Munich Personal RePEc Archive

A review of the global financial crisis and its effects on U.S. working class households - a tale of vulnerability and neglect.

De Koning, Kees (2016): A review of the global financial crisis and its effects on U.S. working class households - a tale of vulnerability and neglect.

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Abstract

Developed economies rely on their financial sector for their well being, which, as a corollary, can be severely compromised by a poorly functioning financial sector. The financial crisis of 2007-2008 was caused by the collective financial sector in the U.S. Their collective mortgage production in 2003 was $1.1 trillion, equivalent to over 16% of the $6.9 trillion outstanding mortgage levels as at the end of 2003. If the 2003 mortgage production was allocated over new housing starts, each new home would have been financed with a mortgage of $635,000, while the average U.S. home sale price that year was $246,300.

In 2001, the Fed lowered its effective funds rate from 5.98% to 1.82%; in the following two years the rate was dropped further to 0.98%. Such action may have been inspired by the low economic growth rate in 2001, which turned negative in the third quarter. What the Fed did not react to was the massive growth in annual mortgage production, which had already started in 1998. In a continuing demonstration of benign neglect, the lowering of the Fed funds rate from 2001-2003 only emboldened the financial sector, which fuelled the annual mortgage production even faster over the period 2003-2006.

Home mortgage loans are mostly granted to individual households and especially in large numbers to working class households. Such households rely on their income levels to repay such mortgages. When house prices grow faster than CPI inflation and incomes, - up to 38% higher than CPI inflation over the years 1997-2006 – working class household’s finances can become rapidly overstretched.

In 2006 mortgage borrowers started to get into trouble as the foreclosure filings show. By 2007, this affected trading in mortgage bond funds and by 2008 a full scale banking crisis was unfolding.

The harm that the financial sector had wreaked on household finances was having a potent economic effect in the real sector: 45% of all mortgagors faced with foreclosure proceedings, 7.6 million job losses, wages growth below CPI inflation levels, 6.1 million home repossessions, a rapid decline in the home ownership rate, a substantial loss in the savings for a pension pot and a doubling of government debt levels.

The reaction of the Fed was to save nearly all the banks, implement a quantitative easing program of some $4.2 trillion and keep interest rates at rock bottom levels, none of which helped the most vulnerable of the protagonists in the global financial crisis: working class households.

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