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Understanding the Subprime Mortgage Crisis: Causes and Consequences

Explore the speculative bubbles, subprime mortgages, and housing market crisis of the 2000s, analyzing the downfall and aftermath. Understand the risks, impact on consumers, banks, and the economy. Gain insights into the credit bubble and its collapse.

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Understanding the Subprime Mortgage Crisis: Causes and Consequences

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  1. 2002 - 2007 1996 - 2000 Holland 1634 - 1637 Speculative Bubbles 1925-29

  2. The Housing Market Crisis • What Happened?

  3. “The Economist” Magazine Covers During the Economic Crisis

  4. The Housing Market Crisis • What Happened?

  5. Buying a house (before 2000): PRIME MORTGAGES ONLY!!! Consumers were required to put a 20% down payment • For a $500,000 home: • $100,000 down payment & borrow $400,000 (mortgage) • loan is paid back over 30-years at a fixed interest rate (ex: 6%/year) • The loan is less than the value of the house • So banks are taking very little/no risk of default

  6. New Sub-prime Mortgages • Sub-prime mortgages were introduced in the year 2000 • These mortgages required no down payment to borrowers with poor credit history • Mortgages often had low initial interest rates which adjusted up later • Known as ARMs (Adjustable Rate Mortgage) or variable rate loans • Example: 2% interest rate/year for the first 3 years; after that the interest rate changes to 9%/year • Personal example

  7. Major Problem! Initial Value of House $1,000,000 Housing Bubble Analysis Subprime Mortgage Example • Price Paid: $1,000,000 • Down Payment: 0 • You owe: $1,000,000 Housing Bubble Bursts: New Value of House: $900,000 Homeowner now owes 1 million but only has a house worth $900,000. • Now he can’t refinance his loan and his house payments skyrocket when the loan resets. • If he can’t pay his monthly mortgage, the Bank will foreclose on his house! • Huge incentive to just walk away from the house.

  8. Subprime Mortgage Analysis The Binge • Banks made loans to consumers who were not qualified with zero down payments • In the short run, this caused home prices to rise • In the long run, this led to “inflated” home prices & people unable to pay their mortgage • The Hangover: • home prices fell substantially • consumers lost their homes to foreclosure • banks failed (as they took the losses on foreclosures)

  9. Caused by Credit Bubble Led to House of Cards

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