The 2008 Subprime Mortgage Crisis: A Beginner’s Guide

The risk of risk mortgage crisis was one of the main contributors to the global financial crisis of 2007-2008. Also known as the “Great Recession”, this is the worst economic downturn since the Great Depression of the 1930s. For many Americans, it took years to recover from the financial crisis.

What is the subprime crisis?

The subprime mortgage crisis occurred from 2007 to 2010 after the collapse of the US housing market. When the housing bubble burst, many borrowers were unable to repay their loans. The dramatic increase in foreclosures has caused the collapse of many financial institutions. Many demanded a government bailout. In addition to the fall in the American real estate market, the stock market has also dropped, the Dow Jones Industrial Average falling by more than half. The crisis has spread around the world and was the main trigger for the global financial crisis.

The subprime crisis explained in detail

Subprime mortgages are loans given to borrowers who have bad credit. They pose a high credit risk because they do not have a strong credit history. They are also more likely to default than others. During the 2000s real estate boom, many lenders granted risky mortgage loans to unskilled borrowers. In 2006, a year before the start of the crisis, financial institutions lent $600 billion in subprime mortgages, which represents nearly 1 in 4 mortgages (23.4%).

A cheap credit and softening loan standards have enabled many high -risk borrowers to buy overpriced houses, supplying a real estate bubble. While the housing market was cooling, many owners had more than their house was worth. As the Federal Reserve Bank raised interest rates, homeowners, especially those with adjustable rate mortgages (ARMs) and interest-only loans, were unable to make their monthly payments. They could not refinance or sell their homes due to falling house prices. In the end, nearly 5 million homes have been seized since the start of the crisis.

This had a huge impact on titles backed by mortgage claims (MBS) and guaranteed debt securities (CDO) – investment products backed by mortgages. Risk mortgages were grouped by financial institutions in complex investment products and sold to investors from around the world. In July 2008, 1 in 5 subprime mortgages were in default with 29% of ARMs seriously in default. Financial institutions and investors holding MBS and CDOs found themselves with dollars of investments almost worthless.

The risk of risk mortgage crisis has had a considerable impact on the American real estate market and on the economy as a whole. This has reduced construction, reduces wealth and consumption expenditure, and has reduced the capacity of financial markets to lend or raise funds. The subprime crisis ultimately extended to a global scale and led to the global financial crisis of 2007-2009.

A timeline of events

The cause of the crisis took years to develop and did not happen overnight.

2000 to 2003

Interest rates during this period were lowered from 6.5% to 1% due to the dot com bubble and the terrorist attacks of September 11, 2001. Low interest rates provided cheap credit and more people borrowed money to buy houses. This demand has contributed to the increase in housing prices.

2004 to 2006

The prices of houses increased quickly and the Fed under Alan Greenspan noted interest rates to cool the market overheating more than a dozen times. From 2004 to 2006, interest rates rose from 1% to 5.25%. This has slowed demand for new homes. Many subprime mortgage borrowers who were unable to afford a conventional 30-year mortgage took out interest-only or adjustable-rate mortgages with lower monthly payments.

Interest rate increases increased monthly payments on subprime loans and many owners could not pay their payments. They were also unable to refinance or sell their house due to the slowdown in the real estate market. The only option was for the owners to default on their loans. Home prices fell for the first time in 11 years in the fall of 2006.

2007 to 2008

As more homeowners began to default, 20 of the top 25 subprime mortgage lenders closed, stopped lending or were sold to avoid bankruptcy. Investment banks Bear Stearns and Lehman Brothers went bankrupt. At the end of 2008, the United States was in recession. Congress passed a Wall Street bailout to stabilize the economy.

What caused the subprime crisis?

There are many different parts that deserve to be blamed for the risk of risk mortgage. It is not a group or an individual who caused the crisis, but several actors who focused on short -term gains.

Financial institutions

Banks, hedge funds, investment companies, insurance companies and other financial institutions have created MBS and CDOs. They continued to recondition them and sell them to investors who thought it was safe investments. The various financial institutions have aggravated the situation by taking more risks than necessary.

Mortgage lenders

Inappropriate mortgage lending practices played a significant role in the crisis. Mortgage lenders have softened their loan standards and granted loans to people who should not have obtained a loan in the first place. They were eager and distributed mortgages with only interest and at a variable rate that the borrowers were unable to reimburse. In other cases, some mortgage lenders have even committed mortgage fraud by inflating borrowers’ income so that they are eligible for a mortgage loan.

Credit rating agencies

Credit agencies had conflicts of interest and did not grant the appropriate notes that many thought that risky mortgages deserved. They assigned AAA ratings to risky MBS and CDOs.

Regulators and government

The regulators have repealed certain laws, giving financial institutions the possibility of investing customer money in complex investment products. The deregulation also allowed banks to expand their markets by merging with different institutions. This made them “too big to fail”. Due to the modifications made to banking legislation, banks have also been able to offer customers subprime loans of interest only and at revisable rate.

Home buyers and sellers

People were borrowing to buy houses even though they couldn’t really afford to pay for them. While some buyers were subject to predatory loan practices, many took too many risks and bought houses that they should not have had. After the Fed noted the interest rates, house buyers could not pay their mortgage payments.

Investors

Investors wanted low -risk investments but generating high yields like an MBS. They fueled demand for subprime mortgages.

Each of the various parties was irresponsible and reckless in their actions. This led to the subprime crisis.

Effects of the subprime mortgage crisis

The subprime mortgage crisis has severely weakened the global financial system. The crisis and the global crisis that followed caused 7.4 dollars of loss on stock paper and wiped around $ 3.4 billion in real estate wealth. Many businesses went bankrupt and an estimated 7.5 million Americans lost their jobs, with the unemployment rate doubling to 10% in 2010. While the economy added jobs after the crisis, many were jobs less well paid and less secure. During the financial crisis, the net value of American households decreased by around 17,000 billion dollars, a loss of 26 %.

The government has launched several bailout programs to help stabilize the economy. As the programs officially ended in 2014, the Fed had injected more than $ 4,000 billion into the American economy. Following the recession, the congress reacted by adopting several laws to help prevent another financial crisis from happening again. They adopted Dodd-Frank legislation, which included the mortgage law and the consumer financial protection law. These laws have introduced banking regulations and created a consumer financial protection office. Since then, mortgage loan practices have evolved to comply with the new practices imposed by law.