subprime mortgage crisis

subprime mortgage crisis
Name	Subprime mortgage crisis
Date	2007–2010
Location	United States, global
Type	Financial crisis
Cause	High-risk mortgage lending, securitization, derivative exposure
Outcome	Global recession, regulatory reform

subprime mortgage crisis

The subprime mortgage crisis was a financial crisis beginning in 2007 that triggered a global financial downturn and a severe recession. The crisis involved widespread defaults on high-risk mortgage loans, collapse of major investment banks and financial institution failures, and large-scale interventions by central banks such as the Federal Reserve System and the European Central Bank. It catalyzed major regulatory reforms including the Dodd–Frank Wall Street Reform and Consumer Protection Act and spurred political responses from administrations including the George W. Bush and Barack Obama presidencies.

Background and causes

Lending practices in the early 2000s, including aggressive expansion of mortgage loan originations by firms like Countrywide Financial and Washington Mutual, fed a housing boom that drew investors into securitized credit such as mortgage-backed securitys and collateralized debt obligations sold by Goldman Sachs, Morgan Stanley, and Lehman Brothers. Low interest rates set by the Federal Reserve System and global capital flows from institutions such as the Bank for International Settlements and Japan Bank for International Cooperation encouraged risk-taking by investment banks, commercial banks, and shadow banks including American International Group and Bear Stearns. Credit-rating agencies like Moody's Investors Service, Standard & Poor's, and Fitch Ratings assigned high ratings to structured products, while securitization chains involving Fannie Mae and Freddie Mac helped distribute exposure. Regulatory oversight failures by agencies such as the Office of the Comptroller of the Currency and the Securities and Exchange Commission and the deregulatory environment influenced by policymakers including Alan Greenspan and legislators in the United States Congress contributed to systemic vulnerability.

Timeline and key events

Key events began with rising mortgage delinquencies in 2006 and accelerated as housing prices declined in 2007, exemplified by the collapse of subprime lenders like New Century Financial and the takeover of Fannie Mae and Freddie Mac in September 2008. The crisis peaked with the bankruptcy of Lehman Brothers on September 15, 2008, and the near-failure of American International Group leading to a government rescue under the United States Department of the Treasury. Emergency programs such as the Troubled Asset Relief Program and central bank actions by the Bank of England, European Central Bank, and People's Bank of China aimed to stabilize markets. Other notable episodes included the 2007 run on Bear Stearns resulting in its acquisition by JPMorgan Chase and the 2008 stock market turmoil affecting exchanges like the New York Stock Exchange and indices such as the Dow Jones Industrial Average.

Financial instruments and market mechanisms

The crisis centered on instruments like mortgage-backed securitys, collateralized debt obligations, credit default swaps sold by firms including AIG Financial Products, and repurchase agreements used in the repo market among entities such as Goldman Sachs and Deutsche Bank. Securitization chains pooled loans from originators such as Countrywide Financial into special-purpose vehicles and tranched risk into senior and mezzanine tranches rated by agencies like Moody's Investors Service. Leverage employed by Lehman Brothers, Bear Stearns, and hedge funds amplified losses, while valuation problems in opaque over-the-counter markets affected liquidity in venues including the Chicago Mercantile Exchange and other derivatives platforms. The interactions of credit risk transfer, leverage, and maturity transformation in shadow banking entities such as structured investment vehicles produced systemic contagion across global capital markets.

Impact on institutions and markets

Major consequences included failures and restructurings at Lehman Brothers, Bear Stearns, Washington Mutual, and near-collapse of AIG, widespread write-downs at Citigroup, Bank of America, and Merrill Lynch, and forced mergers like JPMorgan Chase's acquisition of Bear Stearns. Stock indices including the S&P 500 and FTSE 100 plunged, interbank lending rates such as the LIBOR spiked, and mortgage credit availability tightened sharply impacting mortgage servicers and originators including IndyMac and Countrywide Financial. Sovereign responses included capital injections by treasuries and central banks including the United States Department of the Treasury and the European Central Bank, while sovereign entities such as Iceland experienced banking sector collapses that prompted nationalization and IMF interventions.

Economic and social consequences

The crisis precipitated the Great Recession with significant declines in Gross Domestic Product in countries including the United States, United Kingdom, and Spain, and elevated unemployment rates observed in regions such as Michigan and Andalusia. Foreclosures surged affecting homeowners in markets like Florida, California, and Nevada, contributing to declines in housing construction and retail activity in urban centers including Las Vegas and Miami. Fiscal responses increased public debt burdens in countries including the United States and Greece, while social impacts manifested in heightened economic inequality debates involving figures such as Joseph Stiglitz and Paul Krugman and movements like Occupy Wall Street.

Policy responses and regulatory changes

Policymakers enacted measures such as the Troubled Asset Relief Program and regulatory reforms culminating in the Dodd–Frank Wall Street Reform and Consumer Protection Act, which created the Consumer Financial Protection Bureau and the Financial Stability Oversight Council. Central banks expanded balance sheets through quantitative easing led by the Federal Reserve System and the Bank of England, while international coordination occurred via the G20 and institutions like the International Monetary Fund and the Bank for International Settlements. Reforms altered capital standards under frameworks influenced by Basel Committee on Banking Supervision accords and prompted changes in derivatives markets including reforms tracked by the Commodity Futures Trading Commission.

Litigation and accountability

Litigation followed against originators and underwriters including Countrywide Financial, Goldman Sachs, and Bank of America resulting in settlements overseen by the United States Department of Justice and state attorneys general such as the New York Attorney General. Cases implicated accounting firms like Ernst & Young and KPMG and led to civil and criminal investigations by agencies including the Securities and Exchange Commission and the Federal Bureau of Investigation. Mortgage servicing issues produced multistate settlements and the creation of programs involving entities such as the Office of the Comptroller of the Currency and the Federal Housing Finance Agency to provide homeowner relief and enforce foreclosure practices.

Category:Financial crises