The Financial Crisis created by sub prime mortgages which affected nearly every bank and financial institution around the world, began towards the end of 1999 but stayed under the radar until 2006 when it became apparent that a horrific problem was at hand.
The word "mortgage" comes from Old French and translates to "dead pledge" meaning that an obligation dies when an agreement is fulfilled or payed off. Sort of ironic because there are probably quite a few consumers who were unaware of the consequences of what they were getting into when the whole mess of the sub prime mortgage fiasco unfolded and would have preferred death over losing everything they own.
Mortgages are the security for a loan between a lender and a consumer and are primarily for real estate. Typical mortgages require interest that is measured by an APR (annual percentage rate), and the rate is based on a borrowers credit worthiness. Mortgages can be traced back to the 1860's and while scrutiny towards the borrowers credit worthiness has always been given top priority by the lender, the absence of such scrutiny has been pointed out as a major contributor to the mortgage crisis of recent times.
In the early 1990's a demand for loans for consumers with less than perfect credit worthiness was realized. Wall Street saw this as an opportunity to make a lot of money and sub prime mortgage lending exploded.
The term "sub prime" refers to the lending to borrowers who do not meet "prime" standards. A riskier category of borrowers who prior to the sub prime opportunity could not qualify for loans. Suddenly offered the promises of quick cash, instant access to live much more comfortably, to buy all the things they couldn't afford earlier. Promises that the higher interest rates were only temporary because in a year or two or three they could refinance at a lower interest rate again.
Mortgage backed securities (MBS) began selling on Wall Street to no end. Investors were scrambling over each other to get the government backed, government guaranteed, no risk securities they could. These securities originate as mortgage loans which are bought from lending institutions, pooled together, then sold as claims against the principle and payments on these loans. The banks get paid, the agencies which give the ratings for these securities get paid, the brokers which sell the securities get paid, and the investors are guaranteed, by the government, to receive timely payments. There were also guarantees from Ginnie Mae, Fannie Mae and Freddie Mac to investors against homeowner default. And, while only Ginnie Mae is fully backed and has full faith and credit of the government, both Fannie Mae and Freddie Mac have lines of credit through the government.
A housing market boom took over, mainly fueled by low interest rates, foreign funds, and the incredibly easy credit conditions. The home ownership rate in America which had remained constant for 15 years jumped eight percent in less than ten years, and during the same time home values more than doubled. The conditions which provided the credit to those who previously had none drove overall demand for housing and home prices higher. Soon, with home prices skyrocketing, everyone wanted to take advantage of the price appreciation and become a homeowner. Home builders put more than a million new homes on the market. Consumers were borrowing more, spending more, and saving less. Consumer household debt grew beyond belief and every household was estimated to have more than ten credit cards each, all of which had more than fifty percent of the available credit spent.
An inevitable surplus in housing caused prices to peak in 2006 and a decline in prices followed shortly afterward. The decline in home prices made the option for refinancing impossible for most consumers, and many sub prime borrowers that obtained adjustable rate mortgages realized that they were unable to pay their monthly payments by refinancing, were left with no other option but to default.
The decline of mortgage payments resulted in a decline in the mortgage backed securities which brought a decline in the net worth of the banks. These losses have wiped out much of the capitol of the worlds banks. We haven't heard the last of the aftermath of the sub prime crisis, and, to date, there is an estimated 1.5 trillion in losses around the world.
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