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May 13, 2015 · The financial crisis of 2007–2009 was the culmination of a credit crunch that began in the summer of 2006 and continued into 2007. 8 Most agree that the crisis had its roots in the U.S. housing market, although I will later also discuss some of the factors that contributed to the housing price bubble that burst during the crisis.
- Anjan V. Thakor
- 2015
- Overview
- Causes of the crisis
global economics
Also known as: global financial crisis
Written byBrian Duignan
Brian Duignan
Brian Duignan is a senior editor at Encyclopædia Britannica. His subject areas include philosophy, law, social science, politics, political theory, and religion.
Fact-checked byThe Editors of Encyclopaedia Britannica
Although the exact causes of the financial crisis are a matter of dispute among economists, there is general agreement regarding the factors that played a role (experts disagree about their relative importance).
First, the Federal Reserve (Fed), the central bank of the United States, having anticipated a mild recession that began in 2001, reduced the federal funds rate (the interest rate that banks charge each other for overnight loans of federal funds—i.e., balances held at a Federal Reserve bank) 11 times between May 2000 and December 2001, from 6.5 percent to 1.75 percent. That significant decrease enabled banks to extend consumer credit at a lower prime rate (the interest rate that banks charge to their “prime,” or low-risk, customers, generally three percentage points above the federal funds rate) and encouraged them to lend even to “subprime,” or high-risk, customers, though at higher interest rates (see subprime lending). Consumers took advantage of the cheap credit to purchase durable goods such as appliances, automobiles, and especially houses. The result was the creation in the late 1990s of a “housing bubble” (a rapid increase in home prices to levels well beyond their fundamental, or intrinsic, value, driven by excessive speculation).
Second, owing to changes in banking laws beginning in the 1980s, banks were able to offer to subprime customers mortgage loans that were structured with balloon payments (unusually large payments that are due at or near the end of a loan period) or adjustable interest rates (rates that remain fixed at relatively low levels for an initial period and float, generally with the federal funds rate, thereafter). As long as home prices continued to increase, subprime borrowers could protect themselves against high mortgage payments by refinancing, borrowing against the increased value of their homes, or selling their homes at a profit and paying off their mortgages. In the case of default, banks could repossess the property and sell it for more than the amount of the original loan. Subprime lending thus represented a lucrative investment for many banks. Accordingly, many banks aggressively marketed subprime loans to customers with poor credit or few assets, knowing that those borrowers could not afford to repay the loans and often misleading them about the risks involved. As a result, the share of subprime mortgages among all home loans increased from about 2.5 percent to nearly 15 percent per year from the late 1990s to 2004–07.
Third, contributing to the growth of subprime lending was the widespread practice of securitization, whereby banks bundled together hundreds or even thousands of subprime mortgages and other, less-risky forms of consumer debt and sold them (or pieces of them) in capital markets as securities (bonds) to other banks and investors, including hedge funds and pension funds. Bonds consisting primarily of mortgages became known as mortgage-backed securities, or MBSs, which entitled their purchasers to a share of the interest and principal payments on the underlying loans. Selling subprime mortgages as MBSs was considered a good way for banks to increase their liquidity and reduce their exposure to risky loans, while purchasing MBSs was viewed as a good way for banks and investors to diversify their portfolios and earn money. As home prices continued their meteoric rise through the early 2000s, MBSs became widely popular, and their prices in capital markets increased accordingly.
Learn about good debt and bad debt.
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Events. January 1. Bulgaria and Romania join the European Union, while Slovenia joins the Eurozone. [3] Adam Air Flight 574, en route to Manado, Indonesia, from Surabaya, Indonesia, crashes into the Makassar Strait; killing all 102 on board. [4] January 4 – Nancy Pelosi becomes the first female speaker of the United States House of Representatives.
The TED spread spiked up in July 2007, remained volatile for a year, then spiked even higher in September 2008, reaching a record 4.65% on October 10, 2008. The 2007–2008 financial crisis, or the global financial crisis (GFC), was the most severe worldwide economic crisis since the Great Depression.
Aug 30, 2011 · Historical events from year 2007. Learn about 280 famous, scandalous and important events that happened in 2007 or search by date or keyword.
Aug 25, 2024 · Learn more about the causes, the events, and the aftermath of the 2007–2008 financial crisis and the Great Recession that followed.
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Jan 30, 2022 · The 2007 financial crisis is the breakdown of trust that occurred between banks the year before the 2008 financial crisis. It was caused by the subprime mortgage crisis, which itself was caused by the unregulated use of derivatives .
