The cause of the 2008 global financial crisis, subprime mortgages

  In my last blog, I briefly covered the background of the financial crisis of 2008. However, there were many factors contributing to the financial crisis. In this blog, I will continue to talk about one of the causes of the financial crisis - subprime mortgages.

  The origins of the subprime mortgage boom were attributed to the increased demand for private-label mortgages and the increase in securities backed by domestic and foreign investors, which also led to a sharp increase in the share of subprime mortgages, from 8% in 2001 to 20% in 2006, and the share of the securitised subprime mortgage market, from 54% in 2001 to 75% in 2006.

Sources: Wikipedia
  As a result, the quality of the subprime mortgage market deteriorated dramatically, collapsing around 2007 as market risk increased while markups on mortgages declined over time.

  On the other hand, Subprime mortgages are primarily characterised by delinquencies and foreclosures after only a few months. The main way the bank makes money is the interest on the loan, and the bank makes a series of assessments on the lender. Unable to regulate the parent companies of investment banks in derivatives because of the deregulation adopted by Congress in the late 1990s, investment banks took advantage of the opportunity to increase leverage for maximum profit and to loosen lending standards, undermining the original credit rating agencies. This led to a large number of low and middle-income people borrowing heavily, the quality of the loans deteriorated significantly, and the subprime mortgages fell over time, leading to financial depression.



Sources: Yuliya Demyanyk, Otto Van Hemert, Understanding the Subprime Mortgage Crisis, The Review of Financial Studies, Volume 24, Issue 6, June 2011, Pages 1848–1880, https://doi.org/10.1093/rfs/hhp033

  From the perspective of real estate, the easing of credit ratings made people more willing to take out loans to buy houses that they might not be able to repay, which led to losses for financial institutions. Pajarskas (2014) believed that the direct cause of the financial turmoil was the sharp decline in housing prices after the surge, coupled with the destruction of credit. The bad operation of the lenders led to the large-scale default of the subprime mortgage market, which led to huge losses in mortgage loans and related instruments of financial institutions.

  In my next blog, I will introduce another cause of the financial crisis.

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