IGC, for these kinds of mortgage loans from the




IGC, Hochschule Bremen, City University of applied science

Policy Brief — Prof Wolf Petzold

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Winter semester 2017/18








Term Paper Presented by

Nafisa Aman

[email protected]


January 2018





The crisis of 2007-08 has been termed as the worst financial crisis since the great depression of early 1930’s (Thakor 2015, p–156) one can say that this was the cause of several events and occasions that first hit the Us economy and later spreading it worldwide. This paper focuses on three main questions, the main cause of the global crisis, steps taken by the EU to recover the state of shock and the effect of the meltdown on labour market of EU.



US was introduced to a new lending system coming from England, called mortgage – a legal agreement between two parties which transfers the ownership of a property to a lender as a security for a loan (Parkinson 2006). After the complete verification on employment and minimum income requirement the mortgage loan is sanctioned by the financial institutions with the down payment of 3-20%. If the mortgage borrower defaults or fails to pay the monthly instalment and interest rate, the lender has the mortgage to sell. And as the prize of the mortgage was increasing the financial institutions were never at loss.

 Prime market citizens only qualify for these kinds of mortgage loans from the financial institutions, which also mean that there were lots of people who were deprived of owing the house in US because they do not fulfil the minimum requirement for these mortgage loans. But, the Federal Reserve lowered the rate of interest to 1% for enhancing economic growth, creating new jobs and enables the dream of homeownership for the middle-class citizens. This lower interest rate made it easy from the banks to borrow money and give mortgage loans. Thus, the demand for mortgage loan increased heavily. US banks and investors saw their chance to gain money in the housing market. This was the starting point of the crisis.


The investors instead of investing in low return treasury bills stared inventing in the housing market which gave much higher returns. The investors all around the world bought investments called mortgage backed securities. Mortgage backed securities are created when large financial institutions securitize mortgage. Basically, buy thousands of individual mortgages, bundle them together and sell shares of that pool to investors. The investors gobbled these mortgaged backed securities up. Again, they paid higher returns than investors could get in other places and they looked like safe. The home prizes were going up. So, if the borrower defaults the lender in the worst scenario can just sell the house for more money. The credit rating agencies rate these mortgage-backed securities AAA rating which means best of best.(Niklas Bruun Klaus Lörcher  Isabelle Schömann , 2014 ) The demand for these investments increased among investors and lender in order to create more mortgage loosened their standards and made loans to people with low income and poor credit called Sub-prime mortgages, eventually some institutions also started using Predatory lending practices to generate mortgages. They made loans without verifying income and offered absurd, adjustable rate mortgages with payments people could afford at first, but quickly ballooned beyond their means. The credit rating agencies rate these sub-prime lending practices safe. But the investments were becoming less and less safe all the time. The investors trusted the ratings and kept investing their money.

The new lax lending requirements and low interest rates drove housing prices higher, which only made the mortgage backed securities and CDOs seem like an even better investment. The housing boom was created and soon it was followed by the downturn. The subprime mortgages default rate soon started to rise as borrowers were not able to pay their monthly instalments. The rise of interest rate by the federal  reserve from 1 to 5.25% added to the misery of middle class citizens as the monthly payments increased heavily and they started defaulting. The result was that the house went to the banks and investors, soon the supply of house in the US market exceeded the demand and the price stagnated and after a time home prices started collapsing. Niklas Bruun Klaus Lörcher  Isabelle Schömann , 2014

As prices fell, some borrowers suddenly had a mortgage for way more than their home was currently worth, so they stopped paying. That increased the default rates, pushing prices down further. The financial institutions stopped buying subprime mortgages and subprime lenders were getting stuck with bad loans. By 2007, some really big lenders had declared bankruptcy. All the financial instruments, bets (credit default swaps) resulted in an incredibly complicated web of assets, liabilities, and risks.so when things went bad, they went bad for the entire financial system. Some major financial institutions declared bankruptcy like Lehman brother. Others were forced into mergers. The stock market crashed, and credit market froze.  And US economy was in disastrous recession.


The crash of the US financial market, recession now started spreading globally. All the economy worldwide invested in the real estate market of the US, so they were linked very closely and the world stock market reacted to this crisis with a tremendous fall. In Europe several subsidiaries and offices of the banking companies had to close and banks in Germany had to be rescued by the government as they also invested heavily in American real estate securities ( Hodson, Quaglia 2009).

The global crisis that started in 2007-2008 exposed the weakness of the still young currency and hit the euro area particularly hard. The euro area experienced an interim recovery in 2010-2011, but this proved short lived. Given the interplay between banks and public finances, several member states as well as banks found it increasingly difficult to borrow from the markets. Their capacity to finance themselves was put at risk. Investment collapsed as credit became less available. It fell more than 18% between 2008 and 2013. Unemployment rose sharply. The financial crisis became a crisis of the real economy, affecting millions of citizens and business (COM2017 291, p-9).



A determined response was needed. While the European Central Bank played its role in mitigating the effects of crisis, major few steps were also taken by the other EU institutions to strengthen the integrity of the euro area.

–          European Stability mechanism (ESM) was put in place on an intergovernmental basis as a way to provide support to those member states facing difficulties. Its lending capacity of EUR 500 billion helped countries like Greece, Spain, and Cyprus to finance their public spending and protect them from even more serious harm COM 2017) 291.

–          The rules for the macroeconomic and fiscal surveillance of the euro area were strengthened with the adoption of so called six-pack and two-pack EU legislation, as well as a new fiscal compact(as a part of the intergovernmental Treaty on the stability, Coordination and Governance in the Economic and Monetary Union (TSCG) COM 2017) 291.

–          A number of initiatives were pursued to create safer financial sector for the single market. These initiatives form so called “Single Rulebook” for all financial actors in the EU member’s states. The Single Rulebook aims to provide a single set of harmonised prudent rules that institutions throughout the EU must respect. The single Rulebook is also the foundation for the so-called banking union. While the banking union applies to countries in the euro area, non-euro area countries can also join. As part of the banking union, the responsibility for the supervision and resolution of large and cross-border banks in the EU was placed at the European level. For that purpose, the Single Supervisory Mechanism (SSM) and a single resolution mechanism were created. Basic rules for the insurance of deposits were harmonised across member states so that every individual deposit is now fully protected up to EUR 100000 COM 2017) 291.

–          Priorities differed across countries, in general the measures encompassed fixing structural weakness in the banking sector or improving the functioning of the Labour markets and supporting the unemployed to find new jobs. They also included providing incentives to business for innovation and investment, while others focused on modernising public administrations and pensions and care systems. The adjustments were most profound in the country’s most a risk of being unable to finance themselves (COM 2017) 291.

–          The current Commission, EU policy-making was re-centred around the “virtuous triangle” of boosting investment, pursuing structural reforms, and ensuring responsible fiscal policies. Social fairness was enshrined as an overarching objective.

–           A new Investment Plan for Europe – also known as the “Juncker Plan” – was launched. It is now being doubled to mobilise EUR 630 billion of extra investment for the EU as a whole.

–          Several other key initiatives were taken. The single market is being deepened in the fields of capital markets, energy and digital. This is a source of jobs, growth and innovation and helps to make the single currency more robust in the face of a constantly changing global economic environment



EU labour market started to weaken considerably in the second half of 2008 detoriating further in the case of 2009. According to European commission forecast the unemployment will increase close to 11% in EU. Until the broke of financial crisis in the summer of 2007 the EU labour market had performed relatively well. The employment rate was about 68% of the work force was approaching the Lisbon target of 70%, owning significant increase in the employment rates of women and older workers.

The labour market in EU started weakening in the second half of 2008 and detoriated further in the course of 2009. In the early phase much of job losses were in the member states, largely as a result of pre-existing weakness as well as a larger exposure to direct consequences of shock (adjustment in the financial sector and housing market and relative exposure to international trade). However crisis subsequently put a widespread break on domestic demand across the whole of EU, at a time when external demand was already fading, employment has been falling in all the member states since the first quarter of 2008.

figure 2: On the right shows the unemployment development in the euro area.
It shows two main recessionary phases of crisis in 2008-09 which encompasses the deep and sharp global turndown in activity and trade, and the second in the beginning of the 2011 following the emergence of the sovereign debt in some countries.
Over the course of the great recession all the countries saw increment in their unemployment rates ranging from 0.2% in Germany to 9.8% in Latvia.
Ireland, Greece, Italy, Spain, Cyprus, Portugal and Slovenia (Stressed Economies) have seen large and persistent increase in their unemployment rates since the beginning of the crisis. These country forms the most strongly affected by the financial market crisis.


Figure 3: Change in unemployment rates across the euro area

Source: Eurostat and ESCB calculations

The great recession had a strong sectoral bias, with high proportion of employment losses in manufacturing, transport and business services and in particular construction sector.

Figure 4: Euro area employment by sector- stressed economies versus other economies

Source: Eurostat and ESCB calculations

The above chart shows the employment rates in the stressed economies have fallen much more than other economies in the euro area. The most acute impact on the construction sector. However the non-market services such as education and healthcare continued to contribute positively to employment development virtually in all countries during the first phase of the crisis, fiscal consolidation in the second phase led to a notable downturn in public sector employment in some of the countries.

If we breakdown the labour force by gender and age we can see that overall men, younger workers and low skilled have been particularly hard hit by the crisis. The stronger impact on men than women doubtless reflects in part heavy concentration of the crisis in sector like industry, construction and transport, in which men are typically strong represented. This pattern is repeated across countries and over the course of the crisis. (ECB monthly bulliten,2014)



Figure 5: Employment development in the Euro Area-disaggregated results

Figure 6: A Unemployment rates and youth unemployment rates across the euro area over the course of the crisis

Source: Eurostat ( EU Labour Force Survey)

Source: Eurostat and ESCB calculations

The above figures shows that the youth unemployment (among the under -25s) has risen substantially over the course of the crisis.in some euro are countries the increase has been more substantial still, with youth unemployment rising to over 45% in the stressed economies as a whole an to 56% in Spain and 59% Greece. There are many reasons why youth unemployment rates are typically higher than aggregate unemployment rates; it can also be explained by the typically higher representation of the under-25s among temporary workers who generally are more vulnerable to cyclicality than permanent workers. (ECB monthly bulliten,2014)



The European economy has entered its fifth year of recovery, which is now reaching all euro area Member states. This is expected to continue at a largely steady pace this year and next. Employment is increasing faster than it has since the crisis began: more than 5 million jobs have been created since early 2013 in the euro area. Unemployment has fallen to its lowest level since 2009, at 9.5% in March 2017. Investment is picking up again. The aggregate deficit of euro has fallen from over 6% of GDP on average in 2010 to 1.4% of GDP this year. Sovereign debt in the euro has also started decline. Together with the decisive action of the European central bank , the commitment to strengthen the functioning of the euro and to defend its integrity has been an essential part of the improved performances in recent years. Despite on-going structural reforms in some countries, progress has been partial and uneven across the euro area.  Reducing the current level of structural unemployment can further help to speed up the adjustment process.













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Reflection paper on the deepening of the economic and monetary union, European Commission  page 10 .

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