The Subprime Mortgage Crisis: How Did It All Start?
The sub prime mortgage crisis was born in a decade-long housing boom fueled by low interest rates and excess liquidity. During these ‘boom’ years, mortgage brokers enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment and without proper tax documentation and credit checks. And so the groundwork was established for the coming mortgage meltdown.
These loans, usually adjustable rate mortgages (ARMs) were known as subprime mortgages. They typically cost two or three points above those with less-risky credit reports and carry interest rate structures with low ‘teaser rates’ for the first couple of years, followed by a reset to much higher rates. This reset or jump, frequently resulted in raising the borrower’s monthly payment by as much as 100% and thereby making it financially impossible for him to handle.
The new homeowners saw a rising value of their homes during the initial year or so of their mortgages, and frequently took out home equity loans for extra cash.
In addition, banks and financial institutions often repackaged these debts with other high-risk debts and sold them to worldwide investors creating financial instruments called CDOs or collateralized debt obligations.
The serious sub prime mortgage crisis began in June of 2007 when two Bear Stearns hedge funds collapsed. This had a rapid effect on other parts of the financial markets worldwide which reached the crisis level in August-September of this year and temporarily froze the money market sector that is critically important to banking and financial operations.
When this took place, the Federal Reserve Bank and European Central Bank dumped $100-billion in liquidity into the system that calmed the market down for a short period.
The sub prime mortgage market continued to be solid as long as the housing market continued to escalate and interest rates didn’t go up. Meanwhile, the homeowners continued to incur more debt until it reached a level of $700 billion or 5% of the US GDP in 2004. By 2006, housing prices started to taper off after rising nearly 40% between 200 and 2006. They are expected to continue their decline through 2007 and most of 2008.
As sub prime mortgages began to reset in droves and result in foreclosure, housing prices also declined. Because of the way these loans and CDOs were globally distributed, it knocked the whole system out of whack. Keep in mind that a single CDO package might contain as many as 100 subprime mortgage loans. As the defaults continued, the worldwide CDOs took a major hit and the entire thing went down like a house of cards.The fallout from the subprime mortgages have affected the housing market, financial markets and the entire US economy.
The rest is history. There is a real possibility that all this will force us into a full-blown recession. The stock market has been a volatile roller coaster ride and financial professionals say things will probably get worse before they get better. So hang on!
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I have been a mortgage loan officer working under a broker for almost 20 years and, yes, there are bad loan officers and brokers that take advantage of people but you need to do more research for your story before you start blaming mortgage brokers for “talking borrowers into taking a subprime mortgage”. You should be saying how it started with the secondary mortgage market where the loan programs and guidelines are developed. They made it easy for borrowers to qualify for a mortgage. The idea of a short term fixed loan was that the borrower would improve their credit within that time period and then refinance into a long term fixed rate. You meet with a borrower who wants to buy a house and after looking over their qualifing information you tell them this is the only thing they qualify for. Either don’t buy or take this, improve your credit and then refinance. What do you think they will do? This is not the brokers fault, you need to look further up the chain than that.