The subprime mortgage crisis was a collapse of the US housing market, which was caused by mass defaults on US house mortgages in the face of a sudden decline in US housing prices. This all happens when irresponsible lenders start lending to irresponsible people; this is sub-prime mortgage, a type of loan granted to individuals with poor credit history. The crisis was due to a “housing bubble” an overpricing of housing because of easy credit and house speculation. This is also related to a crisis in worldwide retirement funds, as many of these were invested in the US housing market.
Subprime mortgages represent a higher risk for lenders, due to the fact that many of those homeowners that take loans will go into default. The lenders know that if they lend money to people who cannot afford to pay back, so in other words, they expect them to go into default. However knowing because they know this, what they do is, charge higher interest rates to borrowers.
If you were to ask who’s responsible for these events, it would depend on who you ask the question to, because it has political and class overtones. The Democrats claim that regulation of the banks by the cancellation of the Glass-Steagall Act was to blame. Republicans claim it was the fault of Fannie Mae and Freddie Mac under the oversight of Congressmen Barney Frank and Chris Dodd. Mostly everyone blames the FED, in particular Alan Greenspan, for setting bank’s interests rates too low.
Interest rates are called “cost of money”. Higher interest rates charged to banks means they can only award loans to the most viable business ideas. They have to refuse loans to some business proposals that might have been profitable with a lower interest rate. When interest rates are high, it is difficult to borrow money for people and industries. So, industrial activity slows down due to reduced money supply. If the interest rates are low, it means money can be borrowed at a lesser cost. Due to low interest rates, industries can borrow money easily and can start (and continue) their economic activities easily. This increased economy increases the production in the economy. This increases the GDP of the country. However if this goes on for too long, it leads to a crisis.
Some of the things that could happen are, investors stop investing in banks. Even if it’s the safest way to invest their money, because of the low interest rates they will try to make the most out of their money instead of letting it sit there. On the other hand low interest also makes people want to start borrowing money from banks at that same low rate; their goal being to resell and make profit off whatever they buy with the money they borrowed. Low interest rates basically make people feel like they are cash rich and are therefore tempted to spend more money in shops like M&S. The side effect of all this is, not only are people spending money they do not have, even though everyone makes money, it is bad, since it will lead to a crisis.
It is believed that subprime mortgage crisis started when Clinton was pushing for everyone to have a chance at achieving home ownership. This made banks become relaxed in their underwriting, loan approval processes. As the real estate market prices soared everyone would buy a house without income documentation and after 6 months they would sell that very same house for hefty profits. This went on and then when the market slowed down, many banks had to close down. The government chose to blame mortgage brokers for this crisis. However, the reality is that the banks themselves were doing these loans; otherwise brokers would not have had buyers to sell the paper to. Countrywide had a SISA loan at 100% financing. This means stated income and stated assets without proof any proof, so you could have been a bum and be able to buy a house then sell it later for a very large amount, then pay back the loan and keep the profits.
The repeal of Glass-Steagall was justified as a means to let banks diversify and help provide cheaper credit for the economy. Easy loans by Fannie Mae were justified as a policy that would allow everyone to be able to buy their own home. Mortgage bankers justified their cheap, easy loans by claiming that house value always goes up. Mortgage speculators and house flippers justified their mortgage purchasers on the same grounds.
As a result the market collapsed jobs were lost, more homes were lost and a recession happened. The US and world economies were greatly affected because of this. The US stock market crashed in late 2008 because of it. The US economy plunged into a long recession that it has not gotten out of yet. Credit has become more difficult to qualify for. For the reason that there were severe drops in US consumer purchases, other countries suffered economic problems as well.
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