Global Financial Crisis

NPR discusses how low interest rates helped ease credit access, allowing more people to obtain loans, including for homes. This pushed up demand, hence the prices of real estate. Mortgage lenders were more at ease offering “creative financing” to risky borrowers. One such financing mechanism was adjustable-rate mortgages, or ARMs, which allowed some borrowers to tack on unpaid interest to the principal of their home loan. Borrowers and real estate speculators believed that home prices would continue to rise. “Subprime loans expanded to 20 percent of the mortgage market in 2006, from 9 percent a decade earlier,” writes NPR.

Investopedia has an article called “Who Is To Blame For The Subprime Crisis?” that breaks down the fallout that occurred when borrowers could not keep up with the higher payments after their ARMs reset. Lenders subsequently had reduced liquidity, reducing their ability to make new loans or refinance existing loans. Home prices also began to drop, resulting in some homeowners holding negative equity—having mortgages that were at a higher cost than the real estate itself. This, in addition to the emerging credit crunch, left mortgage holders unable to refinance.

The New York Times has a piece in which former employees from mortgage lender Countrywide Financial describe lending practices that showed little concern about whether borrowers would be able to keep up payments. Among the questionable aspects of Countrywide’s business was a computer system in the subprime unit that took no account of cash reserves when calculating what mortgage to recommend borrowers. This meant that borrowers were steered toward subprime loans when they should have qualified for better interest rates.

CNN describes how the subprime meltdown claimed its first major institutional casualty in April 2007, when New Century Financial Corp. filed for Chapter 11 bankruptcy. CNN reports that New Century had been the “poster child” for the subprime market, and that its financial troubles had been common knowledge since January. Its collapse had serious repercussions for the industry, as New Century was unable to pay more than $8 billion in loans to other financial institutions.

Economist Paul Krugman’s New York Times blog breaks down the housing market in terms of historical prices, pricing trends, expectation on housing prices in October 2007, the number of mortgages issued and foreclosure rates on prime vs. subprime mortgages.