Aftermath Bubble - Great Recession

It began in 2007 with a crisis in the subprime mortgage market in the US, and developed into a full-blown
international banking crisis with the collapse of the investment bank Lehman Brothers on September 15,
2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact
globally. Massive bail-outs of financial institutions and other palliative monetary and fiscal policies were
employed to prevent a possible collapse of the world financial system . The crisis was nonetheless followed
by a global economic downturn, the Great Recession.

Subprime mortgage bubble

The precipitating factor was a high default rate in the United States subprime home mortgage sector.
The expansion of this sector was encouraged by the following factors.

 Low interest rates

 The Community Reinvestment Act (CRA), a US federal law designed to help low- and moderate-
income Americans get mortgage loans.
 Many of these subprime (high risk) loans were bundled and sold, finally accruing to quasi-
government agencies ( Fannie Mae and Freddie Mac). The implicit guarantee by the US federal
government created a moral hazard and contributed to a glut of risky lending.
 Securitization. Many mortgages were bundled together and formed into new financial instruments
called mortgage-backed securities , which could be sold as (ostensibly) low-risk securities partly
because they were often backed by credit default swaps insurance. Because mortgage lenders
could pass these mortgages (and the associated risks) on in this way, they could and did adopt
loose underwriting criteria (due in part to outdated and lax regulation).
 Lax regulation also led to predatory lending in the private sector, especially after the federal
government overrode anti-predatory state laws in 2004.

The accumulation and subsequent high default rate of these subprime mortgages led to the financial
crisis and the consequent damage to the world economy.

Banking crisis
High mortgage approval rates led to a large pool of homebuyers, which drove up housing prices.
This appreciation in value led large numbers of homeowners (subprime or not) to borrow against their
homes as an apparent windfall. This "bubble" would be burst by a rising single-family residential mortgages
delinquency rate beginning in August 2006 and peaking in the first quarter, 2010.

The high delinquency rates led to a rapid devaluation of financial instruments (mortgage-backed
securities including bundled loan portfolios, derivatives and credit default swaps). As the value of these
assets plummeted, the market (buyers) for these securities evaporated and banks who were heavily
invested in these assets began to experience a liquidity crisis. Freddie Mac and Fannie Mae were taken
over by the federal government on September 7, 2008. Lehman Brothers filed for bankruptcy on
September 15, 2008. Merrill Lynch, AIG, HBOS , Royal Bank of Scotland, Bradford & Bingley, Fortis, Hypo
Real Estate, and Alliance & Leicester were all expected to follow—with a US federal bailout announced the
following day beginning with $85 billion to AIG. In spite of trillions paid out by the US federal government, it
became much more difficult to borrow money. The resulting decrease in buyers caused housing prices to
plummet.
Consequences
While the collapse of large financial institutions was prevented by the bailout of banks by national
governments, stock markets still dropped worldwide. In many areas, the housing market also suffered,
resulting in evictions, foreclosures, and prolonged unemployment. The crisis played a significant role in the
failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a downturn in
economic activity leading to the Great Recession of 2008–2012 and contributing to the European sovereign-
debt crisis.

The bursting of the US housing bubble, which peaked at the end of 2006, caused the values of securities
tied to US real estate pricing to plummet, damaging financial institutions globally. The financial crisis was
triggered by a complex interplay of policies that encouraged home ownership, providing easier access to
loans for subprime borrowers, overvaluation of bundled subprime mortgages based on the theory that
housing prices would continue to escalate, questionable trading practices on behalf of both buyers and
sellers, compensation structures that prioritize short-term deal flow over long-term value creation, and a lack
of adequate capital holdings from banks and insurance companies to back the financial commitments they
were making. Questions regarding bank solvency , declines in credit availability, and damaged investor
confidence affected global stock markets, where securities suffered large losses during 2008 and early
2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.
Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion
and institutional bailouts. In the US, Congress passed the American Recovery and Reinvestment Act of
2009.