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The Saudi Mortgage Law was formed as a reaction to the financial and economic crisis that was experienced during the year 2007. These crises made the banks found in several countries have capital of insufficient quality. It was also blamed on the risk coverage that was limited to part of the banks. The banks also were criticized for having built a sheet leverage with excessive off and on- balance. Additional factor was the steady erosion of the quality and the level of capital base. The steady erosion was experienced as buffers of insufficient liquidity were held by banks. This made the banks not to be able to take on credit losses and the systematic trade results. This law was therefore set in place so as to see Saudi gain economic and financial boost (SAMA 98).
An overview of the Saudi Mortgage Law and the Potential Impact it may have on the Saudi Economy and Saudi Banking System.
The Saudi Mortgage Law offers a standard for the whole nation of Saudi for issuance of the mortgage. The process of the mortgage issuance offered in the law is compatible with the law of Muslims. The law provides sustainable ways of dealing with the problems that may arise. In the law, there is an element of protection that is given to both the borrowers and lenders of the mortgage (SAMA 111).
The changes that come in with this law enable the population to get access to the mortgage credit. This would lead to the increase in the supply of the mortgage, thus fueling the property boom as the population gathers to take the loans. As per the investment scenario, this will improve investment as there will be an increase in the demand of the penthouses. This will make the investors enjoy the investment; thus, compete in the development of structures. The policy also has the possibility of ensuring that there is increasing employment rate. This will be a plus to both the banking system and the economy in its totality of Kingdom of Saudi Arabia (SAMA 108).
A review of the role of the two main GSEs in the USA mortgage market has played over the last two decades in USA.
According to Acharya et al., the two main GSEs were nothing but a bomb waiting for its time to explode. These two main GSEs made the prices of housing to increase each and every month as from “July 1995 to May 2006, thus obscuring the ever- increasing credit risk…” (27). The market of the MBS (mortgage backed securities) showed a good sign by taking off in 1980s. This gave a dominance of the market by Freddie and Fannie since they were supported by the government. Freddie and Fannie’s credit risk could be said to be reasonably safe at that time. It was characterized by, “…(i) low- to medium-sized loans, (ii) loan-to-value ratios less than 80%, (iii) high standards for a borrower’s creditworthiness, and (iv) income documentation of the borrower’s ability to make interest payments on the loans” (29)
The GSEs led to a concern in relation to the risks that were associated with the interest rates. The two GSEs held with them ‘hundreds of billions of dollars’ as fixed rate that was long term in nature. This made the money not to cycle in the economy, thus making the economy to suffocate as per these portfolios. The mortgages at a larger extent were funded by with short maturity debts. The GSEs claimed that they had engaged in interest options and swaps to eliminate the risk associated with interest rates. This was baseless since there was no evidence of these derivative transactions (Acharya et al. 31). The GSEs ended up losing due to the vintages that they associated themselves with for survival; it was a miscalculation.
This was followed by the collapse of the MSEs as there was competition in the market that led to the reduction of the standards. This is a unique scenario of competition since competition is expected to improve the standards. Sine this was a government sponsored enterprise and the same time financial institution, the debts made it struggle. The reduction in the demand as time went by made it hard for it to resist the ‘Race to the bottom’. This was the worst financial crisis of the housing boom with the losses experienced being beyond recovery (Acharya et al. 33).
The end result of all this was a financial crisis that is compared to the Great Depression phenomenon. States like New York, Los Angeles and Boston faced modest house decline in the years between 1990- 1995. Since this incident, there has been uncontrollable rise up in the price of houses. “….Case-Shiller 10-city index almost tripled from 77 in June 1996 to a high of 226 in June 2006 -- an increase of 11.3% per year” (Acharya et al. 35). Some of the markets in Nevada, Arizona, Forida and California faced a higher increase in house price. This period was also characterized high increase in the income and wealth inequality. The aftermath of controlling the living cost increase makes the middle class to struggle as their income hardly increased. This is because the prices of the house rose faster compared to the median income. The prices of the national houses also faced a steady increase: “by 31-43% from 2000 to the middle of 2006, depending on the data source” (Acharya et al. 35).
An outline of the importance of creating a liquid secondary mortgage market in an economy
A liquid secondary mortgage market is a market that gives the banks a go ahead in selling mortgages to investors. These mortgages selling can be made to include the insurance companies, pension funds and the federal government. According to Fabozzi and Andrew (13), the importance of this is that:
- The associated proceed enables the banks to have additional funds to offer for more mortgages
- It makes the money that is tied up in terms of loan not to affect the market.
- It makes it easier for home buyers to find lenders easily since the money is available.
- It promotes investment on the fact that the cash is accessible.
- The competition among the lenders makes the rates to be lower compared to when there is no competition; and,
- The mortgages are secured thus reducing the losses or risks that might be associated with it.
According to Ramesh modern economy can do better if there are well developed money markets (39). Money markets promote financial trade, financing industry, investments that are profitable, makes the commercial bank self sufficient and also helps the central bank. These points are elaborated below:
The money markets play an important role when it comes to internal and international trade financing. Bills of exchange make the commercial finance to be more available to traders. The money markets promote the industries’ growth in two ways. It also enables the industries to secure short term loans for day to day activities; it also enables them to secure long term loans for investments. The money markets give the commercial banks a chance to make an investment of the excess reserves. These investments are normally made in a near liquid nature thus can be taken back whenever needed. It also makes the commercial banks’ self sufficient in the situations like emergency since they have their own cash. The money market makes the functioning of the central bank to be more effective and efficient (Ramesh 41).
Recommendation to the KSA Mortgage Market Structure
The KSA act of passing the mortgage law is a plus for the betterment of the KSA economy. The problem is that in most instances the laws are normally good but the implementation of the legal framework becomes a problem. The KSA government therefore should out in place measures that see to it that the relevant institutions are in place. The institutions should also be effective enough to ensure efficiency and effectiveness of the law (SAMA 53).
The policies should also go through some amendments or changes so as to see that it accommodates the appropriate structure. The policies should support and promote competition in the mortgage market. The laws also should push the companies that are relevant to operate in a more efficient manner. The KSA should therefore minimize or eliminate the entrenched bureaucracies so as to ensure accessibility of these funds. The KSA government in the promotion of workers’ welfare should see to it that there is removal in the judicial systems that are conservative. Political pressures also should be put in place to ensure that the welfare of workers is upheld (SAMA 36).
This report is a critical check on the Kingdom of Saudi Arabia (KSA) mortgage law of 2012. The report starts by introducing the Saudi Mortgage Law then goes to highlighting of the major points in the law. The report also gives the review of the GSEs in USA in the past two decades. This is in reference to the main GSEs and their impacts to the USA economy. The report also tackles on the importance of liquid secondary mortgage in the economy. The report ends by giving the recommendation that the KSA should put in place to ensure economic and financial success as per the mortgage law.
Acharya, Viral, Mathew Richardson, Stijn Nieuwerburgh and Lawrence White. Guaranteed to fail. Princeton: Princeton University Press, 2011. Print.
Fabozzi, Frank and Andrew Katotay. Ginnie Mae and the Secondary Mortgage Market: an Integral Part of the American Economic Engine. New York: Ginnie Mae, 2010. Print.
Ramesh, Babu G.Management of Financial Institutions in India. New Delhi: Concept Pub, 2007. Print.
SAMA. Finalized Guidance Document Concerning the Implementation of Basel III. Riyad: Kingdom of Saudi Arabia, 2012. Print.