United States subprime mortgage crisis
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| United States subprime mortgage crisis | |
|---|---|
| Name | United States subprime mortgage crisis |
| Caption | Foreclosures in a residential neighborhood |
| Country | United States |
| Date | 2007–2009 |
| Causes | Subprime mortgage lending, mortgage-backed securities, credit default swaps, housing bubble |
| Outcome | Global financial crisis, Great Recession, regulatory reform |
United States subprime mortgage crisis was a widespread collapse of mortgage lending and related financial markets in the United States beginning in 2007 that precipitated the Global financial crisis of 2007–2008 and the Great Recession. Major financial institutions such as Lehman Brothers, Bear Stearns, AIG, Goldman Sachs, Morgan Stanley, and Citigroup were deeply affected as losses on mortgage-backed securitys and collateralized debt obligations mounted, prompting interventions by the Federal Reserve System, the United States Department of the Treasury, and international actors including the International Monetary Fund and the European Central Bank.
Background
Rapid expansion of mortgage credit in the early 2000s involved originators such as Countrywide Financial, Ameriquest, Washington Mutual, and Indymac Bank selling loans into securitization chains involving firms like Fannie Mae, Freddie Mac, Merrill Lynch, and Deutsche Bank. Rating agencies including Standard & Poor's, Moody's Investors Service, and Fitch Ratings assigned high ratings to complex securities issued by investment banks such as Credit Suisse and UBS. Financial innovation tied to institutions like J.P. Morgan Chase and Bank of America produced asset-backed securitys and derivatives traded in markets centered on hubs such as Wall Street and protected by legal frameworks including statutes enforced by the Securities and Exchange Commission and adjudicated in courts such as the United States District Court for the Southern District of New York.
Causes
Lending practices by firms like New Century Financial Corporation and Option One Mortgage Corporation, combined with underwriting standards tied to incentives at Mortgage Electronic Registration Systems and brokerages, increased exposure to high-risk borrowers. Securitization pipelines involving Bear Stearns hedge funds and structurers at Lehman Brothers relied on short-term funding through the commercial paper and repo markets, which were sensitive to liquidity shocks exemplified by runs on institutions such as Northern Rock and Icelandic banks. Derivatives markets for instruments like credit default swaps, traded among counterparties including AIG Financial Products and cleared through networks used by Intercontinental Exchange, transmitted counterparty risk. Macroeconomic contributors included low interest rate policy by the Federal Open Market Committee of the Federal Reserve System, U.S. housing policy involving Community Reinvestment Act debates, and global imbalances involving investors from China, Japan, and sovereign wealth funds such as the Abu Dhabi Investment Authority.
Timeline
By 2006 housing prices peaked in metropolitan areas like Miami, Las Vegas, Phoenix, and Los Angeles as subprime delinquencies rose, prompting early restructurings by servicers such as Ocwen Financial Corporation and KeyCorp subsidiaries. In 2007 failures at hedge funds linked to Bear Stearns High-Grade Structured Credit Strategies triggered asset fire sales and a 2008 run culminating in the acquisition of Bear Stearns by JPMorgan Chase. The March 2008 takeover of Bear Stearns and the September 2008 bankruptcy of Lehman Brothers coincided with government rescues of AIG and the conservatorship of Fannie Mae and Freddie Mac, while emergency legislation including the Troubled Asset Relief Program passed the United States Congress amid interventions coordinated with the International Monetary Fund.
Economic and financial impacts
The crisis produced severe contractions in credit markets, exemplified by freezes in interbank lending such as the LIBOR spike and stress in money market funds linked to events like the 2008 run on the Reserve Primary Fund, and contributed to declines in major indices including the Dow Jones Industrial Average and the S&P 500. Output declines in sectors such as construction and real estate deepened unemployment spikes tracked by the Bureau of Labor Statistics, while sovereign debt concerns spread to markets in the European sovereign debt crisis. Fiscal and monetary responses by the Federal Reserve System, the United States Department of the Treasury, and central banks including the Bank of England and the European Central Bank sought to mitigate contagion.
Government and regulatory responses
U.S. policy actions included enactment of the Emergency Economic Stabilization Act of 2008 establishing the Troubled Asset Relief Program, regulatory actions by the Federal Deposit Insurance Corporation including resolutions of IndyMac and Washington Mutual, and Federal Reserve programs such as the Term Auction Facility and Quantitative easing. In addition, the Securities and Exchange Commission and the Office of the Comptroller of the Currency issued guidance while the Financial Stability Oversight Council concept emerged in policy debates that led to the Dodd–Frank Wall Street Reform and Consumer Protection Act.
Legal actions and litigation
Litigation involved major banks including Bank of America, Wells Fargo, Citigroup, and Goldman Sachs in suits over foreclosure practices, securities fraud claims brought under the Securities Act of 1933 and the Securities Exchange Act of 1934, and enforcement actions by the Department of Justice and state attorneys general such as those in New York (state), California, and Massachusetts. Settlements included multistate agreements and civil penalties against institutions like JPMorgan Chase and Ally Financial (formerly GMAC), and high-profile trials and arbitration involving trustees, servicers, and insurers.
Aftermath and reforms
Reforms following the crisis included creation of the Consumer Financial Protection Bureau, enhanced capital and liquidity standards under international accords such as Basel III and implementation overseen by groups including the Financial Stability Board. Institutions such as Goldman Sachs and Morgan Stanley shifted business models, and markets adapted through increased use of central clearinghouses like LCH.Clearnet and strengthened supervision by regulators including the Federal Reserve Board of Governors. The crisis influenced scholarship and policy debates at organizations such as the Brookings Institution, National Bureau of Economic Research, and International Monetary Fund about financial regulation, macroprudential policy, and housing finance reform.