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The 2008 financial crisis was the product of several inter-locking forces that amplified one another until the global credit system broke down.
The housing boom and the sub-prime lending explosion
• After 2000, U.S. house prices rose rapidly. Lenders looked for new borrowers and, helped by automated underwriting and Wall-Street demand for mortgages, pushed into ever-riskier “subprime” and “Alt-A” markets. Loans that once required full documentation of income or sizable down-payments were replaced by “low-doc” and “no-doc” products, teaser rates, and 100 % financing [4]. Countrywide, the nation’s largest mortgage company, deliberately loosened standards to chase volume, even falsifying borrower information and steering clients into higher-cost loans [5].
• Many borrowers therefore entered mortgages they could not afford once introductory rates reset or house prices stalled. When prices finally peaked in 2006, delinquencies in the sub-prime segment shot up [3].
Securitization and the spread of bad credit throughout the system
• Mortgage originators did not keep most of the loans they made. Instead they sold them to Wall-Street banks, which bundled thousands of mortgages into mortgage-backed securities (MBS) and then sliced those pools into collateralized debt obligations (CDOs) that were sold worldwide [6].
• Because fees were earned at the moment of sale, everyone in the chain—brokers, banks, rating agencies—was rewarded for volume, not loan quality. The opacity of these engineered products meant that investors, regulators, and even many bankers themselves underestimated the true risk they were assuming [1].
Excess leverage, short-term funding, and a fragile shadow-bank system
• Investment banks, hedge funds, money-market funds, and off-balance-sheet “structured investment vehicles” funded long-term mortgage assets with very short-term borrowing. When losses on sub-prime bonds began to mount, lenders refused to roll over that funding, forcing fire sales that drove prices down further and infected supposedly safe AAA tranches [7].
Public-policy contributions
• Bipartisan political goals to expand home-ownership encouraged the private market’s push into riskier lending. President Bush’s “Blueprint for the American Dream” (2002) and his 2004 campaign speech urged “increasing minority homeownership” and called on lenders to adopt “flexible” standards [8][9].
• HUD housing goals required Fannie Mae and Freddie Mac to make a rising share of their purchases in low- and moderate-income mortgages (reaching 56 % by 2008). To meet those quotas and defend market share, the GSEs purchased large volumes of securities backed by sub-prime and Alt-A loans, further fueling demand for risky paper [10].
Regulatory and market failures
• Bank regulators accepted internal risk models that assumed continued house-price appreciation and allowed thin capital buffers; rating agencies granted investment-grade ratings to complex CDOs built on sub-prime loans; and derivatives such as credit-default swaps let institutions concentrate rather than disperse risk. As the Financial Crisis Inquiry Commission concluded, “this crisis was avoidable” and flowed from “widespread failures in financial regulation and supervision” [7].
Once house prices fell and adjustable-rate mortgages reset, defaults rose, MBS prices collapsed, and confidence in the plumbing of global finance evaporated. Lehman Brothers’ bankruptcy in September 2008 crystallized the panic and led to the broad economic downturn that followed.
Sources
Econlib – Kling, “The Subprime Crisis: Why Asymmetric Information Didn’t Save Us.” Emphasizes how securitization and misaligned incentives let bad loans pass through the system. https://www.econlib.org/archives/2013/05/the_subprime_cr.html
Federal Reserve History – “Subprime Mortgage Crisis.” Provides timeline of housing bust, sub-prime delinquencies, and contagion to global markets. https://www.federalreservehistory.org/essays/subprime-mortgage-crisis
Steve Sailer blog – “Unreal Estate.” Notes rapid price run-up and geographic concentration of defaults. https://isteve.blogspot.com/2010/03/unreal-estate.html
Wikipedia – “No doc loan.” Describes low-documentation mortgages and their role in bubble lending. https://en.wikipedia.org/wiki/No_doc_loan
Ethics Unwrapped – “Countrywide’s Subprime Scandal.” Details Countrywide’s lax underwriting and fraud. https://ethicsunwrapped.utexas.edu/video/countrywides-subprime-scandal
Wikipedia – “Collateralized debt obligation.” Explains how CDOs multiplied sub-prime exposure across the financial system. https://en.wikipedia.org/wiki/Collateralized_debt_obligation
Financial Crisis Inquiry Commission Report (2011). Official investigation blaming excessive leverage, regulatory failure, and securitization incentives. https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf
HUD – White House Conference on Minority Homeownership, “Blueprint for the American Dream” (2002). Sets goal of 5.5 million new minority homeowners and urges flexible lending. https://archives.hud.gov/initiatives/blueprint/
George W. Bush White House Archives – President’s remarks at 2004 RNC. Reiterates commitment to expanding homeownership. https://georgewbush-whitehouse.archives.gov/news/releases/2004/09/20040902-2.html
Federal Register – “HUD’s Housing Goals for Fannie Mae and Freddie Mac, 2005-2008.” Documents rising affordable-housing quotas imposed on the GSEs. https://www.federalregister.gov/documents/2004/11/02/04-24101