Subprime Mortgage Crisis Timeline
Point of interest
Understanding the timeline of the subprime mortgage crisis is an important step to make sure the country does not repeat the events. From 2002 to 2008, events by investors, bankers, homebuyers, and mortgage brokers helped to create one of the worst financial crises ever.
The early 2000s saw one of the worst economic crises in recent history. The subprime mortgage crisis was fueled by a demand for unique investments known as mortgage-backed securities — individual home mortgages grouped as investable security. When people started defaulting on these mortgages in mass numbers, the economy took a major hit. Understanding the timeline of events helps to paint a clearer picture of the events that transpired from the early 2000s through 2008.
Understanding the events that transpired can also help us better to prepare and prevent a similar event from happening again. In recent times, people have speculated if we’re on course for a repeat of the mortgage crisis again in America.
“People are worried that the real estate market today is mirroring what happened a little over 10 years ago,” Caleb Liu, the owner of HouseSimplySold.com, said. “I think those fears are generally misguided. Banks have learned their lesson. Underwriting is properly done with stringent regulations in place. Risk is appropriately accounted for by imposing higher mortgage interest rates on the buyer. The only facet of lending today that even approaches what we saw in the early 2000s is the relaxation of the down payment. FHA loans allow down payments as low as 3.5%. Along with the higher monthly payments due to the larger mortgage balance, the borrower must also pay monthly PMI (private mortgage insurance).”
What was the subprime mortgage crisis?
Securitization is the process of pooling together different types of debt into a single security to sell to investors. In the early 2000s, financial institutions began pooling together home mortgages into mortgage-backed securities. Investors were able to invest in these products and get a return from the loan payments being made by individuals.
The problem was, though, that to fuel the desire for those securities, mortgage loans were getting approved like wildfire. Individuals who could not afford a home were getting approved for a loan so the industry could feed the demand for mortgage-backed securities.
From 2004 to 2006, housing prices dropped, and the Fed raised interest rates. For many, this increased their monthly payments, and people began defaulting on their loans. The result was people losing their homes to foreclosure, and those invested in mortgage-backed securities, in turn, took significant hits. Major banks and lenders were ultimately forced into bankruptcy or had to take a government bailout to prevent the entire economy from collapsing.
The timeline of the subprime mortgage crisis
2000: Over $160 million originated in subprime mortgages:
Subprime mortgages are loans for housing purchases issued to subprime borrowers, or risky borrowers with poor credit ratings. Because of the added risk, the lenders require higher rates of return and more favorable terms in return. Often, this meant adjustable-rate mortgages that didn’t have fixed interest rates for the life of the loan.
Before the year 2000, subprime loans were nearly non-existent. By the year 2000, however, over $160 million of these riskier loans were in circulation.
February 2002: The first warning signs of trouble
The actual crash didn’t happen until 2006, but prominent economic figures and investors drew attention to possible problems as early as 2002. In one of his Chairman’s Letters, Warren Buffet said to investors: “In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
2004 to 2006: Rising interest rates
From 2004 to 2006, the Fed raised interest rates extensively. On June 29th, 2006, the Fed raised the interest rate to 5.25%, the 17th straight increase. For homeowners with fixed-rate mortgages, this was not a problem. However, many of the subprime loans that had been issued were adjustable-rate mortgages that fluctuate with the rise of interest rates, as they’re easier to get those with bad or no credit approved for. These loans had very low teaser rates that would later move higher to become in line with the Fed interest rates. As rates increased, people’s monthly payments increased, and many could not afford the unexpected hike.
2002 to 2007: Billions extended to high-risk borrowers
In 2003, 85% of loans originated were of prime quality. However, that would change over the next few years. In 2004, the prime percentage dropped by over 20%, and only 64% of originated loans were of the higher prime quality, meaning 36% were subprime. The number of subprime loans continued to rise, and in 2005, 44% of loans were subprime. In 2006, nearly half of all loans were subprime at 48%. Almost half of the loans during 2006 had been extended to people who were at a much higher risk of default.
2003 to 2007: Lack of Federal Reserve oversight
From 2003 to 2007, subprime mortgages increase by 292%. Much of this was fueled by the need to fulfill mortgage-backed securities. While the exact cause of the crash is heavily debated, many believe that the Federal Reserve should have stepped in and stopped banks from lending to those who clearly would have problems making future payments, especially as interest rates increased on their adjustable-rate mortgages.
2004: Banks began investing in mortgage-backed securities
As investors became fond of the securitized investment derivatives known as mortgage-backed securities, the pressure was put on the mortgage industry. To fill the demand for these securities, more and more mortgages needed to be written. Unfortunately, this led to extending loans time and again to those who had no business purchasing a home at that time.
2004: Homeownership peaks
In 1995, homeownership rates were around 65%. By 2004, homeownership had peaked to just below 70%. Unfortunately, not all of the people who owned homes were financially qualified to do so. Subprime mortgages allowed lenders to jump through hoops to get people approved for loans. Unfortunately, this was a recipe for what was to come a few years later, with the high numbers of homeownership being an early, if obscure, warning sign.
Early 2006: More warning signs
In 2006, more signs of impending problems were evident in companies across the industry. AIG stopped selling credit protection swaps, a sign that there was more risk than investors had been fully aware of leading up to this time. Additionally, companies like Commerzbank began limiting their positions in the subprime mortgage industry. Ameriquest, a major lender, began closing branches and laying off employees. What once seemed to be a hot investment market now had some of the major players moving in the other direction.
Late 2006: The collapse
In late 2006, the walls started coming down.
- On September 25th, 2006, housing prices fell over 10% — the first price drop since the 1990s. Many homeowners found themselves owing more on their homes than they were worth.
- In November of the same year, new home permits fell by 28%. This signaled a major slowdown in new homes and new mortgages for the next six to nine months.
Effects of the mortgage crisis
- As the housing bubble collapsed, people were left devastated with homes they couldn’t afford or weren’t worth what they’d paid for them. Selling wasn’t much of an option, which led to foreclosures in a lot of cases.
- The ability to borrow money tightened, unemployment increased and many people lost their homes.
- Banks that were heavily invested in mortgage-backed securities lost massive amounts of money. Current estimates say that the market lost nearly $8 trillion from late 2007 to 2009.
- Major bailouts were provided by the federal government to companies to try and protect the entire economy from crashing. The government invested nearly $700 billion to try and save companies that were heavily invested in mortgage-backed securities.
- Some banks, like Lehman Brothers, declared bankruptcy in the months and years to follow. According to the Special Inspector General for TARP, the bailout is still ongoing and has brought in a price tag of nearly $16.8 trillion.
- Following the events of the early 2000s, financial reform was enacted to try and prevent anything like this from happening again. The biggest change was enacting of the Dodd-Frank Act. The purpose of the act was to reform Wall Street and protect consumers for the future.
Subprime mortgage today
Do subprime mortgages exist today? Yes and no. The products exist and are making a comeback, but have been rebranded under the name non-prime loans. While these mortgages have a new name, they are basically the same thing. A subprime mortgage is a home loan to someone with less-than-great credit that comes with a much higher interest rate. A non-prime mortgage is also a home loan to someone with less-than-great credit at a much higher interest rate.
There are some companies are securitizing these loans into mortgage-backed securities, just like in the early 2000s. It begs the question as to whether the industry is on track to repeat what happened a little over a decade ago. Regardless, home buyers should ensure they can afford a home before going through with the purchase so that they don’t end up in a dire situation once the payments start overwhelming their budget. The bottom line is that just being approved for a loan by a lender does not necessarily mean it fits into your budget and financial plans.