Subprime mortgage crisis
Updated: 2008-10-28 09:37
The subprime mortgage crisis is an ongoing financial crisis characterized by contracted liquidity in global credit markets and banking systems triggered by the failure of mortgage companies, investment firms and government sponsored enterprises which had invested heavily in subprime mortgages. The crisis, which has roots in the closing years of the 20th century but has become more apparent throughout 2007 and 2008, has passed through various stages exposing pervasive weaknesses in the global financial system and regulatory framework.
The crisis began with the bursting of the United States housing bubble and high default rates on "subprime" and adjustable rate mortgages (ARM), beginning in approximately 2005–2006. For a number of years prior to that, declining lending standards, an increase in loan 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 US, 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. Foreclosures accelerated in the United States in late 2006 and triggered a global financial crisis through 2007 and 2008. During 2007, nearly 1.3 million US housing properties were subject to foreclosure activity, up 79% from 2006.
Major banks and other financial institutions around the world have reported losses of approximately US$435 billion as of 17 July 2008. The liquidity concerns drove central banks around the world to take action to provide funds to member banks to encourage lending to worthy borrowers and to restore faith in the commercial paper markets. The US government also bailed out key financial institutions, assuming significant additional financial commitments.
The risks to the broader economy created by the financial market crisis and housing market downturn were primary factors in several decisions by the US Federal Reserve to cut interest rates and the economic stimulus package passed by Congress and signed by President George W. Bush on February 13, 2008. During the week of September 14, 2008 the crisis accelerated, developing into a global financial crisis. Following a series of ad-hoc market interventions to bail out particular firms, a $700 billion proposal was presented to the US Congress in September, 2008. These actions are designed to stimulate economic growth and inspire confidence in the financial markets. On October 3, 2008, President George W. Bush signed the amended version of the bill into law. The following week the Dow-Jones index of the largest companies traded on the U.S. stock market declined 22%, the worst week in the index's 118-year history. Since 1 January, 2008, owners of stocks in US corporations have suffered about $8 trillion in losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged about 40%.
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