The United States subprime mortgage crisis was a set of events and
conditions that led to a financial crisis and subsequent recession that
began in 2008. It was characterized by a rise in subprime mortgage
delinquencies and foreclosures, and the resulting decline of securities
backed by said mortgages. These mortgage-backed securities (MBS) and
collateralized debt obligations (CDO) initially offered attractive rates
of return due to the higher interest rates on the mortgages; however,
the lower credit quality ultimately caused massive defaults. Several
major financial institutions collapsed in September 2008, with
significant disruption in the flow of credit to businesses and consumers
and the onset of a severe global recession.
There were
many causes of the crisis, with commentators assigning different levels
of blame to financial institutions, regulators, credit agencies,
government housing policies, and consumers, among others. A proximate
cause was the rise in subprime lending. The percentage of lower-quality
subprime mortgages originated during a given year rose from the
historical 8% or lower range to approximately 20% from 2004 to 2006,
with much higher ratios in some parts o the U.S. A high percentage of
these subprime mortgages, over 90% in 006, for example were
adjustable-rate mortgages (ARM). These two changes were part of a
broader trend of lowered lending standards and higher-risk mortgage
products. Further, U.S. households had become increasingly indebted,
with the ratio of debt to disposable personal income rising from 77% in
1990 to 127% at the end of 2007, much of this increase mortgage-related.
When
U.S. home prices declined steeply after peaking in mid-2006, it became
more difficult for borrowers to refinance their loans. As
adjustable-rate mortgages began to reset at higher interest rates
(causing higher monthly payments), mortgage delinquencies soared.
Securities backed with mortgages, including subprime mortgages, widely
held by financial firms globally, lost most of their value. Global
investors also drastically reduced purchases of mortgage-backed debt and
other securities as part of a decline in the capacity and willingness
of the private financial system to support lending. Concerns about the
soundness of U.S. credit and financial markets led to tightening credit
around the world and slowing economic growth in the U.S. and Europe.
The
crisis had severe, long-lasting consequences for the U.S. and European
economies. The U.S. entered a deep recession, with nearly 9 million jobs
lost during 2008 and 2009, roughly 6% of the workforce. U.S. housing
prices fell nearly 30% on average and the U.S. stock market fell
approximately 50% by early 2009. As early 013, the U.S. stock market had
recovered to its pre-crisis peak but housing prices remained near their
low point and unemployment remained elevated. Economic growth remained
below pre-crisis levels. Europe also continued to struggle with its own
economic crisis, elevated unemployment and severe banking impairments
(estimated at €940 billion between 2008 and 2012).
Background and timeline of events
The
immediate cause or trigger of the crisis was the bursting of the United
States housing bubble with peaked in approximately 2005-2006. An
increase in loan incentives such as easy initial terms and a long-term
trend of rising housing prices had encouraged borrowers to assume risky
mortgages in the anticipation that they would be able to quickly
refinance at easier terms. However, once interest rates began to rise
and housing prices started to drop moderately in 2006-2007 in many parts
of the U.S., borrowers were unable to refinance. Defaults and
foreclosure activity increased dramatically as easy initial terms
expired, home prices fell, and ARM interest rates reset higher. Falling
prices also resulted in 23% of U.S. homes worth less than the mortgage
loan by September 2010, providing a financial incentive for borrowers to
enter foreclosure. The ongoing foreclosure epidemic, of which subprime
loans are one part, that began in late 006 in the U.S. continues to be
key factor in the global economic crisis, because it drains wealth from
consumers and erodes the financial strength of banking institutions.
Several
other factors set the stage for the rise and fall of housing prices
related securities widely held by financial firms. In the years leading
up to the crisis, the U.S. received large amounts of foreign money from
fast-growing economies in Asia and oil-producing/exporting countries.
This inflow of funds combined with low U.S. interest rates from
2002-2004 contributed to easy credit conditions, which fueled both
housing and credit bubbles. Loans of various types (e.g., mortgage,
credit card, and auto) were easy to obtain and consumers assumed an
unprecedented debt load.
As part of the housing and
credit booms, the amount of financial agreements called mortgage-backed
securities (MBS), which derive their value from mortgage payments and
housing prices, greatly increased. Such financial innovation enabled
institutions and investors around the world to invest in the U.S.
housing market. As housing prices declined, major global financial
institutions that had borrowed and invested heavily in MBS reported
significant losses. Defaults and losses on other loan types also
increased significantly as the crisis expanded from the housing market
to other parts of the economy. Total losses were estimated in the
trillions of U.S. dollars globally.
While the housing
and credit bubbles were growing, a series of factors caused the
financial system to become increasingly fragile. Policymakers did not
recognize the increasingly important role played by financial
institutions such as investment banks and hedge funds, also known as the
shadow banking system. Shadow banks were able to mask the extent of
their risk taking from investors and regulators through the use of
complex, off-balance sheet derivatives and securitizations.
These
instruments also made it virtually impossible to reorganize financial
institutions in bankruptcy, and contributed to the need for government
bailouts. Some experts believe these shadow institutions had become as
important as commercial (depository) banks in providing credit to the
U.S. economy, but they were not subject to the same regulations. These
institutions as well as certain regulated banks had also assumed
significant debt burdens while providing the loans described above and
did not have a financial cushion sufficient to absorb large loan
defaults or MBS losses.
These losses impacted the
ability of financial institutions to lend, slowing economic activity.
Concerns regarding the stability of key financial institutions drove
central banks to take action to provide funds to encourage lending and
to restore faith in the commercial paper markets, which are integral to
funding business operations. Governments also bailed out key financial
institutions, assuming significant additional financial commitments.
The
risks to the broader economy created by the housing market downturn and
subsequent financial market crisis were primary factors in several
decisions by central banks around the world to cut interest rates and
governments to implement economic stimulus packages. Effects on global
stock markets due to the crisis have been dramatic. Between 1 January
and 11 October 2008, owners of stocks in U.S. corporations had suffered
about $8 trillion in losses, as their holding declined in value from $20
trillion to $12 trillion. Losses in other countries have averaged about
40%.
Losses in the stock market and housing value
declines place further downward pressure on consumer spending, a key
economic engine. Leaders of the larger developed and emerging nations
met in November 2008 and March 2009 to formulate strategies for
addressing the crisis. A variety of solutions have been proposed by
government officials, central bankers, economists, and business
executives. In the U.S., the Dodd-Frank Wall Street Reform and Consumer
Protection Act was signed into law in July 2010 to address some of the
causes of the crisis.
Mortgage market
Subprime
borrowers typically have weakened credit histories and reduced
repayment capacity. Subprime loans have a higher risk of default than
loans to prime borrowers. If a borrower is delinquent in making timely
mortgage payments to the loan servicer (a bank or other financial firm),
the lender may take possession of the property, in a process called
foreclosure.
The value of American subprime mortgages
was estimated at $1.3 trillion as of March 2007, with over 7.5 million
first-lien subprime mortgages outstanding. Between 2004 and 2006, the
share of subprime mortgages relative to total originations ranged from
18%-21%, versus less than 10% in 2001-2003 and during 2007. The boom in
mortgage lending, including subprime lending, was also driven by a fast
expansion of non-bank independent mortgage originators which despite
their smaller share (around 25 percent in 2002) in the market have
contributed to around 20 percent of the increase in mortgage credit
between 2003 and 2005. In the third quarter of 2007, subprime ARMs
making up only 6.8% of USA mortgages outstanding also accounted for 43%
of the foreclosures which began during that quarter.
By
October 2007, approximately 16% of subprime ARMs were either 90-days
delinquent or the lender had begun foreclosure proceedings, roughly
triple the rate of 2005. By January 2008, the delinquency rate had risen
to 21% and by May 2008 it was 25%.
According to
RealtyTrac, the value of all outstanding residential mortgages, owed by
U.S. households to purchase residences housing at most four families,
was US$9.9 trillion as of year-end 2006, and US$10.6 trillion as of
midyear 2008. During 2007, lenders had begun foreclosure proceedings on
nearly 1.3 million properties, a 79% increase over 2006. This increased
to 2.3 million in 2008, an 81% increase vs. 2007, and again to 2.8
million in 2009, a 21% increase vs. 2008.
By August
2008, 9.2% of all U.S. mortgages outstanding were either delinquent or
in foreclosure. By September 2009, this had risen to 14.4%. Between
August 2007 and October 2008, 936,439 USA residences completed
foreclosure. Foreclosures are concentrated in particular states both in
terms of the number and rate of foreclosure filings. Ten states
accounted for 74% of the foreclosure filings during 2008; the top two
(California and Florida) represented 41%. Nine states were above the
national foreclosure rate average of 1.84% of households.
From
September 2008 to September 2012, there were approximately 4 million
completed foreclosures in the U.S. AS of September 2012, approximately
1.4 million homes, or 3.3% of all homes with a mortgage, were in some
stage of foreclosure compared with 1.5 million or 3.5%, in September
2011. During September 2012, 57,000 homes completed foreclosure; this is
down from 83,000 prior September but well above the 2000-2006 average
of 21,000 completed foreclosures per month.
Sources:
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
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