Impact on Global Economy
Global economy and capital markets are highly affected by the U.S. subprime
mortgage crisis.
Due to the increases of interest rate during the year 2006, adjustable-rate mortgages (ARMs)
were adjusted to a higher rate (higher monthly payment). Those homeowners who overused ARMs
faced difficulty when required to pay a higher monthly payment. For those who defaulted their
mortgages, the lenders will get back the houses as collaterals (supply of houses increase). When the
foreclosure rate increases (decrease in demand of houses) in 2006-2007, the lenders incurred losses
because these increasing their bad debt reserves and reducing their earnings. Many investors and
corporations purchased MBS as investments incurred related losses. At the same time, the excess
supply of home inventory placed a downward pressure on the house prices. Finally, the housing
bubble bursts and causes the housing price plummeted. This is leading to the subprime mortgage
crisis and at the same time causes same financial institutions that invested in MBS go bankrupt.
Due to the widespread dispersion of default risk, lenders are reducing lending activity with
higher threshold or interest rates (credit crunch). This causes the borrowing and spending activities by
households reducing. Similarly, the funds that corporations will obtain from the issuance of the
commercial papers reduced and they will cut their expenses due to the higher cost of borrowing funds.
This leads to higher unemployment rate because there are less business activities conducted.
Corporations will downsize their companies in order to cut their costs. As mentioned above, some
financial institutions go bankrupt also cause the unemployment rate higher. This also reduced the
spending activities by households due to the decreases of income.
