Q1 a Briefly explain why the decline in housing prices led t

Q#1. a) Briefly explain why the decline in housing prices led to a major financial crisis in 2007-2008. (5 points) b) Explain why the U.S. crisis became a world crisis in 2007-2008. (5 points)

Solution

1.
A.
The houses were purchased on loan by the people, including people with poor credit history. When the prices of the houses, declined, it did not change the loans being paid by the people. Here, people observed that they were paying much higher value to the banks when the value of the house were declining very fast. In this scenario, people started making default and denied the payment and it was accelerated by the people with poor credit history. As a result, banks accumulated a huge pile of housing assets with poor value and loans that turned to be bad. In one aspect, banks incurred huge losses and got bankrupt, and in another aspect, people decreased demand in the economy and it led firms to lay off people. It further worsened the situation and financial crisis of 2007-08 started in the US economy.

B.
The USA has been the major importer of goods and services from different countries across the globe. A financial crisis in the USA and subsequent lowering demand, led the cancellation of orders and business contracts across the globe. It causes the different companies to either close down or make lay off in different countries. It also started a negative chain of economic activities and aggregate demand in those economies also suffered. Besides, banks of these countries were also exposed to the US financial market. These banks also suffered from losses when real estate prices fell in the USA. All these developments led to the spreading of the financial crisis across the globe & became a world crisis.

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