What is the US subprime crisis of 2008? [closed]

Question

I have heard that after the US subprime crisis of 2008,particularly a lot of people were pointing fingers at the Economic policymakers. I am not really familiar with why it is so, a detailed explanation to this will be most certainly welcome.

Answer 1

"The real causes of the housing and financial crisis were predatory private mortgage lending and unregulated markets. The mortgage market changed significantly during the early 2000s with the growth of subprime mortgage credit, a significant amount of which found its way into excessively risky and predatory products." According to

https://www.americanprogress.org/issues/economy/reports/2017/04/13/430424/2008-housing-crisis/

Answer 2

First, let's get clear on the 'Subprime Crisis of 2008.' I was working in banking at the time, and was considering seeking promotion into the mortgage department of the community bank I was working at.

The Housing Market Crash/Subprime Crisis/Mortgage Bubble of 2008 was the culmination of a frenzied mortgage market that lead to absolute bananas demand in real estate markets and ultimately a bubble (period of extreme price growth which leads to a groundswell of speculative investing which leads to massive losses for whoever just bought into the bubble when it pops - and it will always pop) with its attendant economic chaos.

You can start your timeline for the crisis basically at any point in human history, I'm going to choose to do so with the repeal of Glass-Stegall in 1999. The Glass-Stegall Act forbid retail banks (where you have a checking account) from engaging in investment banking (where things like bonds and hedge funds come from, to oversimplify the terminology a bit). This, in turn, led to a wave of innovation in financial securities as people tried to figure out which permutations of "Retail Banking Product + Securities" would lead to the greatest profit.

The main difference, before G-S got repealed, between Retail Banking Products and Investment Banking Products (securities) was risk. Retail banking products were FDIC insured, meaning consumers were protected from losing their money if the bank went under, but that insurance demanded that banks stay away from certain, risky investments. As a consequence, a set of industry norms around mortgage lending developed which limited who could get mortgages (screened by creditworthiness, usually) and under what conditions. Things like down payments and requiring inspections before purchase, etc.

The thing about investing, however: for a number of reasons, mostly to do with market forces, low risk investments give low yields. If you want the possibility of big gains, you have to find ways to expose yourself to larger risks. Freed from the prohibition against providing investment products, retail banks began looking for ways to get more risk into their portfolios so that they could start seeking larger profits.

Enter the Sub-prime Mortgage. In banking, a 'sub prime' borrower is anyone whose credit score is below 'Prime,' generally speaking this is a credit score of 670 or lower. These types of borrowers generally couldn't get mortgages at all, because the statistical risk that they would default on their mortgage was too high. Basically the home-buyer equivalent of a junk-bond rating.

Low credit score, however, wasn't the only reason you'd be considered a 'subprime' buyer. Perhaps your credit score was good, but you didn't have enough money for a down payment (traditionally 20% of the home's purchase price) to start your home ownership path out with some equity already baked in? How about we also loan you the down-payment, but make you pay an insurance company to protect the bank in case the house goes up in smoke, leaving you no way to pay back the mortgage? All sorts of unusual norm-violating practices began to emerge in order to justify selling more mortgages.

As this went on, banks began to compete with one another for borrowers who weren't traditionally qualified to buy homes, but who the bank felt could be relied upon and charged higher than market interest rates to boot. A race to the bottom began.

At the height of the subprime mortgage crisis even mortgage lenders knew that the market was behaving with a glorious lack of regard for fiscal safety. The general thinking among the mortgage lenders I was thinking of joining was "but what can you do, if we don't compete, we don't get business." We're talking things like buyers making no down payment to buy a home they've never seen, that hasn't had an inspection done recently to make sure everything is okay, and doing so without an escrow period. Many of these reckless practices have become the new normal, even today. (Ultimately, I decided to get out of banking, instead of getting any deeper into the madness.)

The problem is that as banks got into this feeding frenzy, anyone you might consider remotely creditworthy had long since been sold a mortgage. At some point, banks realized their risk profiles were nothing less than suicidal. They needed to unload some risk. It was time to cash out.

Enter the mortgage-backed-security (MBS). An MBS is like a bond in that it's money lent to someone in exchange for regular payments. It differs, however, in that instead of lending directly to a company, an MBS is a loan to a group of home buyers and the payments are their mortgage payments, collectively. Moreover, before 2007 anyway, mortgages were viewed as incredibly safe and reliable debt to own: after all, even if someone would default on some of their debt, to default on your mortgage was to lose your home! Surely no one would fight any less than their utmost to keep their home! Plus, banks were reputed to have excellent noses for sniffing out risky borrowers, and everyone knew that banks would never loan to someone who wasn't creditworthy. A retail bank's definition of 'risky' was still well within a speculator's definition of 'extremely safe.'

Retail banks began capitalizing on this reputation by creatively re-packaging mortgages into MBS. They would explain away the incredibly risky nature of the individual mortgages through how they were bundled. The purported idea is that by bundling sub-prime borrowers together, certainly some of them would default, but not all of them so the law of averages would ensure that a return was made. The MBS became the darling of debt securities and suddenly everyone wanted to pour money into them. Retail banks could not pack them and sell them fast enough. Moreover, MBS derivatives started to crop up, which picked the cream of the crop out of a bundle of MBS and sold off the riskier elements of it. The proposed returns on these junk-of-the-junk MBS were extremely seductive to some.

All of this cash flowing into MBS meant there was money to burn as long as you wanted to give it to someone who wanted to buy a house. Which meant if you wanted to buy a house, you could literally go on the internet, fill out a webform, and have people e-mailing mortgage offers the way many of us get 'free' credit cards in our junk mail. (And now you get offers to consolidate your student loans.)

Which meant there was an absolute insane amount of money, all loaned, hitting the housing market, looking for homes to buy. That kind of demand raises prices. And as everyone knows for a fact: real estate prices never go down! (Please note that this is the height of sarcasm, but it was a thing people were saying left and right.)

If you weren't buying houses, or mortgages, or MBS, you were being told what a complete idiot you were by all of your friends who were. It's just about as classic an investment bubble as you can get.

And then things started to go wrong. It turns out that just because a bank gives you money, doesn't mean you can make the payments on the loan. People began to default. For a while, defaulted mortgages were simply being repackaged and re-sold as even riskier debt securities, but at some point people realized that the risks were being grossly undercharacterized, that their boundless faith in retail bankers as judges of financial risk were grossly off the mark, and that MBS wasn't safe at all. The sell began, and the bubble popped... taking housing prices with it. Huge swaths of homes had been bought, entirely with debt, for twice or more what their worth now was.

An MBS is only as good as the mortgages that back it. Whole portfolios evaporated into waste paper, and any institution holding them was suddenly facing massive losses.

This is the Subprime Crisis of 2008, and the economic chaos would be felt for years thereafter, arguably we're still feeling it.

The second part of your question is why people point fingers at economic policy wonks. The answer is: because when things go wrong, people look to blame someone. But in order for things to get this bad, there's mountains of blame to go around:

1. Someone thought repealing Glass-Stegall was a good idea.
2. Someone thought doing away with various norms that protect banks and home-buyers from fraud was smart.
3. Someone thought people who weren't creditworthy would surely be able to make payments on loans with massive principals that take decades, sometimes lifetimes, to pay back.
4. Someone thought that such mortgages were something you could sell to investors.
5. Millions of people thought that real estate prices only ever go up, ignoring thousands of years of evidence to the contrary.
6. Plenty of people got on the news and bragged about how everyone should be buying homes now, and they'd instantly get rich.

and so on, and so on.

Are there economic policymakers to blame? Sure. Statistically speaking more people are to blame, than aren't. But there's no single actor, system, or event that you lay the full weight of the crisis at the feet of.