Economics There Are a Number of Different Essay

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Economics

There are a number of different causes for the most recent recession in the United States. The primary cause was instability in the banking industry, which was brought about mismanagement of mortgage assets. This paper will investigate this cause in particular, although there were other causes as well.

The housing bubble was created when, fueled by easy access to cheap loans, housing prices increased rapidly. These prices increased rapidly in part because the financial institutions that underwrote the mortgages were able to offload that debt onto other investors. They did this by packaging that debt into instruments that were known as collateralized debt obligations (CDOs). These rare derivative instruments were used by financial institutions to hedge loan risk, by spreading that risk around the financial services industry. Loans were packaged, and these complex bundles of loans were typically seen to be low risk. They were not, however, and when the housing market collapsed these CDOs were spread throughout the U.S. economy. As a result, not only did the financial institutions that wrote the bad mortgages face the risk of those bad mortgages, but so did every financial institution that bought into the risk through the CDO (Wigan, 2007).

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With the risk of the entire housing market spread around not only the U.S. banking system but a number of other banking systems, the end of the housing market bubble meant the onset of recession. There was a lack of planning, however. As early as 2005, some analysts were predicting a major recession as the result of the end of the housing bubble (AP, 2005). However, the actual scenario was worse than was predicted at the time, and this was because of the CDOs. The recession may have been inevitable, but it was made more severe when the actual risk level of the CDOs became apparent.

The CDOs were found to be more risky than originally believed, and as a result of this they became illiquid -- nobody wanted to buy them.….....

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