The subprime mortgage crisis was a major cause the 2008 financial crisis
, which then led to the worst recession
since the Great Depression
. This primer tracks how the subprime crisis unfolded, flattening the real estate market, creating the 2007 banking crisis and finally leading to the global recession. Get the definitions for important terms. Understand how interest rates
and real estate play an integral role in the U.S. economy. Uncover resources for those who need helpt from the effects of the subprime mortgage crisis.(Updated March 20, 2012)
Tim Boyle/Getty Images News/Getty Images
In December 2006, it was already apparent (at least to the readers of this website) that the real estate market threatened the U.S. economy. We just didn't know the cause - subprime mortgages - and how far subprime mortgages reached into the stock market and the overall economy.
By March 2007, it became apparent that the housing slump was spreading to the stock markets via hedge fund
By August, banks stopped lending to each other because they were afraid of getting caught with bad subprime mortgages. The Federal Reserve stepped in to restore liquidity
and confidence. And stepped in. And stepped in.
By October, we learned about other debt packages, called collateralized debt obligations
, that were also at risk. This speech by Federal Reserve Governor Kroszner explains why.
In November, then Treasury Secretary
Paulson convinced three banks, Citigroup, JPMorgan Chase and Bank of America, to set up a $75 billion superfund. It was managed by Blackrock Investments to buy distressed portfolios of defunct subprime mortgages. No one was interested and $75 billion was not nearly enough.
began lending to subprime borrowers a few years ago, it seemed great. Suddenly, anyone could buy a house, even with little or no money down. But not all of those borrowers were good candidates for the loan. Their defaults helped kick off the subprime crisis.
Interest-only loans made a lot of subprime mortgages possible. That's because homeowners were only paying the interest, and never paying down principal. That was fine until the interest rate kicker raised monthly payments up substantially. Often the homeowner could no longer afford the payments. As housing prices started to fall, they often found they could not longer afford to sell the home either. Voila! Subprime mortgage mess.
repackaged subprime mortgages into investments, thus allowing them to be sold on the stock market. It also helped spread the cancer of subprime mortgages to investors throughout the U.S. and the rest of the world.
The secondary market is how the repackaged subprime mortgages were sold to investors. Without it, banks would have to keep all mortgages on their books - and perhaps would have been more careful about whom they made the loans to.
This provides background information on how interest rates are set, and the relationship between mortgage rates, the Federal Reserve
and 10-year Treasury notes
. Mandatory reading if you are the least bit confused so far.