In 2008, the United States entered its worst financial crisis since the Great Depression. A reduction in the amount of services and goods sold and produced, a business cycle downturn and a general slowdown of economic activity—all of these were characteristics of the recession.
With mounting foreclosures, an astronomical national debt and skyrocketing unemployment rates, Americans were all too eager to know where to point their fingers. Although the recession officially ended in 2009, many citizens still are feeling the effects of this monetary travesty.
Among the many statistics that are yet to stabilize is the foreclosure rate. According to MSN, RealtyTrac Vice President Rick Sharga expects a 35 percent to 40 percent jump in foreclosure filings this year. Clearly, the effects of the subprime-mortgage crisis still are resonating.
What is the subprime-mortgage crisis?
The subprime-mortgage crisis is categorized by high rates of late mortgage payments and foreclosures. This led to the deterioration of securities that were buttressed by those mortgages and forced thousands of families out of their homes.
So, who’s the culprit behind the subprime-mortgage crisis? The government? The banks? According to Forbes, no one party is to blame.
An ineffective monetary ideology was a principal cause of the crisis.
Although many would say that the gears were set in motion back in 1998 when the Glass-Steagall legislation was dismantled, ultimately, the crisis was a product of a monetary ideology shared by several of the nation’s top financial gurus.
The Glass-Steagall legislation instituted checks and balances to ensure that banks did not engage in risky behaviors. When the law was repealed, there was no separation between investment banks and regular banks. All funds officially were protected by the government, so investment banks could gamble with other people’s money, knowing that their coffers were insured against any losses.
When the $1.3-trillion dot-com world went toes up in 2001, investors sought liquidity. However, asset managers couldn’t get decent returns from municipal bonds, because the Federal Reserve Board (Fed) lowered interest rates to 1 percent. So, they opted for high-yield securities that were backed by mortgages.
In 2006, 84 percent of all subprime mortgages were held by private lenders, and 83 percent of home loans were handed out to low- and moderate-income borrowers. Combined, these loans were worth approximately $2 trillion.
Wall Street banks leveraged more than they could afford.
In 2004, the Securities and Exchange Commission (SEC) altered loan-leverage regulations for five banks: Goldman Sachs, Morgan Stanley, Merrill Lynch (now a component of Bank of America), Lehman Brothers (no longer in business) and Bear Stearns (absorbed by JPMorgan Chase). These institutions were allowed unlimited leverage.
Some of these banks reached leverage ratios as high as 40 to 1. This means that the bank’s assets, such as home loans, were 40 times the amount of its core capital. Not surprisingly, only two of the five banks survived past 2008, and this was possible only because of government subsidies.
Low interest rates motivated people to buy homes that they couldn’t afford.
Wall Street investors weren’t the only parties taking advantage of low interest rates; low- and medium-income citizens were entering mortgage agreements that they couldn’t afford. Thanks to non-traditional mortgages that offered “no down payments,” the American Dream became attainable for people who ultimately would default on their payments.
Those who purchased their homes without adequate income were hoping that their new assets would appreciate. This would allow them to refinance for lower rates and appropriate equity for other spending.
Unfortunately, the high demand for homes reduced their values, so many never appreciated. No banks were able to give loans, because they had no money to leverage. Therefore, homes could not be paid for nor sold, leading to mass foreclosures.
So, there are three possible parties to blame for the subprime-mortgage crisis:
1. Banks that leveraged too much money
2. Citizens that purchased homes that they couldn’t afford
3. The Fed for establishing monetary policies that let it all happen
Although hindsight is 20/20, there’s still no clear culprit behind the subprime-mortgage crisis. If there’s one silver lining, it’s that economic policymakers are more informed and better prepared to prevent future economic travesties.
