Subprime mortgage crisis

The subprime mortgages crisis arose from defaults on the United States mortgage markets, and led to the global 2007-2008 financial crisis.

Glossary

For definitions of the terms shown in italics in this article, please see the glossary.

Timeline

The Timeline subpage lists the major events of the crisis with links to contemporary news reports.

The Crisis

Unexpected defaults by the holders of some mortgages led to general uncertainty about the value of mortgage-backed securities. Operators in the financial markets became reluctant to lend money on the security of such assets, placing holders of those securities in difficulties. There developed a loss of confidence in organisations that were suspected of being vulnerable to the falling value of their holdings of mortgage-related securities, and that created a widespread financial crisis.

Among the factors that are considered to have contributed to the development of the crisis are the conduct of monetary policy, the inflow of funds from abroad, the creation of new ways of financing mortgages, the policies adopted by providers of mortgage finance, and the consequent behaviour of the housing markets.

Monetary policy

There is some evidence of a connection between the subprime crisis and the Federal Reserve Bank's conduct of monetary policy. Since the 1980s, the Bank's monetary policy had successfully stabilised the American economy - and its housing market - by the application of the "Taylor Rule" under which changes to the bank's discount rate had been related to the spare capacity in the economy. During the period from 2003 to 2006, however, the discount rate was held well below the level suggested by that rule. The author of the rule, Professor John Taylor of Stanford University, has given an account of the consequences of that departure . He argues that those low interest rates helped to foster the extraordinary surge which occurred in the demand for housing, and that the eventual fall in housing prices would have been less steep, and the following crisis less severe, had the Taylor rule been followed.

The "wall of money"

In the early years of the 21st century there were large inflows of money from abroad, corresponding to the country's large current account deficit . That development was attributed by some commentators to increases in the federal budget deficit, but Federal Reserve Bank Chairman Ben Bernanke argued that it was caused mainly by a "savings glut" in China and other developing countries resulting in large purchases of US treasury bonds. . A correlation between the growing deficit and increases in housing investment had noted by the Board's previous Chairman .

Housing market developments

In response to the surge in the demand for housing in the period 2003 to 2006, the annual rate of growth of house prices rose to ten percent in the fourth quarter of 2004 and continued at that average rate for two years, reaching twenty percent at times. Expectations of price increases further accelerated the demand for housing, putting further upward pressure on prices. With the consequent development of a major "housing bubble", there was a fall in the number of defaults and foreclosures of subprime mortgages, leading to increases in the credit ratings of mortgage-backed securities. Those increases turned out to be transitory, however: when interest rates returned to more normal levels in 2007, the demand for housing fell sharply, and increases in subprime mortgage defaults led to substantial write-downs in their ratings.