The subprime mortgage crisis has put the U.S. economy into the worst recession since 1982. This primer tracks how the subprime crisis unfolded, affecting first the real estate market and then the economy overall. It gives you definitions of important terms. It also explains how interest rates and real estate play an integral role in the U.S. economy. Finally, it gives resources for those who are suffering from the subprime mortgage crisis directly.
In December of 2006, it was already apparent (at least to the readers of this website) that the real estate market could depress the U.S. economy. We just didn't know the cause - subprime mortgages - and how far subprime mortgages had extended 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 investments.
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.
In October, it became apparent that other debt packages, called collateralized debt obligations, were also at risk. This speech by Federal Reserve Governor Kroszner explained why.
In November, three banks - Citigroup, JPMorgan Chase and Bank of America - hired Blackrock Investments to run a $75 billion superfund. This fund was supposed to buy distressed portfolios of defunct subprime mortgages. No one was interested, and we know today that $75 billion was not nearly enough.
When banks 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 contributed to the current recession.
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.
Mortgage-backed securities 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.
