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.

The Consumerist explains that CDOs were categorized into tranches according to their risk. The tranches deemed less risky, issued a AAA rating by credit rating agencies, were the first to get paid, then came the others, in order of increasing risk. When funds stopped coming in due to defaulted mortgages, the lower-rated debt tranches dried up. Financial blog Consumerist posted a video that explains how CDOs functioned—and ceased to function—by likening the investment vehicle to a champagne glass tower and mortgages to a bottle of bubbly.

The New York Times has a step-by-step guide that traces how risky mortgage-backed securities were repackaged to eventually reemerge as bonds rated “safe” by bonds-rating agencies.

Seeking Alpha has an article from June 2007—while the financial markets were still generally on the rise—that examines hedge funds and how they were keen to buy CDOs. It also mentions investment banks at risk of exposure to “toxic debt” from CDOs. Among them were long-standing investment houses that would either fail or be acquired by other banks, including Bear Stearns and Merrill Lynch and Lehman Brothers, as well as banks that weathered the crisis that would roil Wall Street 14 months later, including Morgan Stanley, Goldman Sachs and Barclays.

Fortune wrote in a November 2007 report that the subprime crash is shocking in that it hit some well-established, respectable players, yet it was hardly unpredictable. The norm on Wall Street, according to Fortune’s Shawn Tully, is that it “always rides a wave until it crashes. As the fees roll in, one firm after another abandons itself to the lure of easy money.” Tully quotes Tiger Williams, CEO of Williams Trading, who said, “The fee engine becomes so huge that these products take on a life of their own. Everyone rationalizes that it’s safe because they’re making so much money. But it’s far from safe.”

The New York Times has an August 2007 article explaining how the CDO market roiled Wall Street and other world financial markets, including how inaccurate credit ratings were apparently issued on the packaged debt securities. As investors became aware that the securities were riskier than originally thought, they began to sell them off out of panic. The New York Times article also has a graph showing the rise and fall of CDO issuance.

CNN Money has a concise timeline of major events in the subprime mortgage crisis, beginning with HSBC’s announcement in February 2007 that it expected to see substantial losses from defaults on subprime loans; the June 2007 asset dump of two Bear Stearns hedge funds largely exposed to toxic debt; and the U.S. government taking mortgage lenders Fannie Mae and Freddie Mac into federal conservatorship in September 2008.

The New York Times covers the August 9, 2007, plunge in the Dow Jones. It dropped 387 points to close at 13,270.68, its biggest one-day decline since the previous February. Investors were growing nervous about the effects the subprime crisis could have on the credit markets. That morning, addressing whether the rising number of foreclosures and mortgage defaults could have a detrimental effect on the credit markets, President George W. Bush said at a news conference, “The fundamentals of our economy are strong” and there was no need for the federal government to provide money to the financial markets.

FindingDulcinea has an August 2007 article examining developments in the subprime mortgage crisis to that point, including the Aug. 17 Federal Reserve interest rate cut in a bid to free up credit markets, the Fed’s moves to inject money into the banking system, and a March 2007 congressional hearing at which five top subprime lenders were invited to testify.

Barron’s published an article in 2004 titled “No Margin of Safety,” which took a skeptical view of the rocketing stock prices for subprime lenders.