The Subprime Mortgage Crisis

What is the subprime mortgage crisis?


The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system.

What does subprime mean?

Many USA mortgages issued in recent years are subprime, meaning that little or no downpayment was made, and that they were issued to households with low incomes and assets, and with troubled credit histories. When USA house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime mortgages, widely held by financial firms, lost most of their value. The result has been a large decline in the capital of many banks and USA government sponsored enterprises, tightening credit around the world.


How did this lead to such a "melt-down"?

  • Following the tech bubble and the events of September 11, the Federal Reserve stimulated a struggling economy by cutting interest rates to historically low levels.
  • Thus, a housing bull market was created
  • People with poor credit got in on the action when mortgage lenders created non-traditional mortgages: interest-only loans, payment-option ARMs and mortgages with extended amortization periods.
  • Eventually, interest rates climbed back up and many subprime borrowers defaulted when their mortgages were reset to much higher monthly payments. This left mortgage lenders with property that was worth less than the loan value due to a weakening housing market. Defaults increased; the problem snowballed, and several lenders went bankrupt.
  • Investors and hedge funds also suffered because lenders sold mortgages they originated into the secondary market. Essentially, the mortgages were bundled together and sold to investors as collateralized debt obligations (CDOs) and other mortgage-backed securities (MBSs).
  • When the higher risk underlying mortgages started to default, investors were left with properties that were quickly losing value. In the wake of the meltdown, central banks released liquidity into the market place, which allowed struggling lenders and hedge funds to continue operations and make the necessary payments on their obligations.
  • Thus, banks were forced to write-down billions of dollars because they had these worthless subprime mortgage securities left on their books.
  • This led to depleted capital in most investment banks, and a loss of confidence in bank's lending and their ability to pay back their debts.

…thus, the subprime mortgage crisis was born!

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