History Of Subprime Mortgage Crisis

Published Date: 02 Nov 2017

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Subprime Mortgage Crisis

Abstract

The subprime mortgage crisis, popularly known as ‘mortgage meltdown’ or ‘mortgage mess’ came to prominence when a steep rise in home foreclosures in the year 2006 spiraled out of control in 2007, prompting a national economic or financial crisis, which went global. The housing market plummeted, consumer spending was down, the number of foreclosures continued to rise, and the stock market was shaken. This crisis spurred massive media attention; numerous different explanations of the crisis have been hinted. This paper provides a discussion on the subprime mortgage crisis.

Discussion

Since 2000, with low intermediation margins, low interest rates, and depressed stock markets, most private investors were fervently looking for securities offering greater yields and numerous financial institutions were looking for better fees and better margins. The focus on growth and yields blinded them to the risk repercussions of what they were doing ( ). They found it fitting to rely on the rating agencies evaluations of credit risks without realizing that these evaluations involved some evident flaws. Because investment banks were hungry for the business of securitization, and the hunger of investors for securities that were particularly high yielding, there was little to contain ethical hazard in mortgage origination that indeed appeared to have steadily risen from the year 2001 to 2007 ( ). For some time the flaws in the system were hidden since real estate prices were escalating, partially in reaction to the inflow of funds produced by this system. But, after real estate prices started to fall in 2006, the credit risk in the underlying mortgages become evident ( ).

In mid 2007, numerous experts thought that the crisis would be contained within the area of mortgage issuers who had overloaded on their subprime loans ( ). Few experts would have forecasted that the crisis would be so serious as to threaten the whole economy to the extent that it did. While downturns in the housing and mortgage markets previously caused economic problems, experts explained that this crisis was exceptional. ( ) states that in the past such crisis have generated downturns in the entire economy through a credit crunch in the finance non-banking sector and this was the first time downturns were driven by a credit crunch in this sector. Numerous economists and experts believe that the subprime crisis was caused by several factors: the housing bubble, historically low interest rates, criticism of greenspan, and housing market correction.

Why did this crisis bring down the global financial system? According to ( ) given the flaws in the system of securitization and subprime mortgage finance in the U.S, the collapse of the system should not have come as a big surprise. Long before the occurrence of this crisis, some economists had cautioned that residential real estate markets were experiencing a housing bubble, and the only issue was when this bubble could break. But, the problems in subprime mortgage securitization and finance as well as the collapse of the system only provided one part of the explanation for the crisis. These economists could not explain why since 2007, the fallout from the subprime crisis had shaken the whole global financial system ( ). Even in May 2007, when market regulators and participants were already aware that subprime mortgage markets were in a state of crisis in the U.S, no one seemed to have expected the repercussions, which followed. For example, the IMF global financial report of 2007 gives a detailed account of problems with mortgage backed securities and subprime mortgages in the U.S, but concludes that the problem would not affect the entire economic system ( ).

The differences between the subprime mortgage crisis and other crisis is not in the magnitude of the significant losses, but in the systemic repercussions and linkages. In early 2000 in the stock market decline, most of the burden was experienced by final investors. But in the S&l crisis, the failing institutions were closed by the government; assets disposed of without undue haste and depositors paid off ( ). By contrast, in the subprime crisis, there has been no surgical separation of failing institutions and failing asserts from the rest of the economic system.

Numerous mortgage lenders, banks, real estate hedge funds and investment trusts suffered considerable losses because of mortgage asset devaluation or mortgage payment defaults. Mortgage home builders and lenders were hard hit, and losses cut across all sectors, with some of the worst affected industries like mining and metal companies, having only the vaguest of ties with mortgages or lending ( ). And as the crisis continued to unfold, participants in the several important markets acted as one would expect them to act when there is momentous apprehensiveness about the quality of counterparties, quality of assets, and the evolution of the financial system in the future. They insisted on big discounts on any assets of unknown quality and withdrew funding. In a crisis as large as the subprime mortgage one, such reactions entailed an element of panic. Because the surprises that investors and lenders experienced with the multiple step downgrades of mortgage backed securities, investors might have wondered what other surprises were in store. For instance, institutional investors like managers of hedge funds and money market funds might have been wondering how their own financiers would have reacted to the news. Anybody who had to fear his/her financiers’ reaction would have felt at least compelled to increase liquidity or reduce risks in his/her portfolio.

Conclusion

Analysts and economists have come to understand the causes and implications of the subprime mortgage crisis. Regulators, legislators, industry insiders and everyone have witnessed the overwhelming effect of this crisis on the global and United States economies. However, the most important issue of the subprime mortgage crisis still looms; what steps should be taken to prevent such a crisis from occurring again?