subprime mortgage crisis

subprime mortgage crisis. The subprime mortgage crisis was a severe nationwide banking emergency that triggered a global financial crisis and the Great Recession. It was precipitated by the collapse of a housing bubble and the subsequent failure of numerous mortgage-backed securities and credit default swaps. The crisis caused the failure or near-failure of major financial institutions like Lehman Brothers and AIG, leading to massive government interventions.

Background and causes

The origins of the crisis lie in a confluence of factors spanning several decades. A prolonged period of low Federal Reserve interest rates after the dot-com bubble burst increased liquidity and encouraged riskier lending. Financial deregulation, including the repeal of the Glass–Steagall Act via the Gramm–Leach–Bliley Act, allowed commercial and investment banks to merge, fueling complex derivative markets. Government-sponsored enterprises Fannie Mae and Freddie Mac expanded their purchases of mortgages, while lenders like Countrywide Financial engaged in predatory lending to subprime borrowers. The widespread securitization of these risky loans into collateralized debt obligations, which were rated highly by agencies like Moody's and Standard & Poor's, created a systemic vulnerability throughout Wall Street.

Timeline of events

The crisis unfolded in distinct phases, beginning with early warning signs in 2006-2007. In early 2007, major subprime lender New Century Financial filed for Chapter 11 bankruptcy. By mid-2007, Bear Stearns announced the collapse of two of its hedge funds heavily invested in mortgage securities. In March 2008, the Federal Reserve facilitated the fire-sale of Bear Stearns to JPMorgan Chase. The crisis reached its zenith in September 2008, when the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship. Days later, Lehman Brothers filed for the largest bankruptcy in U.S. history, and Bank of America acquired a faltering Merrill Lynch. The Treasury and Federal Reserve then orchestrated an $85 billion bailout for AIG.

Impact on financial markets

The collapse of the mortgage market precipitated a catastrophic credit crunch and a loss of confidence in the global banking system. Stock markets plummeted, with the Dow Jones Industrial Average and S&P 500 experiencing historic declines. The LIBOR-OIS spread, a key measure of banking sector stress, spiked dramatically. Major institutions like Washington Mutual and Wachovia failed or were acquired under duress. The crisis spread internationally, affecting banks such as UBS in Switzerland, Royal Bank of Scotland in the United Kingdom, and Fortis in the Benelux region, leading to coordinated interventions by central banks including the European Central Bank and the Bank of England.

Government response and bailouts

Federal authorities responded with unprecedented emergency measures to stabilize the financial system. The Emergency Economic Stabilization Act of 2008 created the Troubled Asset Relief Program, authorizing the Treasury to inject capital into banks like Citigroup and Bank of America. The Federal Reserve launched novel facilities like the Term Asset-Backed Securities Loan Facility and slashed the federal funds rate to near zero. A key component was the bailout of the American automotive industry, providing loans to General Motors and Chrysler. Globally, governments from the United Kingdom to Germany implemented their own bank rescue packages and stimulus plans.

Aftermath and regulatory changes

The crisis resulted in the Great Recession, with millions of foreclosures, steep unemployment, and a slow economic recovery. In response, the Obama administration signed the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, which established the Consumer Financial Protection Bureau and the Financial Stability Oversight Council, and introduced the Volcker Rule. International accords like Basel III strengthened bank capital requirements. The crisis led to significant legal settlements, with banks like Goldman Sachs and JPMorgan Chase paying billions for their roles, and spurred public movements such as Occupy Wall Street. Its legacy profoundly influenced monetary policy and financial regulation for years to come.

Category:Financial crises Category:2000s economic history Category:Housing in the United States