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Looking Back at the Great Recession: Part 1

A series examining the causes and effects of the Financial Crisis

The Financial Crisis of 2008 was caused by a combination of factors, including: subprime mortgages, which were given to borrowers with poor credit; the failure of banks and other financial institutions to properly assess the risk of these mortgages; the use of financial derivatives, such as mortgage-backed securities, which spread the risk of these mortgages throughout the global financial system; and a lack of regulation and oversight of these practices. Additionally, low interest rates and a housing market boom in the early 2000s contributed to the crisis.

The Boom

It is critical to understand just how significant the housing boom of the early 2000s was. Housing prices in the United States increased rapidly between 2000 and 2006, with some areas experiencing price appreciation of over 50%. This was driven by a combination of factors, including low interest rates, which made borrowing to purchase a home more affordable, and a strong economy. Additionally, there was a lot of speculation in the housing market, as many people believed that housing prices would continue to rise indefinitely.

This led to an increase in housing construction and home sales, as well as a rise in the number of people taking out mortgages to purchase homes. The number of mortgages that originated during this time period was at an all-time high, and many of them were subprime mortgages given to borrowers with poor credit who may not have qualified for a mortgage under normal lending standards.

As housing prices peaked in 2006 and began to decline, many borrowers found themselves unable to make their mortgage payments, leading to a wave of foreclosures and a crash in the housing market, which was one of the triggers of the Financial Crisis of 2008.

The Borrowers

Borrowers with poor credit were given loans for several reasons. One reason was that during the early 2000s, housing prices were increasing rapidly, making it easier for lenders to approve loans to borrowers with poor credit, as the value of the homes used as collateral was increasing. This led to a decrease in lending standards, and many lenders began to approve loans to borrowers who would not have qualified for them in the past.

Another reason was the availability of new financial products, such as adjustable-rate mortgages (ARMs) and interest-only mortgages, which made it easier for borrowers with poor credit to qualify for loans. These types of loans often had low “teaser” rates that were adjustable after a few years, which made the payments more affordable for borrowers in the short term.

Additionally, the increased use of automated underwriting systems also contributed to the approval of loans for borrowers with poor credit, as these systems may not have been able to take into account all the nuances of a borrower’s credit history, resulting in approval of loan application which would otherwise have been denied.

Finally, there was a high demand for mortgages and the mortgage-backed securities they generated. As a result, many lenders and financial institutions were motivated to approve as many loans as possible, regardless of the creditworthiness of the borrowers.