In the early 2000s, mortgage rates were low, which allowed people to borrow more money with lower monthly payments. According to Katalina M. Bianco, author of “The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown” the U. S. ownership rate increased from 64% in 1994 to 69. 2% in 2004; this demand helped fuel the rise of housing prices (Bianco, 2008). Because home prices were increasing, many homeowners decided to refinance and take second mortgages to cash out of their homes’ equity.
According to Merrill Goozner of The Fiscal Times, a simple explanation for what caused the Great Recession is people had too much debt; during the housing bubble, too many homeowners used their inflated home equity like “piggybanks” to support their spending (Goozner, 2012). Banks also contributed to the creation of the U. S housing bubble by offering easy access to money. Many borrowers got into high risk mortgages and numerous people with bad credit could qualify as subprime borrowers.
According to Bianco, subprime borrowing was a key factor in the increase in home ownership rates during the housing bubble (Bianco, 2008). Some experts suggest mortgage standards relaxed during this period because each link in the “mortgage chain” believed it was passing on the risk to someone else (Bianco, 2008). Most banks do not keep mortgages on their books; instead, they sell these loans to investors. Before the crisis, many people, businesses, and governments chose to invest in mortgage linked investments because of the low interest rates.
After the dot-com bubble crash in 2000, the Federal Reserve Board cut short-term interest rates from about 6. 5% to 1% (Bianco, 2008). Since banks and mortgage brokers could sell loans before they went bad, loan quality deteriorated. Mortgage denial rates reported under the Home Mortgage Disclosure Act dropped from 29% in 1998 to 14% in 2002 and 2003 (Bianco, 2008). When home prices stopped increasing and interest rates rose, monthly payments increased due to adjustable rate mortgages. This marked the end of the housing bubble.
Many borrowers could no longer afford their mortgages, and defaulted on their loans. The U. S. foreclosure epidemic eroded the financial strength of banking institutions. Losses on other types of loans started to increase as the crisis extended beyond the housing market. Banks and investors began losing money, and to decrease their exposure risk, reduced lending to each other. As a result of the slowing lending, hundreds of banks and high-profile institutions failed. Just as a number of factors caused the mortgage crisis, a number of different factors caused the global recession.
The bursting of the U. S. housing bubble was not the only cause of the banking and financial meltdown of 2007-2009, but it was the immediate trigger of the economic crisis. Word Count 550 ? Works Cited Bianco, K. M. (2008, April 8). business. cch. com. Retrieved from http://business. cch. com/bankingfinance/focus/news/Subprime_WP_rev. pdf Goozner, M. (2012, March 16). Real recovery: America’s debt is on the decline. The Fiscal Times. Retrieved from http://www. thefiscaltimes. com/Articles/2012/03/16/Real-Recovery-Americas-Debt-is-on-the-Decline. aspx