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The Crisis Outlined

The financial crisis of 2007–present is a crisis triggered by a liquidity shortfall in the United States banking system. It resulted in the collapse of large financial institutions, the "bail out" of banks by national governments and downturns in stock markets around the world.

In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.

It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. Many causes have been proposed, with varying weight assigned by experts.Both market-based and regulatory solutions have been implemented or are under consideration, while significant risks remain for the world economy over the 2010–2011 periods.Although this economic period has at times been referred to as "the Great Recession," this same phrase has been used to refer to every recession of the several preceding decades.

The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006.

High default rates on "subprime" and adjustable rate mortgages (ARM), began to increase quickly thereafter. An increase in loan packaging, marketing and incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume 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

 

Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. The combination of easy cr

The collapse of a global housing bubble, which peaked in the U.S. in 2006, caused the values of securities tied to real estate pricing to plummet thereafter, damaging financial institutions globally. Questions regarding bank solvency, declines in credit availability, and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during late 2008 and early 2009. Economies worldwide slowed during this period as credit tightened and international trade declined. Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st century financial markets. Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion, and institutional bailouts.

Between 1997 and 2006, the price of the typical American house increased by 124%.

During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006. This housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation.

 

In a Peabody Award winning program, NPR correspondents argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. Further, this pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this demand with the MBS and CDO, which were assigned safe ratings by the credit rating agencies. In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that funded the brokers, to the giant investment banks behind them.

By approximately 2003, the supply of mortgages originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain. Eventually, this speculative bubble proved unsustainable.

The CDO in particular enabled financial institutions to obtain investor funds to finance subprime and other lending, extending or increasing the housing bubble and generating large fees.

A CDO essentially places cash payments from multiple mortgages or other debt obligations into a single pool, from which the cash is allocated to specific securities in a priority sequence. Those securities obtaining cash first received investment-grade ratings from rating agencies. Lower priority securities received cash thereafter, with lower credit ratings but theoretically a higher rate of return on the amount invested.

By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.

As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default. During 2007, lenders began foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006.This increased to 2.3 million in 2008, an 81% increase vs. 2007.

By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure. By September 2009, this had risen to 14.4%