What caused the mortgage crisis hair electricity dance moms

Banks offered easy access to money before the mortgage crisis emerged. Borrowers got into high-risk mortgages such as option-ARMs, and they qualified for mortgages with little or no documentation. Even people with bad credit could qualify as subprime borrowers.

Risky borrowers: Borrowers were able to borrow more than ever before, and individuals with low credit scores increasingly qualified as subprime borrowers. Lenders approved “no documentation” and “low documentation” loans, which did not require verification of a borrower’s income and assets (or verification standards were relaxed).

Risky products: In addition to easier approval, borrowers had access to loans that promised short-term benefits (with long-term risks). Option-ARM loans allowed borrowers to make small payments on their debt, but the loan amount might actually increase if the payments were not sufficient to cover interest costs. Interest rates were relatively low (although not at historic lows), so traditional fixed-rate mortgages might have been a reasonable option.

Fraud: Lenders were eager to fund purchases, but some home buyers and mortgage brokers added fuel to the fire by providing inaccurate information on loan applications. As long as the party never ended, everything was fine. Once home prices fell and borrowers were unable to afford loans, the truth came out. Sloshing Liquidity

Where did all of the money for loans come from? There was a glut of liquidity sloshing around the world — which quickly dried up at the height of the mortgage crisis. People, businesses, and governments had money to invest, and they developed an appetite for mortgage-linked investments as a way to earn more in a low-interest rate environment.

However, banks now sell your loan, and it may be further divided and sold to numerous investors. These investments are extremely complex, so many investors just rely on rating agencies to tell them how safe the investments are (without really understanding them).

Because the banks and mortgage brokers did not have any skin in the game (they could just sell the loans before they went bad), loan quality deteriorated. There was no accountability or incentive to ensure borrowers could afford to repay loans. Early Stages of Crisis

Unfortunately, the chickens came home to roost and the mortgage crisis began to intensify in 2007. Home prices stopped going up at a breakneck speed, and prices started falling in 2006. Borrowers who bought more home than they could afford eventually stopped making mortgage payments. To make matters worse, monthly payments increased on adjustable rate mortgages as interest rates rose.

Homeowners with unaffordable homes were left with few choices. They could wait for the bank to foreclose, they could renegotiate their loan in a workout program, or they could just walk away from the home and default. Of course, many also tried to increase their income and cut expenses. Some were able to bridge the gap, but others were already too far behind and facing mortgage payments that simply weren’t sustainable.

Traditionally, banks could recover the amount they loaned at foreclosure. However, home values fell to such an extent that banks increasingly took hefty losses on defaulted loans. State laws and the type of loan determined whether or not lenders could try to collect any deficiency from borrowers. The Plot Thickens

Once people started defaulting on loans in record numbers (and once the word got around that things were bad), the mortgage crisis really heated up. Banks and investors began losing money. Financial institutions decided to reduce their exposure to risk very quickly, and banks hesitated to lend to each other because they didn’t know if they’d ever get paid back. Of course, banks and businesses need money to flow to operate smoothly, so the economy came to a grinding halt.

Bank weakness (and fear) caused bank failures. The FDIC ramped up staff in preparation for hundreds of bank failures caused by the mortgage crisis, and some mainstays of the banking world went under. The general public saw these high-profile institutions failing and panic increased. In a historic event, we were reminded that money market funds can “break the buck.”

Lawmakers, consumers, bankers, and businesspeople scurried to reduce the effects of the mortgage crisis. It set off a dramatic chain of events and will continue to unfold for years to come. The public got to see “how the sausage is made” and was shocked to learn how leveraged the world is.

The lasting effect for most consumers is that it’s more difficult to qualify for a mortgage than it was in the early-to-mid 2000s. Lenders are required to verify that borrowers have the ability to repay a loan — you generally need to show proof of your income and assets. The home loan process is now more cumbersome, but hopefully, the financial system is healthier than before.