It may seem longer to some, but just over a decade ago a catastrophic housing crisis destroyed the lives of many Americans, with effects that still exist today.
As we approach the tenth anniversary of the Lehman Brothers collapse and the Great Recession, we should look back on the subprime mortgage crisis. How did it start and who was to blame? What happened and what is still happening as a result of it? And what makes even a subprime mortgage?
What is a subprime mortgage?
Subprime mortgages are named for the borrowers to whom the mortgages are granted. While the prime rate on a mortgage is that offered to people with good credit and a history of reliability, subprime loans are for those who have struggled to meet those standards.
People who are approved for subprime mortgages have historically had low credit scores and debt problems. There is no exact number set, but a FICO score below 640 is generally considered a subprime for a loan such as a mortgage.
People with irregular credit histories like this often have enormous difficulty getting approved for a mortgage loan, and as such, monthly payments have much higher interest rates than normal. because the lenders consider the loan to be much riskier.
How did the subprime mortgage crisis start?
How did the US economy get to a point where, in 2007, a real housing crisis erupted?
It doesn’t happen overnight. From the early to mid-2000s, interest rates on real estate payments were actually quite low. In what appeared to be a strong economy after a brief recession in the early 2000s, more and more people with poor credit were able to qualify for subprime mortgages at manageable rates, and happily took action.
This sudden surge in subprime mortgages was due in part to the Federal Reserve’s decision to significantly lower the federal funds rate to stimulate growth. People who couldn’t afford housing or get loan approval suddenly qualified for subprime loans and made the choice to buy, and the number of homeowners in the United States has increased. increased exponentially.
Home purchases have increased not only for subprime borrowers, but also for affluent Americans. As prices rose and people expected it to continue, investors who were burnt by the dot-com bubble of the early 2000s and needed a replacement in their wallets began to invest in real estate.
House prices were rising rapidly and the number of subprime mortgages issued increased even more. In 2005, some began to fear that it was a real estate bubble. From 2004 to 2006, the Federal Reserve raised the interest rate more than a dozen times in an attempt to slow this trend and avoid severe inflation. At the end of 2004, the interest rate was 2.25%; in mid-2006 it was 5.25%.
It couldn’t stop the inevitable. The bubble has burst. 2005 and 2006 saw the real estate market collapse. Subprime mortgage lenders are starting to lay off thousands of employees if they don’t go bankrupt or shut down completely.
Which parties are responsible for the crisis?
The subprime mortgage crisis, which guided us through the Great Recession, has many parties who can share the blame. On the one hand, lenders were selling them as mortgage-backed securities. Once the lenders have approved and made the loan, that loan would be sold to an investment bank. The investment bank would then bundle that mortgage together with other similar mortgages that other parties could invest in, and the lender would, as a result of the sale, have more money to use for home loans.
It’s a process that has worked in the past, but the housing bubble saw an unusually high number of subprime mortgages approved for people with credit and income issues. When the Fed repeatedly started raising interest rates, these loans became more expensive and borrowers were unable to repay them.
Lenders were far too willing to give up so many risky loans at once, apparently assuming house prices would continue to rise and interest rates would stay low. Investment banks appear to have had similar motives, becoming more daring with their investments in mortgage-backed securities.
While these parties decidedly took advantage of people with bad credit and in need of a place to live, homebuyers and the uniquely American quest to own a home played a small role in this as well. The dream of upward mobility and owning bigger homes led people to be riskier with their own real estate investments, and predatory lenders were all too willing to help.
Effects of the mortgage crisis
Home prices have fallen dramatically as the housing bubble has completely burst. This crushed many recent homeowners, who saw the interest rates on their mortgages rise rapidly as the home’s value deteriorated.
Unable to pay their mortgage on a monthly payment and unable to sell the home without suffering a massive loss, many had no choice. Banks have foreclosed on their homes. The owners were left in ruins and many of the suburbs turned into ghost towns. Even homeowners with good credit who qualified for standard mortgages have struggled with steadily rising interest rates.
By the time these homes were foreclosed, their value had collapsed. This meant that the banks were also taking massive losses on real estate. Investors have also been hit hard, as the value of the mortgage-backed securities in which they invest has fallen. This was made more difficult by the fact that people were still buying houses even when the bubble started to burst in 2006 at the beginning of 2007. Loans were still made and taken as sales collapsed.
The investment banks that bought and sold these delinquent loans began to go bankrupt. The lenders no longer had the money to continue distributing them. In 2008, the economy was in complete free fall.
Some institutions have been bailed out by the government. Other banks that had been so involved in the mortgage industry weren’t so lucky.
Subprime Mortgage Crisis and Lehman Brothers
Lehman Brothers has been one of the world’s largest investment banks for years. It was also one of the first investment banks to get heavily involved in investing in mortgages, something that would pay off until it became their downfall.
Falling house prices and widespread mortgage default have crushed Lehman Brothers. They were forced to shut down their subprime lenders and despite their many attempts to stop the bleeding (such as issuing shares) they continued to take losses until, on September 15, 2008, Lehman Brothers files for bankruptcy.
Lehman Brothers was one of the world’s largest financial services companies. Its rapid fall into bankruptcy was one of the main causes of the 2008 stock market crash.
Subprime Mortgages Today
Subprime mortgages were gone for a while after that, as they were seen as one of the most important parts of an economic collapse. But they were renamed somewhat, as lenders began selling “non-senior loans” to borrowers struggling with their credit.
There are also other forms of loans and debt that some economists fear they have in terms of the similarities to sub-prime mortgages of the mid-2000s. For example, a 2017 Citi report showed parallels between the subprime mortgage crisis and today’s ever-growing student debt.
Millennials with student debt have been a prime candidate for lenders to offer these unsecured loans, raising concerns that financial institutions have not learned or are ignoring the lessons of a decade ago.