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The housing market in the early 2000s was a perfect home buyers market. Mortgage interest rates were low, property values were rising fast with no signs of slowing. This was a good time for the average american to get a loan. Property was considered by banks to be such a good collateral, that they were willing to make mortgage deals that they assumed the buyer may not be able to pay back. If the buyer defaulted, the bank would come into ownership of a rising property asset.
These loans were known as subprime mortgages, and were given to people with bad credit ratings, no credit history, or people with a history of late or missed payments These loans often had higher interest rates in order to compensate for the increased risk the banks were taking.
Sometimes they had low initial interest rates, called teaser rates, to trick buyers into thinking they were affordable, when in reality the rates would increase exponentially after a few years and quickly render the loans unaffordable.
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These loans give buyers no cushion for unexpected events such as job losses or changes in the market. At the same time, people who already had well structured mortgages wanted to access the equity in their homes which were locked in the increasing value of their property. This meant that in order to access their home’s equity, homeowners would need to refinance, often borrowing much more money with a higher interest rate. They then gain access to equity but are stuck with a much less favorable mortgages.
In a market where property values are constantly rising, this isn’t really a concern. This did however create subprime borrowers out of normal reliable borrowers. This, combined with the number of subprime borrowers that was growing as a result of the favorable market, created a very dangerous situation if the market were to change, however, many people thought that it never would, and that home prices would continue to grow steadily. The problem got worse when large investors began investing in high-risk, high-return mortgage bundles. These bundles were mortgages sold by banks who combined prime and the riskier subprime mortgages into products for investment.
Although creating better returns, investors didn’t fully understand the risks they were taking on, and banks hardly cared about the quality of the mortgage deals they were making as they were selling them off in bundles, relieving them of the responsibility. The crisis came on when property values stopped rising, and many subprime borrowers found themselves unable to repay their loans, causing them to default. This would have been okay in a good market, but when prices fell, banks started foreclosing on houses that were rapidly losing value. With more defaults, banks lost more money on their foreclosures, and the mortgage bundle investors lost money in their investments, essentially stalling the cash flow. Other factors contributed to this stall, and as a result the economy fell into recession.
Comparison of Great Depression and Great Recession. (2022, May 30). Retrieved from https://studymoose.com/comparison-of-great-depression-and-great-recession-essay
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