The Crisis of Subprime Mortgages (2003 – 2008)

Accounting scandals and the dot-com bust hurt American markets. Riskier stocks outperformed bonds. Banks created a mortgage-backed debt market to give investors large returns with minimal risk (MBS). Mortgage-backed securities are traded by speculators. MBS holders get borrower interest and principal. Defaulting MBS owners can foreclose. By 2003, dot-com bubble mania and 9/11 shocks dissipated. Rate cuts boosted credit. Real estate outperformed stocks after the dot-com bubble. Strong demand, easy financing, and limited supply strengthened the housing market. Property ads were everywhere. Americans were encouraged to use their homes as “piggy banks” Banks developed mortgage-backed derivatives. CDOs (Collateralized Debt Obligation) combine mortgage-backed securities and corporate bonds into a structure that rewards buyers depending on default risk. Synthetic CDOs were created. During the housing boom, CDO buyers thought underlying mortgages were low risk. In event of default, investors could be given underlying assets without mortgage cash flows. Risk-free synthetic CDOs Wall Street supposedly built a perpetual motion machine. Low interest rates and investors seeking unsustainable income increased demand for MBS. Everybody could get a mortgage. NINJA loans are for people with no credit, income, or collateral. The unbankable bought homes with these commodities. Predatory lending. Low initial rate raises monthly payments. 50-year mortgages were offered by some lenders. During the housing boom, mortgage-backed credit soared to $62 trillion. Rating agencies failed to assess buyers’ credit risk and composite CDO products. High-risk financial products rated triple-A mislead customers. Dealers pay credit rating firms, creating a conflict of interest. Credit agencies misrepresented MBS for profit. MBS merchants were encouraged to sell more things, generating moral hazard. Unsustainable housing boom raised income and debt. 2000s consumption barely grew. During the housing boom, many racked up debts they couldn’t pay. By September 2008, house prices were 20% lower than in 2006. Failures in composite goods lowered credit derivatives. Many banks MBS contained mis rated subprime mortgages. AHM declared bankruptcy on August 6, 2007. BNP Paribas prohibited withdrawals from three Northern Rock investment funds, causing the bank’s first run in one hundred years. All sizes of financial companies defaulted, hurting the economy. Soon after, Lehman Brothers and Bear Stearns collapsed in the U.S. and Europe. The Senate passed the Emergency Economic Stabilization Act of 2008 on October 1, 2008. 2009’s global banking meltdown caused the worst economic catastrophe of the 21st century. Greed, moral hazard, and reckless financialization constructed a sophisticated house of cards. Public pays most.

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