What Was the Subprime Meltdown?
The subprime meltdown was the sharp increase in high-risk mortgages that went into default beginning in 2007, contributing to the most severe recession in decades. The housing boom of the mid-2000s – combined with low interest rates at the time – prompted many lenders to offer home loans to individuals with poor credit. When the real estate bubble burst, many borrowers were unable to make payments on their subprime mortgages.
Subprime Meltdown Explained
Following the tech bubble and the economic trauma that followed the terrorist attacks in the U.S. on September 11, 2001, the Federal Reserve stimulated the struggling U.S. economy by cutting interest rates to historically low levels. As a result, the housing market soared for several years. To capitalize on the home-buying frenzy, some lenders extended mortgages to those who could not otherwise qualify for traditional loans because of a weak credit history or other disqualifying credit measures. This period even sparked the NINJA loan: no income, no job, no asset – no problem, money was easy flowing. Investment firms were eager to buy these loans and repackage them as mortgage-backed securities (MBSs) and other structured credit products.
Many subprime mortgages were adjustable-rate loans with reasonable interest rates but could reset to a dramatically higher interest rate after a given period. And they did when credit and liquidity dried up during the teeth of the Great Recession. This sudden increase in mortgage rates played a major role in the growing number of defaults, starting in 2007 and peaking in 2009. Significant job losses throughout the economy did not help; as many borrowers were losing their jobs, their mortgage payment was going up at the same time. Without a job, it was nearly impossible to refinance the mortgage with a lower fixed rate. The ensuing meltdown caused dozens of banks to go bankrupt and led to enormous losses on Wall Street and hedge funds that marketed or invested heavily in risky mortgage-related securities. The fallout was a major contributor to the lengthy economic downturn that followed.
Placing Blame for the Subprime Meltdown
In the wake of the subprime meltdown, myriad sources have received blame. These include mortgage brokers and investment firms that offered loans to people traditionally seen as high-risk, as well as credit agencies that proved overly optimistic about non-traditional loans. Critics also targeted mortgage giants Fannie Mae and Freddie Mac, which encouraged loose lending standards by buying or guaranteeing hundreds of billions of risky loans.