Te state and local governmentemployees grow 12.7 million aster than thepopulation at large in USA. Te state and local

government employees grow rom 3.3 millionin 1946 to 19.3 million employees today.Tat is more than 470 percent aster than thenational population growth.

Total US Federal Obligations FarExceed the GDP of the WholeWorld

Te real ederal budget decit was USD12.3trillion, not the USD455 billion previouslyreported. Despite the huge decit, the Obamaadministration continues to push throughCongress its USD800 billion decit-spendingeconomic stimulus plan, the Americanpublic is largely unaware that the true decito the ederal government already is measuredin trillions o dollars, and in act its USD 90trillion in total obligations ar exceeds the grossdomestic product o the entire world.

Since 1990s, the trade decit has continued to

FIGURE 2: Rapid Increase o FederalGovernment Debt rom aLong-Term Perspective.

Source: http://mwhodges.home.att.net/debt.htm

FIGURE 3 Huge Trade Decit Shows theImbalance o Production andConsumption in USA

US$10 trillionand of FY 2008

Defcits

Source: http://www.alkalizeorhealth.net/Ldebtclock.htm


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increase in USA. Te country consumes morethan it produces. Te trade decit reects theimbalance o production and consumption inUSA. It requires the government to seriouslycut its spending, not the other way around.

Oversupply of US DollarsDistort Real Economy

In response to the rocketing expenditureand decits, the United States maintainedexpansionary scal and monetary policies,

whereby more and more money was suppliedto the nancial market and made US dollars

overow in nancial institutions. Teoversupply o dollars led to rapid increasedcommodity prices and ination and reduced

FIGURE 4: Depreciation o US Dollar to Gold

the purchasing power parity o US Dollar.Te magnitude o the currency problem canbe reected in the rocketing rise o gold price.Te gold price increased rom USD 288 perounce in 1999 to more than USD 905 in 2008

(Figure 4), and urther rocketed to more thanUSD 1,530 in early June 2011.

Te oversupply o US dollars led to thedepreciation o US Dollar. Many householdsneeded to spend more money or the sameamount o services and consumption in non-housing items. Tis resulted in less moneyavailable or them to pay housing mortgagesand increased their likelihood o deaults in

their residential mortgages.

Source: Finacts Ireland 2008


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FIGURE 6: Infation-Adjusted Housing Prices in USA

Source: http://en.wikipedia.org/wiki/United_States_housing_bubble

80%

Nevada

Califonia Virginia

Arizona

Alaska

Hawaii

New Mexico

Colorado

Wyoming

South Dakota

Nebraska

Kansas

Texas

Oklahoma Arkansas

Louisiana

Mis

sissip

pi

Missouri

IllinoisIndiana

Ohio

Pennsylvania

New York

Florid

a

Maire

Alaba

ma

Georgia

Tennessee

Kentucky

North Carolina

SouthCarolina

WisconsinMichigan

Rhode Island

New Hampshire

Vermont

Massachusetts

Connecticut

New Jersey

Delaware

Maryland

Washington D.C

West Virginia

North Dakota Minnesota

Iowa

Utah

Montana

Idaho

Oregon

Washington

0 100 km

0 100 mi0 200

0 200

FIGURE 7: Housing Prices vs. Owner-Equivalent Rent in USA

Source : http://www.jparsons.net/housingbubble/


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Figure 7 shows the change in nominal housingprices and in nominal rents since 1983.Housing prices are over-priced compared tothe rent level. Housing prices are over-inateddue to the oversupply o US dollars.

Mr. Ben Bernanke warns that i the ederalbudget decit is not under control, it willendanger the economy down the road.However, the ederal government is stillincreasing decits. During the recession, theFederal Reserve purchased some USD 1.7trillion mortgage securities, corporate debtand government bonds. It increased spendingdrastically instead o cutting costs. Te over-

indebtedness o the government will lead tothe ination and devaluation o the dollar.

Deregulation Opens Door forSub Prime Lending

Another important actor to boost the subprime lending is the deregulation o thenancial markets. In 1980, the United

States passed the Depository InstitutionsDeregulation and Monetary Control Act(DIDMCA). DIDMCA helped the Savingsand Loan (S&L) industry to oer checkabledeposits. DIDMCA also allowed nancialinstitutions to charge interest rates they choseto.

In 1982, deregulation continued withthe passage o the Alternative Mortgage

ransaction Parity which preempted statelaws that restricted banks rom making anymortgage except conventional xed rateamortizing mortgages. Te 1982 law allows theuse o variable interest and balloon paymentsand also allows lenders to make loans withterms that may obscure the total cost o loans,

which led to new mortgage instruments manyborrowers ailed to understand and could notaord.

Tese laws opened the door or the developmento a sub prime market, but sub prime lending

would not become a viable large-scale lendingalternative until the passage o the ax Reorm

Act o 1986 (RA). Te RA removed the

tax deduction o interest on consumer loansbut encouraged the homeownership initiativesthrough increasing the home mortgage interestdeduction as well as the addition o low incomehousing tax credit to boost homeownership orlow income households.

In 1995, the US Federal Governmentimplemented a major reorm o theCommunity Reinvestment Act (CRA) and

issued its National Homeownership Strategy,both o which led nancial institutions tourther lower the mortgage lending standards.CRA encouraged the use o innovative andexible lending practices; it increased riskierand unsustainable lending practices throughlowering mortgage underwriting standards andshiting rom ensuring the equitable lendingprocedures to ensuring equitable lendingoutcomes without due careul consideration

o the borrowers ability to repay the mortgageloans.

With the oversupply o money andderegulation, the sub prime mortgage marketreceived rapid expansion. It grew rom USD35 billion in 1994 to USD 650 billion in May2007 (Figure 8).


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Reckless Lending of FinancialInstitutions

Reckless lending o nancial institutions isa key contributing actor or the sub primemortgage crisis. Financial institutions extendedsub prime loans to individuals who do notqualiy or prime credit, and are generally noteligible or credit rom traditional sources. Itrepresents mortgage lending that allows theunsuitable borrowers to get credit, as they areoten unable to oer a down payment, theyhave a record o being unable to pay debts andthey do not have a source o income. In thecase o those who have income, their creditliability is disproportional to that income.

Financial institutions went down markets toreach lower income and minority borrowersas lenders promised loans with less paperwork,quick approval and no down payments.Financial institutions seduced the sub primeborrowers with easy-to-get loans and attractiveshort-term interest rates or the beginningyears; but they subsequently had to reset tohigher rates or the remaining majority o theloan period.

Lack o due diligence resulted in dierent typeso subprime loans. Some loans required little

or no proo o a borrowers ability to meetrepayments known as low documentationor no documentation loans while otherloans needed no proo o income or credithistory. Other types o mortgages includedjumbos- particularly large loans which weredisproportionate to borrowers incomes orhouse values. Mortgages were also sold bybrokers and intermediaries without assessingthe buyers aordable capacity.

The Role of Mortgage Brokersin Promoting Loans to Sub-prime Borrowers

Te sub prime loans were oten not respondingto borrower demand; rather, they were createdto maximize short-term prots o the suppliers,and they were aggressively push-marketedto consumers, who oten couldnt aord.Brokers played a key role in this aggressivemarketing and have contributed to the surgein delinquencies.

Te main problem is that mortgage brokers

do not represent the borrowers who pay themor advice. Instead, they are more driven byhidden ees and other incentives provided by

FIGURE 8: Sub Prime Mortgage Market Growth and Share o Total MortgageMarket


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the lenders. Sub prime mortgages are sold tohome buyers with lower credit scores. Whenthe housing market boomed, mortgage brokersinuence grew as they became involved inarranging the majority o home loans.

One o the most controversial paymentsthat mortgage brokers receive rom lendersis called a Yield Spread Premium. I a brokercan persuade a borrower to accept a mortgage

with a higher interest rate than the par rate, thebroker will get a ee rom the lender equal toa percentage o the value o the mortgage (i.e.the Yield Spread Premium), which rewards thebroker or arranging a loan that pays an above-

market interest rate. Te higher the interestrate, the higher the Yield Spread Premium is.But the Yield Spread Premium is oten abusedby mortgage brokers who want to collect asmany ees as possible or arranging a loan anddont care that borrowers can end up paying ahigher interest rate without even knowing it,and this practice contributed to the high rateo sub prime loan deaults.

The Role of Securitisationin Expanding SubprimeMortgages

Te subprime crisis is the rst one thatsmagnied by securitization. Te originatorso the sub prime mortgages sell o sub primemortgage through securitization. As longas the originators can sell these sub prime

mortgages, they transer the high risk o thesemortgages to investors who buy the mortgages.Investors buy bundles o mortgages whichare so complex that investors could not ullyunderstand the real value. Investors relied onratings agencies to value these mortgage assets.But the nancial institutions pay the ratingsagencies that give the highest rating.

Investors seem not to know what these

mortgages are worth, who owns them,how much has been borrowed using thesemortgages as collateral or how deeply their

value has declined. Te disconnection betweeninvestors and its real physical assets created aloophole in its cycle o operations. Originatorscan write o sub prime mortgages throughsecuritization and get back their capital quickly

and then originate more sub prime mortgages.Securitization accelerates the growth o subprime mortgages.

Over-emphasis ofHomeownership and Lackof Oversight Driving RiskierLending

From the very beginning, the US ederalgovernment showed its preerence ohomeownership through the creation o FannieMae and Freddie Mac. Te privatization othe agencies did not reduce its competitiveadvantages backed by the ederal government.

At their prime, they controlled over threequarters o the secondary market or primemortgages in USA. However, Fannie Mae and

Freddie Mac went much ar and were otenexempt rom ederal regulations guiding banksand lending. For example, they were allowed tooperate with much lower capital requirementthan their private sector competitors. Tey

were only required to hold 2.5 percent capitalagainst their on-balance sheet mortgage whilebanks are required to hold 4 percent capitalagainst their mortgages. Lower down paymentson mortgages and low capital requirements

allowed Fannie Mae and Freddie Mac toachieve a huge leverage ratio o exceeding 70-to-1.

Fannie Mae and Freddie Mac were also exemptrom key regulatory and market oversight.Tis exempt rom oversight made Fannieand Freddie to conveniently engage in riskierpractices. In 1990s, Fannie Mae and FreddieMac injected USD 5 trillion to promote

aordable housing. Fannie Mae introducedqualiying exibility or low incomeborrowers and reduced the down payments to


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as little as 3 percent, and by 2001, it was evenoering to buy zero-down payment mortgageloans. Te riskier behaviors o Fannie Mae,Freddie Mac and nancial institutions alsoencouraged the riskier behaviors o borrowers.

Lower down payment reduced the equity stakein the homes borrowers purchased and madethem less responsible or their homes whentimes got rough. Lower down payment alsoallured borrowers to increase their leverageand to purchase expensive houses they wouldbe unable to aord and also to spend moregenerously on other goods using the moneysaved due to the low down payment omortgages. For example, in 2000, the ratio o

housing price to income in USA was 4 to 1. In2005, the ratio increased to 8 to 1. As a result,the mortgage debt between 2000 and 2006 inUSA increased by 80 percent.

Rapid Increase of SubprimeMortgages Leading to CreditCrunch

Te delinquency rate or sub prime mortgagesincreased to 25 percent in the second quartero 2008, which was about 6 times higher thanthat o prime loans. An estimated 1.3 trillionsub prime mortgages are currently outstanding.Tat is as large as the entire Caliornia economy.Te sub prime mortgage oreclosure rates inUSA are getting worse (Figure 9).


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5% 10%

11% 15%

16% 20%

21% 24%

5% 10%

11% 15%

16% 20%

21% 24%

FIGURE 9: Projected State Foreclosure Rates or Sub Prime Loans

ProjectedState ForeclosureRates for SubprimeLoans Originated1998-2001

ProjectedState ForeclosureRates for SubprimeLoans Originated1998-2001

Source: Center or Responsible Lending, 2008


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The Bursting of the HousingBubble

From 2000 to 2006, the USA observed a rapidrise in housing prices. In some areas housingprices doubled, which increased ar beyondthe rate o undamental economic growth.

Te housing bubble was mainly the result ooversupply o US dollars, leading to over owso dollars in the housing market through theprovision o low interest rates by the US Federal

Reserve. Te Federal Reserve cut interest ratesby a total o 550 basis points between 2001and 2004. Te low return on the stock marketsand treasury bonds urther pushed moneyto ow into the housing market to boost thehousing bubble. Much o this money waslent to the households who otherwise would

not be qualied or mortgage loans. In 2008,the housing bubble burst. Housing prices ellsignicantly in many parts o United States(Figure 10).

FIGURE 10: Housing Price Changes in USA

Nov1987 Nov1990 Nov1993 Nov1996 Nov1999 Nov2002 Nov2005 Nov2008

220 220

200 200

180 180

160 160

140 140

120 120

100 100

80 80

Index

2000=100

Miami

National

Phoenix

Los Angeles

,In the sun belt as house prices rose,perceptions of risk declined and creditstandards declined boosting demand and

driving prices higher. As the bubble burst,

seemingly 'safe as bricks and mortar'

investments lost almost half of their value,one of the root causes of the current

nancial problems. But prices are now

much closer to fair value.

Source: McKibbin, Warwick (2006)

IMPACTS OF THE SUB PRIME CRISIS


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The Broken Dream ofHomeownership

Te global nancial crisis started with the subprime mortgage lending crisis in USA. Te

oreclosure rates deteriorated rapidly. In thethird quarter o 2007, sub prime adjustablerates mortgages (ARMs) only accounted or 6.8percent o the US mortgages outstanding butaccounted or 43 percent o the oreclosures.In October 2007, the delinquency rate o subprime ARM mortgages almost tripled the rates

o 2005. In January 2008, the delinquencyrate increased to 21 percent and urtherincreased to 25 percent in our month time.During 2007, lenders started oreclosureproceedings on about 1.3 million properties, a

79 percent increase over 2006. Te propertieswith oreclosure activities aced steady increasein USA (Figure 11). It is estimated that theoreclosures will increased to 2.4 million in2009 alone and 9 million during the period o2009-2012.

FIGURE 11: Properties with Foreclosure Activity in USA

Source: http://upload.wikimedia.org/wikipedia/en/4/4c/Foreclosure_Trend_-_2007.png

Impact on Remittances

o many developing countries, remittancesare an important source o nance. Recordedremittances to developing countries were USD336 billion in 2008. Tis is three times as largeas overall ofcial development assistance todeveloping countries. Te real gure can beeven higher. In some countries, remittances

are close or even higher than oreign directinvestment. In Lesotho, Moldova, ajikistan,

the remittances exceed one-third o nationalincome (Figure 12). Te global nancial crisisaected the work and income o migrants andsubsequently led to the decrease o remittances.Remittances to developing countries decreased6 percent in 2009. Te impact on Europe,Central Asia, Latin America and Middle East

was more obvious. Remittances to Europe andCentral Asia, Latin America and Caribbean,and Middle East decreased respectively 20.7percent, 12.3 percent and 8.1 percent.


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Impact on Foreign Direct

InvestmentTe global nancial crisis led to a deteriorationo oreign investment. In the ace o the globaleconomic slowdown, tighter credit conditionsand alling corporate prots and consumerscondence, many companies began to curtailproduction, lay o workers, and cut capitalexpenditure, which have implications ororeign direct investment. Developed countries

were severely aected by the global nancialcrisis and aced an economic slowdownand did not have more money to investin oreign countries. Companies have lessnancial capacity to invest both internally andexternally. Tey scaled back investment dueto the pessimistic prospective, high level operceived risks and uncertainties.

On average, global oreign direct investmentell by more than 20 percent in 2008 while

oreign direct investment in developedcountries declined by about 33 percent.

Impact on International Trade

Te international trade reached a recordlevel o USD 16.1 trillion beore the globalnancial crisis in 2008. IMF estimated thatthe international trade measured by totalexports o goods and services declined by 11.9percent and that o developed countries ell

by 13.6 percent in 2008. World merchandisetrade experienced a urther unprecedenteddecline o 23 percent in 2009, reecting themost severe decline in global trade (Figure 13).Imports o the United States declined 25.9percent during 2009. Federal Reserve Banko Dallas publication shows that the scale ointernational trade decline exceeded the lossesduring the 1930s.

FIGURE 12: The Importance and Fall o Remittances


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Oversupply of CurrenciesDistorts the Real Economy andthe Welfare of People

Te oversupply o currencies can be reectedin the rapid growth o the nancial assetscompared to the value o total outputsmeasured in national accounts in the lastew years. In 2006, the global nancial assets

were equivalent to our times world GDP. Onany one day o April 2007 the average dailyturnover o interest rate and non-traditionaloreign exchange derivatives contracts reached

USD2,090 billion, 71 percent higher thanthree years earlier. Tat is 50 times the valueo world exports during the same time. Hedgeunds have increased rom USD 39 billionin 1990 to USD 1,900 billion in 2007. Teprots o nancial institutions in the UnitedStates incredibly reached 41 percent o thetotal prots ater tax in 2007, up rom 5percent in 1982. In New York, one third oall salaries paid were in the nancial sector.

Te world was overowed by US dollars.Te oversupply o currencies created thenancial and economic bubbles and distorted

the real economy. A wave o excess globalcredit creation has created the wall o money

which was then recklessly lent. Tis was notappropriately regulated but much o this tookplace under the auspices o Alan Greenspanas chairman o the Fed, who put orward theview that nancial markets could regulatethemselves, and it was not the job o the Fedto intervene to prick the bubble o excesslending and irrational expectations. Tisview o limited regulation has been shown tobe awed.

Smart Investing Daily Editor Sara Nunnally

criticised that the US government wasprinting money like mad. Tis creates a hugeoversupply o US dollars and devaluationo the currency. Te bailout commitmentsnow stand at USD 11.8 trillion, which is arhigher than the original plan o USD 800billion. Despite the worldwide worries overthe huge debt o the US ederal government,the Obama administration signed a bill inFebruary 2011, which urther increased the

public debt ceiling rom USD 12.394 trillionto USD 14.294 trillion. Tis is a second

Source: UN-DESA

FIGURE 13: Growth o International Trade and World Gross Product


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increase in less than two months time. TeFinancial Management Services o the USreasury estimated that the total obligationso the US government exceed USD 90 trillion.Te US government now has the worlds No.

1 highest debt to GDP ratio, which is wellabove that o Zimbabwe. Te total US debtplus ununded obligations are more than 625percent o GDP. Tis world No. 1 debt ratiois at serious odd with prudent nancial andeconomic principles. It could erode peoplescondence in US economy and US currency.It could cause a new round o crisises.

With the diminishing purchasing power

o US dollars and other world reservecurrencies, people suddenly elt that theyare impoverished by the devaluation o USdollars and other world reserve currencies.Tey can buy much less goods and services

with the same amount o money. Peopleswelare is hugely negatively aected by thehigh government debt, and depreciation ocurrencies. Tis will aect their condence inUS dollars and other world reserve currencies.

Te ination and devaluation o US dollarwill erode peoples condence in real economyand lead to a vicious cycle.

Te depreciation o US dollars and otherworld reserve currencies hurt the export-oriented countries most. Many export-oriented countries work hard to export theirgoods and earn US dollars. Eventually, theynd their wealth holding in US dollars or

other world reserve currencies losing value.Te more you export the more you lose. Temore you interact with the international

world through trade and services, the moreyou lose; simply because these goods andservices are traded in US dollars or other

world currencies. When countries realisedthat all their losses are simply caused by theuse o US dollars or other world currenciesin their trade and services, they began to nd

ways to avoid the use o these currencies.

Te depreciation o US dollar made countriesto seek alternatives to protect the loss o their

wealth. India transormed its USD 6.7 billioninto 200 metric tons o gold (it bought 200metric tons o gold rom IMF at the cost o

USD 6.7 billion), which is the biggest singlecentral bank purchase in the last 30 years.Brazilian Central Bank President HenriqueMeirelles said that they were considering thegradual elimination o US dollar in trade withChina, Russia and India. Russia is consideringtrade in national currencies. Latin Americancountries consider establishing a regionalcurrency called sucre. Gul countries plan toestablish a Gul currency.

When countries nd that dollars hurt theirreal economy and wealth, they nd ways toavoid the currency in their economy and tradeto avoid urther losses. Te recovery o USeconomy requires people to have more savings.But individual people have less interest to savein dollars in order to avoid their losses due tothe ination and depreciation o US dollars.Lack o savings will dry up investments. It

in turn leads to the tendency to print moredollars, leading to higher ination, whichmakes people and countries to avoid using USdollars. It becomes a vicious cycle. Tereore,it is very important to take concrete measuresto control the expenditure, decit, and supplyo US dollars to restore peoples condence inUS dollar. Tis is essential or the US economybut also or the global economy.

The Rapid Increase ofUnemployment

International Labour Organisation (ILO)reports that the global nancial crisiscould increase world unemployment by anestimated 20 million. It will bring the total

world unemployment to over 200 million in2009. However, the situation seems ar worse

than that.


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IMFs estimate shows that the unemploymentcaused by the global nancial crisis is morethan 30 million, which pushes the total worldunemployment to more than 210 million. Teunemployment caused by the global nancial

crisis can be ar more than this gure too. InChina alone, the global nancial crisis led tothe closure o more than 67,000 small andmedium-sized enterprises and more than 20million people lost their jobs. Another 300,000small enterprises are partially closing down.

Te hardest-hit parts have been themanuacturing sectors in China. Te same istrue or the United States. Te manuacturing

regions such as Michigan, Ohio and RhodeIsland, and regions which had huge housingbubbles such as Caliornia, Florida andNevada have highest unemployment rates.In El Centro, Caliornia, the unemployment

rate is as high as 22.6 percent (Figure 14).Te unemployment rates have a negative co-relations with the level o education. It causesmore job losses among the less educated thanthose with high education. Tose without highschool diplomas are hit hardest. Te next worsthit group are high school graduates. In other

words, the poor people are hit hardest by thecrisis (Figure 15).

FIGURE 14: Geographic Distribution o Unemployment Rates in USA in 2009

Unemployment rate

0 5 10 15 20%

Source: New York Times


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FIGURE 15: Uneumployment Rates or Workers 25 Years and Older, by Education inUSA

Source: New York Times


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REFERENCES

Alexandrov, Andrey (2010), the Future o the US Dollar, http://www.globalcrisisnews.com/usa/the-uture-o-the-u-s-dollar/id=1450/

Ahsan A & Ratha D (2009) Global Financial Crisis and Implications or Migration andRemittance, World Bank

Dilorenzo, J (2007), Te Government-Created Subprime Mortgage Meltdown, LewRockwell

Herrmann, J M, Drye K & Warren LLP (2010), Te Global Financial Crisis: Impact onInternational rade and Matters Potentially Coming beore the U.S. Court o Internationalrade, the U.S. Court o International rades 16th Judicial Conerence, 18 Nobvember 2010

ILO (2008), Decent Work, ILO, Geneva

McKibbin, Warwick (2006) Bursting o the US Housing Bubble, www.economicscenarios.com

Mohapatra, Sanket, and Ratha, Dilip (2010) the Impact o the Global Financial Crisis onMigration and Remittances, World Bank

New York imes Newspaper

Nunnally, Sara (2010), What the Growing Budget Decit Means or You, http://countingpips.com/x/2010/10/12/what-the-growing-budget-decit-means-or-you/

ashman H M (2007), Te Subprime Lending Industry: An Industry in Crisis, Te Banking LawJournal, May 2007

http://countervailingtruths.blogspot.com/

http://countingpips.com/x/2010/10/12/what-the-growing-budget-decit-means-or-you/

http://dallased.org/research/eclett/2009/el0908.html

http://www.nacts.ie/irishnancenews/article_1020527.shtml

http://mwhodges.home.att.net/

http://www.worldnetdaily.com/

http://en.wikipedia.org/

http://www.responsiblelending.org/

http://www.ilo.org/

REFERENCES


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http://www.instantmortgageusa.com/

http://gbmcon2009.dunance.ac.bd/

http://www.marketwatch.com/story/

http://www.bloggingstocks.com/

UNCAD (2009) Assessing the Impact o the Current Financial and Economic Crisis on GlobalFDI Flows

U.S.A. House o Representatives Committee on Oversight and Government Reorm (2010), TeRole o Government Aordable Housing Policy in Creating Global Financial Crisis o 2008


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UNITED NATIONS HUMAN SETTLEMENTS PROGRAMMEP.O.Box 30030,Nairobi 00100,Kenya;Tel: +254-20-7623120;

Fax: +254-20-76234266/7 (Central ofce)inohabitat@unhabitat org

The subprime crisis reers to the collapse o subprime mortgagemarkets in the United States due to the sharp rise in oreclosuresbeginning in 2006, which led to the ailure, merger, and governmentbailout o leading American fnancial institutions and enterprises.This report examines the causes and impacts o subprime crisis.

The report examines the elements causing the crisis, particularlythe over-spending behaviors o both governments and individualsand deregulation and lack o monitoring. The over-spendingbeyond the income/revenue capacity leads to the imbalancebetween income/revenue and spending and eventually causesthe sub-prime crisis and urther the global fnancial and economiccrisis. The report then examines the impacts o the crisis.

HS/069/11EISBN (Series): 978-92-1-132027-5ISBN(Volume): 978-92-1-132363-4

The Global Urban economic DialoGUe SerieS

Documents

57431174 the Sub Prime Crisis the Crisis of Over Spending