What is now known as the United States subprime mortgage crisis was a nationwide banking emergency that contributed to the concurrent repression from 2007 to 2009, spanning the years 2007 to 2010. As it swept through the financial markets in the United States, it took time for the US Federal Reserve Bank to solve this crisis, affecting a large portion of the US and its homeowners. Since then, it has been seven years, but how did this nationwide banking emergency happen? With the market in a better place in recent years, the question now becomes about how this crash was eventually overcome and what long-lasting effects remain.
The Subprime Mortgage Crisis
During the financial recession in the US, one of the biggest issues was with the housing market. Beginning in 2007, the expansion of mortgages to high-risk borrowers mixed with rising housing prices contributed to the turmoil in financial markets. This issue reached so far into the market that it took three years and the help of the Federal Government to correct it.
How Did It Begin?
Essentially, this entire crisis came from an earlier expansion in mortgage credit, meaning that people who previously had trouble getting mortgages had fewer problems. With rising home prices on the decline however due to the collapse of a housing bubble, many people ended up with mortgage delinquencies and foreclosures. Housing lost much of its value as people began to spend less money and debt was only expanded with mortgage backed securities and collateralized debt obligations.
All of these factors began in 2007, and by September of 2008, some major financial institutions collapsed. This led to a disruption in the flow of credit to businesses and consumers, forcing a global recession as well.
The Crisis Itself
More than 25 subprime lenders declared bankruptcy around this time due to losses. Even the largest subprime lender, New Century Financial, dropped 84%, while the world’s largest bond fund PIMCO, warned of the eventual effects this would have on the economy in general. Companies began to collapse or bail one another out.
At the same time, the fallout from poor lending practices that initially gave people with subprime credit a mortgage left many of those same homeowners struggling to remain in their homes. This is because adjustable rate mortgages began to reset at higher interest rates, which increased people’s monthly payments. Securities backed with mortgages then lost most of their value as a result of as private financial systems declined to support lending from that point on.
When the US credit and financial markets were on the verge of collapse, credit tightened around the world. Slower economic growth resulted, with severe effects both in the US and European economies.
In 2007, BNP Paribas said it was unable to value assets in three funds due to exposure to the US subprime lending markets, and with the possibility of exposure to those markets, the European Central Bank got involved. They tried to ease some of the market issues by opening $130 billion of low interest credit.
Crisis Solving Attempts
When the financial panic swept through Europe, the US Federal Reserve Bank conducted an open market operation to move $38 billion in temporary reserves in order to fix some of the issues as a result of the credit crunch. Even the discount window rate was lowered so lending was made easier between the Federal Reserve Bank and banks themselves.
Open market operations like this one are common tools used to control money in the US, with various forms available during crisis. In this case, the Federal Reserve Bank was able to give currency to the banks in order to alleviate some of the credit issues.
The mortgage industry crisis forced hearings between Senator Chris Dodd and the top five subprime lending mortgage companies as they were required to explain their lending practices. Even federal bailouts were proposed by Senator Charles Schumer to save homeowners from ending up without their homes.
Around this time, the US entered its recession as 9 million people lost jobs in 2008 and 2009 alone. Housing prices fell around 30% on average while the stock market took a 50% hit by 2009. By 2013, the US stock market has recovered, but housing prices remain low and unemployment is still high. Europe continued to struggle with their own banking impairments and unemployment between 2008 and 2012, emphasizing the far-reaching effects of the subprime mortgage crisis even years later.