Real Estate Crisis

Real Estate Crisis: causes and Effects

Real estate bubble

A real estate bubble also called property bubble or housing bubble for residential markets is a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in valuations of real property such as housing until they reach unsustainable levels relative to incomes and other economic elements.

As with any type of economic bubble, it is often claimed that a real estate bubble is difficult for many to identify except in hindsight, after the crash. Real Estate bubble - Old HouseThe crash of the Japanese houses price bubble from 1990 on has been very damaging to the Japanese economy and the lives of many Japanese who have lived through it, as is also true of the recent crash of the real estate bubble in China's largest city, Shanghai. Unlike a stock market crash following a bubble, a real-estate "crash" is usually a slower process, because the real estate market is less liquid than the stock market. Other sectors such as office, hotel and retail generally move along with the residential market, being affected by many of the same variables such as income and interest rates and also sharing the "wealth effect" of booms.

Real estate bubbles have existed in the recent past and are widely believed to still exist in many parts of the world including the United States, Argentina, Britain, the Netherlands, Italy, Australia, New Zealand, Ireland, Spain, France, Poland, South Africa, Israel, Greece, Bulgaria, Croatia, Canada, Norway, Singapore, South Korea, Sweden, Baltic states, India, Romania, South Korea, Russia, Ukraine and China. U.S. Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) … it's hard not to see that there are a lot of local bubbles". The Economist magazine, writing at the same time, went further, saying "the worldwide rise in house prices is the biggest bubble in history". Real estate bubbles are invariably followed by severe price decreases also known as a house price crash that can result in many owners holding negative equity, which means that a mortgage debt held is higher than the current value of the property.

Subprime mortgage crisis

Subprime lending is the practice of making loans to borrowers who do not qualify for market interest rates owing to various risk factors, such as income level, size of the down payment made, credit history, and employment status. The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007, with over 7.5 million first-lien subprime mortgages outstanding. Approximately 16% of subprime loans with adjustable rate mortgages (ARM) were 90-days delinquent or in foreclosure proceedings as of October 2007, roughly triple the rate of 2005. By January 2008, the delinquency rate had risen to 21% and by May 2008 it was 25%. The U.S. mortgage market is estimated at $12 trillion with approximately 9.2% of loans either delinquent or in foreclosure through August 2008. Subprime ARMs only represent 6.8% of the loans outstanding in the US, yet they represent 43.0% of the foreclosures started during the third quarter of 2007. During 2007, nearly 1.3 million properties were subject to foreclosure filings, up 79% versus 2006.

Traditionally, banks lent money to homeowners for their mortgage and retained the risk of default, called credit risk. However, due to financial innovations, banks can now sell rights to the mortgage payments and related credit risk to investors, through a process called securitization. The securities the investors purchase are called mortgage backed securities (MBS) and collateralized debt obligations (CDO). This new "originate to distribute" banking model means credit risk has been distributed broadly to investors, with a series of consequential impacts. There are four primary categories of risk involved: credit risk, asset price risk, liquidity risk, and counterparty risk.

There is a greater interdependence now than in the past between the U.S. housing market and global financial markets due to MBS. When homeowners default, the amount of cash flowing into MBS declines and becomes uncertain. Investors and businesses holding MBS have been significantly affected. The effect is magnified by the high debt levels maintained by individuals and corporations, sometimes called financial leverage.

The subprime mortgage crisis is an ongoing financial crisis characterized by contracted liquidity in global credit markets and banking systems triggered by the failure of mortgage companies, investment firms and government sponsored enterprises which had invested heavily in subprime mortgages. The crisis, which has roots in the closing years of the 20th century and has become more apparent throughout 2007 and 2008, has passed through various stages exposing pervasive weaknesses in the global financial system and regulatory framework.

The subprime mortgage crisis began with the bursting of the United States housing bubble and high default rates on "subprime" and adjustable rate mortgages (ARM), beginning in approximately 2005–2006. For a number of years prior to that, declining lending standards, an increase in loan incentives such as easy initial terms, and a long-term trend of rising housing prices had encouraged borrowers to take difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in the United States in late 2006 and triggered a global financial crisis through 2007 and 2008. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from 2006.

Major banks and other financial institutions around the world have reported losses of approximately US$435 billion as of 17 July 2008. The liquidity concerns drove central banks around the world to take action to provide funds to member banks to encourage lending to worthy borrowers and to restore faith in the commercial paper markets. The U.S. government also bailed out key financial institutions, assuming significant additional financial commitments.

Causes of subprime mortgage crisis

The reasons for the subprime mortgage crisis are varied and complex. The subprime crisis can be attributed to a number of factors pervasive in both the housing and credit markets, which developed over an extended period of time. There are many different views on the causes, including the inability of homeowners to make their mortgage payments, poor judgment by the borrower and/or the lender, speculation and overbuilding during the boom period, risky mortgage products, high personal and corporate debt levels, financial innovation that distributed and perhaps concealed default risks, central bank policies, and government regulation or alternatively lack of such regulation.

- Boom and bust in the real estate sector

A combination of low interest rates and large inflows of foreign funds helped to create easy credit conditions for many years leading up to the real estate crisis. Subprime borrowing was a major contributor to an increase in home ownership rates and the demand for housing. The overall U.S. home ownership rate increased from 64% in 1994 (about where it was since 1980) to a peak in 2004 with an all-time high of 69.2%.

This demand helped fuel housing price increases and consumer spending. Between 1997 and 2006, American home prices increased by 124%. For the two decades until 2001, the national median home price went up and down, but it remained between 2.9 and 3.1 times the median household income. By 2004, however, the ratio of home prices to income hit 4.0, and by 2006 the ratio was 4.6. Some homeowners used the increased property value experienced in the housing bubble to refinance their homes with lower interest rates and take out second mortgages against the added value to use the funds for consumer spending. U.S. household debt as a percentage of income rose to 130% during 2007, versus 100% earlier in the decade. A culture of consumerism is a factor "in an economy based on immediate gratification". Americans spent $800 billion per year more than they earned. Household debt grew from $680 billion in 1974 to $14 trillion in 2008, with the total doubling since 2001. During 2008, the average U.S. household owned 13 credit cards, and 40 percent of them carried a balance, up from 6 percent in 1970.

Overbuilding during the boom period eventually led to a surplus inventory of homes, causing home prices to decline, beginning in the summer of 2006. Easy credit, combined with the assumption that housing prices would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages they could not afford after the initial incentive period. Once housing prices started depreciating moderately in many parts of the U.S., refinancing became more difficult. Some homeowners were unable to re-finance and began to default on loans as their loans reset to higher interest rates and payment amounts.

By March 2008 an estimated 8.8 million homeowners — nearly 10.8% of total homeowners — had zero or negative equity, meaning their homes were worth less than their mortgage. This provided an incentive to "walk away" from the home, despite the credit rating impact.

Increasing foreclosure rates increased the supply of housing inventory available. Sales volume (units) of new homes dropped by 26.4% in 2007 compared to the prior year. By January 2008, the inventory of unsold new homes stood at 9.8 months based on December 2007 sales volume, the highest level since 1981. A record of nearly four million unsold existing homes were for sale including nearly 2.9 million vacant homes.

This excess supply of home inventory placed significant downward pressure on prices. As prices declined, more homeowners were at risk of default and foreclosure. According to the S&P/Case-Shiller price index, by November 2007, average U.S. housing prices had fallen approximately 8% from their Q2 2006 peak and by May 2008 they had fallen 18.4%. The price decline in December 2007 versus the prior year period was 10.4% and for May 2008 it was 15.8%. Housing prices are expected to continue declining until this inventory of surplus homes (excess supply) is reduced to more typical levels.

- High-risk lending practices

A variety of factors have caused lenders to offer an increasing array of higher-risk loans to higher-risk borrowers including illegal immigrants. The share of subprime mortgages to total originations was 5% ($35 billion) in 1994, 9% in 1996, 13% ($160 billion) in 1999, and 20% ($600 billion) in 2006. A study by the Federal Reserve indicated that the average difference in mortgage interest rates between subprime and prime mortgages, also called the "subprime markup" or "risk premium", declined from 2.8 percentage points in 2001, to 1.3 percentage points in 2007. In other words, the risk premium required by lenders to offer a subprime loan declined. This occurred even though subprime borrower credit ratings and loan characteristics declined overall during the 2001–2006 period, which should have had the opposite effect. The combination is common to classic boom and bust credit cycles.

In addition to considering higher-risk borrowers, lenders have offered increasingly high-risk loan options and incentives. These high risk loans included the "No Income, No Job and no Assets" loans, sometimes referred to as Ninja loans. In 2005 the median down payment for first-time home buyers was 2%, with 43% of those buyers making no down payment whatsoever.

Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest with no principal repayments during an initial period. Still another is a "payment option" loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal. Further, an estimated one-third of ARM originated between 2004 and 2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment.

Mortgage underwriting practices have also been criticized, including automated loan approvals that critics argued were not subjected to appropriate review and documentation. In 2007, 40% of all subprime loans were generated by automated underwriting. The chairman of the Mortgage Bankers Association claimed mortgage brokers profited from a home loan boom but did not do enough to examine whether borrowers could repay. Mortgage fraud has also increased.

- Speculation in the real estate sector

Speculation in the real estate sector was a contributing factor. During 2006, 22% of homes purchased were for investment purposes, with an additional 14% purchased as vacation homes. During 2005, these figures were 28% and 12%, respectively. In other words, nearly 40% of record levels home purchases were not primary residences. NAR's chief economist at the time, David Lereah, stated that the fall in investment buying was expected in 2006. "Speculators left the market in 2006, which caused investment sales to fall much faster than the primary market."

While homes had not traditionally been treated as investments like stocks, this behavior changed during the housing boom. For example, one company estimated that as many as 85% of condominium properties purchased in Miami were for investment purposes. Media widely reported the behavior of purchasing condominiums prior to completion, then selling them for a profit without ever living in the home. Some mortgage companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly leveraged positions in multiple properties.

Keynesian economist Hyman Minsky described three types of speculative borrowing that can contribute to the accumulation of debt that eventually leads to a collapse of asset values: the "hedge borrower" who borrows with the intent of making debt payments from cash flows from other investments; the "speculative borrower" who borrows based on the belief that they can service interest on the loan but who must continually roll over the principal into new investments; and the "Ponzi borrower", named for Charles Ponzi, who relies on the appreciation of the value of their assets such as real estate to refinance or pay-off their debt but cannot repay the original loan.

The role of speculative borrowing has been cited as a contributing factor to the subprime mortgage crisis.

 - Securitization practices

Securitization is a structured finance process in which assets, receivables or financial instruments are acquired, pooled together as collateral for the third party investments. There are many parties involved. Due to the securitization, investor appetite for mortgage-backed securities (MBS), and the tendency of rating agencies to assign investment-grade ratings to MBS, loans with a high risk of default could be originated, packaged and the risk readily transferred to others. Asset securitization began with the structured financing of mortgage pools in the 1970s. In 1995 the Community Reinvestment Act (CRA) was revised to allow for the securitization of CRA loans into the secondary market for mortgages.

The traditional mortgage model involved a bank originating a loan to the borrower/homeowner and retaining credit/default risk. With the advent of securitization, the traditional model has given way to the "originate to distribute" model, in which the credit risk is transferred and distributed among investors through MBS. The securitized share of subprime mortgages, those passed to third-party investors via MBS increased from 54% in 2001, to 75% in 2006. Securitization accelerated in the mid-1990s. The total amount of mortgage-backed securities issued almost tripled between 1996 and 2007, to $7.3 trillion. The debt associated with the origination of such securities was sometimes placed by major banks into off-balance sheet entities called structured investment vehicles or special purpose entities. Moving the debt "off the books" enabled large financial institutions to circumvent capital reserve requirements, thereby assuming additional risk and increasing profits during the boom period. Such off-balance sheet financing is sometimes referred to as the shadow banking system and is thinly regulated. Alan Greenspan stated that the securitization of home loans for people with poor credit — not the loans themselves — was to blame for the current global credit crisis.

However, instead of distributing mortgage-backed securities to investors, many financial institutions retained significant amounts. The credit risk remained concentrated within the banks instead of fully distributed to investors outside the banking sector. Some argue this was not a flaw in the securitization concept itself, but in its implementation.

Some believe that mortgage standards became lax because of a moral hazard, where each link in the mortgage chain collected profits while believing it was passing on risk.

Under the CRA guidelines, a bank gets credit originating loans or buying on a whole loan basis, but not holding the loans. So, this gave the banks the incentive to originate loans and securitize them, passing the risk on others. Since the banks no longer carried the loan risk, they had every incentive to lower their underwriting standards to increase loan volume. The mortgage securitization freed up cash for banks and thrifts, this allowed them to make even more loans. In 1997, Bear Sterns bundled the first CRA loans into MBS.

- Misleading credit ratings

Credit rating agencies are now under scrutiny for giving investment-grade ratings to securitization transactions such as CDOs and MBSs based on subprime mortgage loans. Higher ratings were believed justified by various credit enhancements including over-collateralization (pledging collateral in excess of debt issued), credit default insurance, and equity investors willing to bear the first losses. However, there are also indications that some involved in rating subprime-related securities knew at the time that the rating process was faulty. Internal rating agency emails from before the time the credit markets deteriorated, released publicly by U.S. congressional investigators, suggest that some rating agency employees suspected at the time that lax standards for rating structured credit products would produce widespread negative results. For example, one 2006 email between colleagues at Standard & Poor's states "Rating agencies continue to create an even bigger monster—the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters."

High ratings encouraged the flow of investor funds into these securities, helping finance the housing boom. The reliance on ratings by these agencies and the intertwined nature of how ratings justified investment led many investors to treat securitized products — some based on subprime mortgages — as equivalent to higher quality securities and furthered by SEC removal of regulatory barriers and reduced disclosure requirements in the wake of the Enron scandal. Critics claim that conflicts of interest were involved, as rating agencies are paid by the firms that organize and sell the debt to investors, such as investment banks. On 11 June 2008 the U.S. Securities and Exchange Commission proposed far-reaching rules designed to address perceived conflicts of interest between rating agencies and issuers of structured securities.

Rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed securities from Q3 2007 to Q2 2008. This placed additional pressure on financial institutions to lower the value of their MBS. In turn, this may require these institutions to acquire additional capital, to maintain capital ratios. If this involves the sale of new shares of stock, the value of existing shares will be reduced. In other words, ratings downgrades pressured MBS and stock prices lower.

- Government regulation

To increase home ownership was a goal of both Clinton and Bush administrations. In mid-1990s the Clinton administration’s top housing official, Mr. Cisneros loosened mortgage restrictions so first-time buyers could qualify for loans they could never get before, contributing to the great real estate and financial crisis that began 10 years later.

Several critics have commented that the current regulatory framework is outdated. President George W. Bush stated in September 2008: "Once this crisis is resolved, there will be time to update our financial regulatory structures. Our 21st century global economy remains regulated largely by outdated 20th century laws. Recently, we've seen how one company can grow so large that its failure jeopardizes the entire financial system." The Securities and Exchange Commission (SEC) has conceded that self-regulation of investment banks contributed to the subprime mortgage crisis.

In the United States, capital requirements played an important role in stimulating mortgage securitization. A paper by Paul S. Calem and Michael LaCour-Little points out that mortgages originated and held by banks are put into an arbitrary risk classification that requires more capital than similar mortgages originated by third parties but held as securities. Freddie Mac and Fannie Mae are regulated differently, and for all but the riskiest loans Freddie and Fannie face lower capital requirements and hence lower costs.

Even more surprising is the way that capital requirements favor private mortgage securities - securities not issued by Freddie Mac or Fannie Mae. Those securities, even when backed by high-risk mortgages, can obtain attractive risk ratings from credit rating agencies through use of tranches that only are subject to losses if a substantial proportion of loans goes into default. FDIC capital regulations give a lower risk weight to highly-rated mortgage securities, which may be backed by loans with little or no down payment, than to loans originated within the bank with down payments of up to 40 percent. These relative risk ratings embedded in capital requirements are the opposite of actual experience.

If capital requirements were identical between banks and Freddie/Fannie, then it is unlikely that Freddie Mac and Fannie Mae would have grown to dominate the mortgage market. Had the bank capital requirements for mortgages and mortgage securities been based on objective calculations of risk based on default probabilities, it is unlikely that banks would have found it attractive to hold private mortgage securities backed by the types of loans originated in recent years. Objective measure of risk would have steered banks toward originating and holding loans with higher down payments. Thus, the entire securitization phenomenon, which was at the center of the financial crisis in the United States, was artificially generated by poorly-designed capital requirements.

Liberal economist Robert Kuttner has criticized the repeal of the Glass-Steagall Act by the Gramm-Leach-Bliley Act of 1999 as possibly contributing to the subprime mortgage crisis, although other economists disagree. A taxpayer-funded government bailout related to mortgages during the savings and loan crisis may have created a moral hazard and acted as encouragement to lenders to make similar higher risk loans. Additionally, there is debate among economists regarding the effect of the Community Reinvestment Act, with detractors claiming it encourages lending to not creditworthy consumers and defenders claiming a thirty year history of lending without increased risk. Detractors also claim that amendments to the CRA in the mid-1990s, raised the amount of home loans to otherwise unqualified low-income borrowers and also allowed for the first time the securitization of CRA-regulated loans containing subprime mortgages. A study by a legal firm which counsels financial services entities on Community Reinvestment Act compliance found that CRA-covered institutions were less likely to make subprime loans having only 20–25% of all subprime loans, and when they did the interest rates were lower. The banks were half as likely to resell the loans to other parties.

Some have argued that, despite attempts by various U.S. states to prevent the growth of a secondary market in repackaged predatory loans, the Treasury Department's Office of the Comptroller of the Currency, at the insistence of national banks, struck down such attempts as violations of Federal banking laws.

The U.S. Department of Housing and Urban Development's mortgage policies fueled the trend towards issuing risky loans. In 1995, Fannie Mae and Freddie Mac began receiving affordable housing credit for purchasing mortgage backed securities which included loans to low income borrowers. This resulted in the agencies purchasing subprime securities. Subprime mortgage loan originations surged by 25% per year between 1994 and 2003, resulting in a nearly ten-fold increase in the volume of these loans in just nine years. In 1996 the Housing and Urban Development (HUD) agency directed Freddie and Fannie to provide at least 42% of their mortgage financing to borrowers with income below the median in their area. This target was increased to 50% in 2000 and 52% in 2005. In addition, HUD required Freddie and Fannie to provide 12% of their portfolio to “special affordable” loans. Those are loans to borrowers with less than 60% of their area’s median income. Naturally, these targets increased over the years with the 2008 target being 28%. At a hearing in 2003, Barney Frank explicitly stated that Fannie and Freddie’s government privileges were conditional on their willingness “to make housing more affordable.” The only way to achieve the low income loan targets while dramatically increasing lending was to erode underwriting standards. Fannie Mae aggressively bought Alt-A loans, where these loans may require little or no documentation of a borrower’s finances. As of November 2007 Fannie Mae held a total of $55.9 billion of subprime securities and $324.7 billion of Alt-A securities in their portfolios. As of the 2008Q2 Freddie Mac had $190 billion in Alt-A mortgages. Together they have more than half of the $1 trillion of Alt-A mortgages. The growth in the subprime mortgage market, which included B, C and D paper bought by private investors such as hedge funds, fed a housing bubble that later burst. In 2004, HUD ignored warnings from HUD researchers about foreclosures, and increased the affordable housing goal from 50% to 56%. These securities were very attractive to Wall Street, and while Fannie and Freddie targeted the lowest-risk loans, they still fueled the subprime market as a result.

A September 30, 1999 New York Times article stated, "... the Fannie Mae Corporation is easing the credit requirements on loans... The action... will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough... Fannie Mae... has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers whose incomes, credit ratings and savings are not good enough for conventional loans... Fannie Mae is taking on significantly more risk... the government-subsidized corporation may run into trouble... prompting a government rescue... the move is intended in part to increase the number of... home owners who tend to have worse credit ratings..."

On September 10, 2003, U.S. Congressman Ron Paul gave a speech to Congress where he said that the then current government policies encouraged lending to people who couldn't afford to pay the money back, and he predicted that this would lead to a bailout, and he introduced a bill to abolish these policies.

- Role of central banks

Central banks are primarily concerned with managing monetary policy, therefore they are less concerned with avoiding asset bubbles, such as the housing bubble and dot-com bubble. Central banks have generally chosen to react after such bubbles burst to minimize collateral impact on the economy, rather than trying to avoid the bubble itself. This is because identifying an asset bubble including a housing bubble and determining the proper monetary policy to properly deflate it is a matter of debate among economists.

Federal Reserve actions raised concerns among some market observers that it could create a moral hazard. Some industry officials said that Federal Reserve Bank of New York involvement in the rescue of Long-Term Capital Management in 1998 would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf.

A contributing factor to the rise in home prices was the lowering of interest rates earlier in the decade by the Federal Reserve, to diminish the blow of the collapse of the dot-com bubble and combat the risk of deflation. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%. The central bank believed that interest rates could be lowered safely primarily because the rate of inflation was low and disregarded other important factors. The Federal Reserve's inflation figures, however, were flawed. Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas, stated that the Federal Reserve's interest rate policy during this time period was misguided by this erroneously low inflation data, thus contributing to the housing bubble.

- Role of financial institutions and their debt levels

Many financial institutions borrowed enormous sums of money during 2004–2007 and made investments in mortgage-backed securities (MBS), essentially betting on the continued appreciation of home values and sustained mortgage payments. Borrowing at a lower interest rate to invest at a higher interest rate is using financial leverage. This is analogous to an individual taking out a second mortgage on their home to invest in the stock market. This strategy magnified profits during the housing boom period, but drove large losses after the bust. Financial institutions and individual investors holding MBS also suffered significant losses as a result of widespread and increasing mortgage payment defaults and MBS devaluation beginning in 2007 onward.

A SEC regulatory ruling in 2004 greatly contributed to US investment banks' ability to take on additional debt, which was then used to purchase MBS. The top five US investment banks each significantly increased their financial leverage during the 2004–2007, which increased their vulnerability to the MBS losses. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, a figure roughly 30% the size of the U.S. economy. Three of the five either went bankrupt such as Lehman Brothers or were sold at fire-sale prices to other banks including Bear Stearns and Merrill Lynch during September 2008, creating instability in the global financial system.

The remaining two converted to commercial bank models, subjecting themselves to much tighter regulation. In 2006, Wall Street executives took home bonuses totaling $23.9 billion, according to the New York State Comptroller's Office. "Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their firm. The whole system—from mortgage brokers to Wall Street risk managers—seemed tilted toward taking short-term risks while ignoring long-term obligations. The most damning evidence is that most of the people at the top of the banks didn't really understand how those [investments] worked."

Impact of subprime mortgage crisis

- Financial sector downturn

Financial institutions from around the world have recognized subprime mortgage crisis-related losses and write-downs exceeding U.S. $501 billion as of August 2008. Profits at the 8,533 U.S. banks insured by the FDIC declined from $35.2 billion to $646 million (89%) during the fourth quarter of 2007 versus the prior year, due to soaring loan defaults and provisions for loan losses. It was the worst bank and thrift quarterly performance since 1990. For all of 2007, these banks earned approximately $100 billion, down 31% from a record profit of $145 billion in 2006. Profits declined from $35.6 billion to $19.3 billion during the first quarter of 2008 versus the prior year, a decline of 46%.
The financial sector began to feel the consequences of the subprime mortgage crisis in February 2007 with the $10.5 billion writedown of HSBC, which was the first major CDO or MBO related loss to be reported. During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold. Top management has not escaped unscathed, as the CEOs of Merrill Lynch and Citigroup were forced to resign within a week of each other. Various institutions followed up with merger deals.

- Market downturns and weaknesses


On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing above 14,000 for the first time.

On August 15, 2007, the Dow dropped below 13,000 and the S&P 500 crossed into negative territory for that year. Similar drops occurred in virtually every market in the world, with Brazil and Korea being hard-hit. Through 2008, large daily drops became common, with, for example, the KOSPI dropping about 7% in one day, although 2007's largest daily drop by the S&P 500 in the U.S. was in February, a result of the subprime crisis.

Mortgage lenders and home builders fared terribly, but losses cut across sectors, with some of the worst-hit industries, such as metals and mining companies, having only the vaguest connection with lending or mortgages.

Stock indices worldwide trended downward for several months since the first panic in July–August 2007.


The TED spread – an indicator of credit risk – increased dramatically during September 2008.

The crisis caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value". Financial speculation in commodity futures following the collapse of the financial derivatives markets has contributed to the world food price crisis and oil price increases due to a "commodities super-cycle." Financial speculators seeking quick returns have removed trillions of dollars from equities and mortgage bonds, some of which has been invested into food and raw materials.

Beginning in mid-2008, all three major stock indices in the United States - the Dow Jones Industrial Average, NASDAQ, and the S&P 500 - entered a bear market. On 15 September 2008, a slew of financial concerns caused the indices to drop by their sharpest amounts since the 2001 terrorist attacks. That day, the most noteworthy trigger was the declared bankruptcy of investment bank Lehman Brothers. Additionally, Merrill Lynch was joined with Bank of America in a forced merger worth $50 billion.

inally, concerns over insurer American International Group's ability to stay capitalized caused that stock to drop over 60% that day. Poor economic data on manufacturing contributed to the day's panic, but were eclipsed by the severe developments of the financial crisis. All of these events culminated into a stock selloff that was experienced worldwide. Overall, the Dow Jones Industrial plunged 504 points (4.4%) while the S&P 500 fell 59 points (4.7%). Asian and European markets rendered similarly sharp drops.

The much anticipated passage of the $700 billion bailout plan was struck down by the House of Representatives in a 228–205 vote on September 29. In the context of recent history, the result was catastrophic for stocks. The Dow Jones Industrial Average suffered a severe 777 point loss (7.0%), its worst point loss on record up to that date. The NASDAQ tumbled 9.1% and the S&P 500 fell 8.8%, both of which were the worst losses those indices experienced since the 1987 stock market crash.

Despite congressional passage of historic bailout legislation, which was signed by President Bush on Saturday, Oct. 4, Dow Jones Index tumbled further when markets resumed trading on Oct. 6. The Dow fell below 10,000 points for the first time in almost four years, losing 800 points before recovering to settle at -369.88 for the day. Stocks also continued to tumble to record lows ending one of the worst weeks in the Stock Market since September 11, 2001."

It is also estimated that even with the passing of the so-called bailout package, many banks within the United States will tumble and therefore cease operating. It is estimated that over 100 banks in the United States will close their doors because of the financial crisis. This will have a severe impact on the economy and consumers. It is expected that it will take years for the United States to recover from the financial and real estate crisis.

- Indirect economic effects

The subprime mortgage crisis had a series of other economic effects. Housing price declines left consumers with less wealth, which placed downward pressure on consumption. Certain minority groups received a higher proportion of subprime loans and experienced a disproportional level of foreclosures. Home related crimes including arson increased. Job losses in the financial sector were significant, with over 65,400 jobs lost in the United States as of September 2008.

Many renters became victims of the subprime mortgage crisis, often evicted from their homes without notice due to foreclosure of their landlord's property. In October 2008, Tom Dart, the elected Sheriff of Cook County, Illinois, criticized mortgage companies for their actions, and announced that he was suspending all foreclosure evictions.

The sudden lack of credit also caused a slump in car sales. Ford sales in October 2008 were down 33.8% from a year ago, General Motors sales were down 15.6%, and Toyota sales had declined 32.3%. One in five car dealerships are expected to close by the end of 2008.



This article uses material from the Wikipedia articles "Subprime mortgage crisis", "Real estate bubble"