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Subprime mortgage crisis

The United States (U.S.) subprime mortgage crisis was financial system to support lending.[6] Concerns about
a nationwide banking emergency that contributed to the the soundness of U.S. credit and financial markets led to
U.S. recession of December 2007 – June 2009.[1] It tightening credit around the world and slowing economic
was triggered by a large decline in home prices after growth in the U.S. and Europe.
the collapse of a housing bubble, leading to mortgage
The crisis had severe, long-lasting consequences for the
delinquencies and foreclosures and the devaluation of U.S. and European economies. The U.S. entered a deep
housing-related securities. Declines in residential invest-
recession, with nearly 9 million jobs lost during 2008
ment preceded the recession and were followed by reduc- and 2009, roughly 6% of the workforce. One estimate
tions in household spending and then business investment. of lost output from the crisis comes to “at least 40% of
Spending reductions were more significant in areas with 2007 gross domestic product”.[10] U.S. housing prices fell
a combination of high household debt and larger housing nearly 30% on average and the U.S. stock market fell ap-
price declines.[2] proximately 50% by early 2009. As of early 2013, the
The expansion of household debt was financed with U.S. stock market had recovered to its pre-crisis peak but
mortgage-backed securities (MBS) and collateralized housing prices remained near their low point and unem-
debt obligations (CDO), which initially offered attractive ployment remained elevated. Economic growth remained
rates of return due to the higher interest rates on the mort- below pre-crisis levels. Europe also continued to struggle
gages; however, the lower credit quality ultimately caused with its own economic crisis, with elevated unemploy-
massive defaults.[3] While elements of the crisis first be- ment and severe banking impairments estimated at €940
came more visible during 2007, several major financial billion between 2008 and 2012.[11]
institutions collapsed in September 2008, with signifi-
cant disruption in the flow of credit to businesses and con-
sumers and the onset of a severe global recession.[4] 1 Background and timeline of
There were many causes of the crisis, with commenta-
tors assigning different levels of blame to financial insti-
events
tutions, regulators, credit agencies, government housing
policies, and consumers, among others.[5] A proximate Main articles: Subprime crisis background information,
cause was the rise in subprime lending. The percentage Subprime crisis impact timeline, United States housing
of lower-quality subprime mortgages originated during a bubble, and United States housing market correction
given year rose from the historical 8% or lower range to The immediate cause or trigger of the crisis was
approximately 20% from 2004 to 2006, with much higher
ratios in some parts of the U.S.[6][7] A high percentage of
these subprime mortgages, over 80% in 2006 for exam-
ple, were adjustable-rate mortgages.[4] These two changes
were part of a broader trend of lowered lending stan-
dards and higher-risk mortgage products.[4][8] Further,
U.S. households had become increasingly indebted, with
the ratio of debt to disposable personal income rising
from 77% in 1990 to 127% at the end of 2007, much
of this increase mortgage-related.[9]
When U.S. home prices declined steeply after peaking in
mid-2006, it became more difficult for borrowers to re-
finance their loans. As adjustable-rate mortgages began
to reset at higher interest rates (causing higher monthly
payments), mortgage delinquencies soared. Securities
backed with mortgages, including subprime mortgages,
Subprime mortgage lending jumped dramatically during the
widely held by financial firms globally, lost most of their 2004–2006 period preceding the crisis (source: Financial Crisis
value. Global investors also drastically reduced purchases Inquiry Commission Report, p.70 Figure 5.2).
of mortgage-backed debt and other securities as part of
a decline in the capacity and willingness of the private the bursting of the United States housing bubble which

1
2 1 BACKGROUND AND TIMELINE OF EVENTS

Several other factors set the stage for the rise and fall of
housing prices, and related securities widely held by fi-
nancial firms. In the years leading up to the crisis, the
U.S. received large amounts of foreign money from fast-
growing economies in Asia and oil-producing/exporting
countries. This inflow of funds combined with low U.S.
interest rates from 2002 to 2004 contributed to easy
credit conditions, which fueled both housing and credit
bubbles. Loans of various types (e.g., mortgage, credit
card, and auto) were easy to obtain and consumers as-
sumed an unprecedented debt load.[14][15]
As part of the housing and credit booms, the amount of
financial agreements called mortgage-backed securities
(MBS), which derive their value from mortgage payments
Factors contributing to housing bubble and housing prices, greatly increased. Such financial in-
novation enabled institutions and investors around the
world to invest in the U.S. housing market. As housing
prices declined, major global financial institutions that
had borrowed and invested heavily in MBS reported sig-
nificant losses. Defaults and losses on other loan types
also increased significantly as the crisis expanded from
the housing market to other parts of the economy. To-
tal losses were estimated in the trillions of U.S. dollars
globally.[16]
While the housing and credit bubbles were growing, a se-
ries of factors caused the financial system to become in-
creasingly fragile. Policymakers did not recognize the in-
creasingly important role played by financial institutions
such as investment banks and hedge funds, also known
as the shadow banking system. These entities were not
Domino effect as housing prices declined subject to the same regulations as depository banking.
Further, shadow banks were able to mask the extent of
their risk taking from investors and regulators through
peaked in approximately 2005–2006.[12][13] An increase the use of complex, off-balance sheet derivatives and
in loan incentives such as easy initial terms and a long- securitizations.[17] Economist Gary Gorton has referred
term trend of rising housing prices had encouraged bor- to the 2007–2008 aspects of the crisis as a “run” on the
rowers to assume risky mortgages in the anticipation that shadow banking system.[18]
they would be able to quickly refinance at easier terms. The complexity of these off-balance sheet arrangements
However, once interest rates began to rise and hous- and the securities held, as well as the interconnection be-
ing prices started to drop moderately in 2006–2007 in tween larger financial institutions, made it virtually im-
many parts of the U.S., borrowers were unable to refi- possible to re-organize them via bankruptcy, which con-
nance. Defaults and foreclosure activity increased dra- tributed to the need for government bailouts.[17] Some
matically as easy initial terms expired, home prices fell, experts believe these shadow institutions had become as
and adjustable-rate mortgage (ARM) interest rates reset important as commercial (depository) banks in provid-
higher. ing credit to the U.S. economy, but they were not sub-
As housing prices fell, global investor demand for ject to the same regulations.[19] These institutions as well
mortgage-related securities evaporated. This became ap- as certain regulated banks had also assumed significant
parent by July 2007, when investment bank Bear Stearns debt burdens while providing the loans described above
announced that two of its hedge funds had imploded. and did not have a financial cushion sufficient to absorb
These funds had invested in securities that derived their large loan defaults or MBS losses.[20]
value from mortgages. When the value of these securities The losses experienced by financial institutions on their
dropped, investors demanded that these hedge funds pro- mortgage-related securities impacted their ability to lend,
vide additional collateral. This created a cascade of sell- slowing economic activity. Interbank lending dried-up
ing in these securities, which lowered their value further. initially and then loans to non-financial firms were af-
Economist Mark Zandi wrote that this 2007 event was fected. Concerns regarding the stability of key finan-
“arguably the proximate catalyst” for the financial market cial institutions drove central banks to take action to pro-
disruption that followed.[4]
2.1 Overview 3

vide funds to encourage lending and to restore faith in the


commercial paper markets, which are integral to funding
business operations. Governments also bailed out key fi-
nancial institutions, assuming significant additional finan-
cial commitments.
The risks to the broader economy created by the housing
market downturn and subsequent financial market crisis
were primary factors in several decisions by central banks
around the world to cut interest rates and governments
to implement economic stimulus packages. Effects on
global stock markets due to the crisis were dramatic. Be-
tween 1 January and 11 October 2008, owners of stocks
in U.S. corporations suffered about $8 trillion in losses,
as their holdings declined in value from $20 trillion to
$12 trillion. Losses in other countries averaged about U.S. households and financial businesses significantly increased
borrowing (leverage) in the years leading up to the crisis
40%.[21]
Losses in the stock markets and housing value declines
place further downward pressure on consumer spending, emerged over a number of years. Causes proposed in-
a key economic engine.[22] Leaders of the larger devel- clude the inability of homeowners to make their mortgage
oped and emerging nations met in November 2008 and payments (due primarily to adjustable-rate mortgages re-
March 2009 to formulate strategies for addressing the setting, borrowers overextending, predatory lending, and
crisis.[23] A variety of solutions have been proposed byspeculation), overbuilding during the boom period, risky
government officials, central bankers, economists, and mortgage products, increased power of mortgage origi-
business executives.[24][25][26] In the U.S., the Dodd– nators, high personal and corporate debt levels, financial
Frank Wall Street Reform and Consumer Protection Act products that distributed and perhaps concealed the risk
was signed into law in July 2010 to address some of the of mortgage default, bad monetary and housing policies,
causes of the crisis. international trade imbalances, and inappropriate gov-
ernment regulation.[6][27][28][29][30] Excessive consumer
housing debt was in turn caused by the mortgage-backed
2 Causes security, credit default swap, and collateralized debt obli-
gation sub-sectors of the finance industry, which were of-
fering irrationally low interest rates and irrationally high
Further information: Causes of the 2007–2012 global levels of approval to subprime mortgage consumers be-
financial crisis and Causes of the United States housing cause they were calculating aggregate risk using gaussian
bubble copula formulas that strictly assumed the independence
of individual component mortgages, when in fact the
credit-worthiness of almost every new subprime mort-
2.1 Overview gage was highly correlated with that of any other because
of linkages through consumer spending levels which fell
sharply when property values began to fall during the
initial wave of mortgage defaults.[31][32] Debt consumers
were acting in their rational self-interest, because they
were unable to audit the finance industry’s opaque faulty
risk pricing methodology.[33]
Among the important catalysts of the subprime cri-
sis were the influx of money from the private sec-
tor, the banks entering into the mortgage bond mar-
ket, government policies aimed at expanding homeown-
ership, speculation by many home buyers, and the preda-
tory lending practices of the mortgage lenders, specifi-
cally the adjustable-rate mortgage, 2–28 loan, that mort-
gage lenders sold directly or indirectly via mortgage
brokers.[34] On Wall Street and in the financial industry,
Housing price appreciation in selected countries, 2002–2008 moral hazard lay at the core of many of the causes.[35]
In its “Declaration of the Summit on Financial Markets
The crisis can be attributed to a number of factors per- and the World Economy,” dated 15 November 2008,
vasive in both housing and credit markets, factors which leaders of the Group of 20 cited the following causes:
4 2 CAUSES

During a period of strong global growth, was avoidable and was caused by: Widespread failures in
growing capital flows, and prolonged stability financial regulation, including the Federal Reserve’s fail-
earlier this decade, market participants sought ure to stem the tide of toxic mortgages; Dramatic break-
higher yields without an adequate appreciation downs in corporate governance including too many fi-
of the risks and failed to exercise proper due nancial firms acting recklessly and taking on too much
diligence. At the same time, weak underwrit- risk; An explosive mix of excessive borrowing and risk
ing standards, unsound risk management prac- by households and Wall Street that put the financial sys-
tices, increasingly complex and opaque finan- tem on a collision course with crisis; Key policy makers
cial products, and consequent excessive lever- ill prepared for the crisis, lacking a full understanding of
age combined to create vulnerabilities in the the financial system they oversaw; and systemic breaches
system. Policy-makers, regulators and super- in accountability and ethics at all levels.“[40]
visors, in some advanced countries, did not ad-
equately appreciate and address the risks build-
ing up in financial markets, keep pace with 2.2 Narratives
financial innovation, or take into account the
systemic ramifications of domestic regulatory
actions.[36]

Federal Reserve Chair Ben Bernanke testified in Septem-


ber 2010 regarding the causes of the crisis. He wrote that
there were shocks or triggers (i.e., particular events that
touched off the crisis) and vulnerabilities (i.e., structural
weaknesses in the financial system, regulation and super-
vision) that amplified the shocks. Examples of triggers
included: losses on subprime mortgage securities that be-
gan in 2007 and a run on the shadow banking system that
began in mid-2007, which adversely affected the func- U.S. residential and non-residential investment fell relative to
tioning of money markets. Examples of vulnerabilities GDP during the crisis
in the private sector included: financial institution depen-
dence on unstable sources of short-term funding such as There are several “narratives” attempting to place the
repurchase agreements or Repos; deficiencies in corpo- causes of the crisis into context, with overlapping ele-
rate risk management; excessive use of leverage (borrow- ments. Four such narratives include:
ing to invest); and inappropriate usage of derivatives as
a tool for taking excessive risks. Examples of vulnera- 1. There was the equivalent of a bank run on the
bilities in the public sector included: statutory gaps and shadow banking system, which includes investment
conflicts between regulators; ineffective use of regula- banks and other non-depository financial entities.
tory authority; and ineffective crisis management capa- This system had grown to rival the depository sys-
bilities. Bernanke also discussed "Too big to fail" institu- tem in scale yet was not subject to the same regula-
tions, monetary policy, and trade deficits.[37] tory safeguards.[18][41]
During May 2010, Warren Buffett and Paul Volcker sep- 2. The economy was being driven by a housing bubble.
arately described questionable assumptions or judgments When it burst, private residential investment (i.e.,
underlying the U.S. financial and economic system that housing construction) fell by nearly 4% GDP and
contributed to the crisis. These assumptions included: consumption enabled by bubble-generated housing
1) Housing prices would not fall dramatically;[38] 2) Free wealth also slowed. This created a gap in annual
and open financial markets supported by sophisticated fi- demand (GDP) of nearly $1 trillion. Government
nancial engineering would most effectively support mar- was unwilling to make up for this private sector
ket efficiency and stability, directing funds to the most shortfall.[42][43]
profitable and productive uses; 3) Concepts embedded
in mathematics and physics could be directly adapted to 3. Record levels of household debt accumulated in the
markets, in the form of various financial models used decades preceding the crisis resulted in a balance
to evaluate credit risk; 4) Economic imbalances, such sheet recession (similar to debt deflation) once hous-
as large trade deficits and low savings rates indicative ing prices began falling in 2006. Consumers began
of over-consumption, were sustainable; and 5) Stronger paying down debt, which reduces their consumption,
regulation of the shadow banking system and derivatives slowing down the economy for an extended period
markets was not needed.[39] while debt levels are reduced.[2][41]
The U.S. Financial Crisis Inquiry Commission reported 4. Government policies that encouraged home owner-
its findings in January 2011. It concluded that “the crisis ship even for those who could not afford it, con-
2.3 Housing market 5

tributing to lax lending standards, unsustainable


housing price increases, and indebtedness.[44]

Underlying narratives #1-3 is a hypothesis that growing


income inequality and wage stagnation encouraged fam-
ilies to increase their household debt to maintain their
desired living standard, fueling the bubble. Further, this
greater share of income flowing to the top increased the
political power of business interests, who used that power
to deregulate or limit regulation of the shadow banking
system.[45][46][47]

2.3 Housing market


Vicious cycles in the housing and financial markets.
2.3.1 Boom and bust

Main articles: United States housing bubble and United stable.[48] The bubble was characterized by higher rates
States housing market correction of household debt and lower savings rates, slightly higher
According to Robert J. Shiller and other economists, rates of home ownership, and of course higher housing
prices. It was fueled by low interest rates and large inflows
of foreign funds that created easy credit conditions.[49]
Between 1997 and 2006 (the peak of the housing bub-
ble), the price of the typical American house increased by
124%.[50] From 1980 to 2001, the ratio of median home
prices to median household income (a measure of abil-
ity to buy a house) fluctuated from 2.9 to 3.1. In 2004 it
rose to 4.0, and by 2006 it hit 4.6.[51] The housing bubble
was more pronounced in coastal areas where the ability
to build new housing was restricted by geography or land
use restrictions.[52] This housing bubble resulted in quite a
few homeowners refinancing their homes at lower inter-
est rates, or financing consumer spending by taking out
second mortgages secured by the price appreciation. US
household debt as a percentage of annual disposable per-
Household debt relative to disposable income and GDP. sonal income was 127% at the end of 2007, versus 77%
in 1990.[9][53]
While housing prices were increasing, consumers were
saving less[54] and both borrowing and spending more.
Household debt grew from $705 billion at year end 1974,
60% of disposable personal income, to $7.4 trillion at
yearend 2000, and finally to $14.5 trillion in midyear
2008, 134% of disposable personal income.[55] During
2008, the typical US household owned 13 credit cards,
with 40% of households carrying a balance, up from 6%
in 1970.[56]
Free cash used by consumers from home equity extrac-
tion doubled from $627 billion in 2001 to $1,428 bil-
lion in 2005 as the housing bubble built, a total of nearly
$5 trillion over the period.[57][58][59] U.S. home mort-
gage debt relative to GDP increased from an average
Existing homes sales, inventory, and months supply, by quarter. of 46% during the 1990s to 73% during 2008, reach-
ing $10.5 trillion.[60] From 2001 to 2007, U.S. mort-
housing price increases beyond the general inflation rate gage debt almost doubled, and the amount of mortgage
are not sustainable in the long term. From the end of debt per household rose more than 63%, from $91,500 to
World War II to the beginning of the housing bubble $149,500, with essentially stagnant wages.[61] Economist
in 1997, housing prices in the US remained relatively Tyler Cowen explained that the economy was highly de-
6 2 CAUSES

pendent on this home equity extraction: “In the 1993- Increasing foreclosure rates increases the inventory of
1997 period, home owners extracted an amount of equity houses offered for sale. The number of new homes sold in
from their homes equivalent to 2.3% to 3.8% GDP. By 2007 was 26.4% less than in the preceding year. By Jan-
2005, this figure had increased to 11.5% GDP.”[62] uary 2008, the inventory of unsold new homes was 9.8
This credit and house price explosion led to a build- times the December 2007 sales volume, the highest value
ing boom and eventually to a surplus of unsold homes, of this ratio since 1981.[71] Furthermore, nearly four mil-
which caused U.S. housing prices to peak and begin de- lion existing homes were for sale,[72] of which roughly 2.2
clining in mid-2006.[63] Easy credit, and a belief that million were vacant.[73]
house prices would continue to appreciate, had encour- This overhang of unsold homes lowered house prices. As
aged many subprime borrowers to obtain adjustable-rate prices declined, more homeowners were at risk of default
mortgages. These mortgages enticed borrowers with a or foreclosure. House prices are expected to continue de-
below market interest rate for some predetermined pe- clining until this inventory of unsold homes (an instance
riod, followed by market interest rates for the remainder of excess supply) declines to normal levels.[74] A report in
of the mortgage’s term. January 2011 stated that U.S. home values dropped by 26
The US home ownership rate increased from 64% in percent from their peak in June 2006 to November 2010,
1994 (about where it had been since 1980) to an all-time more than the 25.9 percent drop between [75]
1928 to 1933
high of 69.2% in 2004. [64]
Subprime lending was a ma- when the Great Depression occurred.
jor contributor to this increase in home ownership rates From September 2008 to September 2012, there were ap-
and in the overall demand for housing, which drove prices proximately 4 million completed foreclosures in the U.S.
higher. As of September 2012, approximately 1.4 million homes,
Borrowers who would not be able to make the higher or 3.3% of all homes with a mortgage, were in some
stage of foreclosure compared to 1.5 million, or 3.5%,
payments once the initial grace period ended, were plan-
ning to refinance their mortgages after a year or two of in September 2011. During September 2012, 57,000
homes completed foreclosure; this is down from 83,000
appreciation. As a result of the depreciating housing
prices, borrowers ability to refinance became more dif- the prior September but well above the 2000–2006 aver-
age of 21,000 completed foreclosures per month.[76]
ficult. Borrowers who found themselves unable to escape
higher monthly payments by refinancing began to default.
As more borrowers stopped making their mortgage pay- 2.3.2 Homeowner speculation
ments, foreclosures and the supply of homes for sale
increased. This placed downward pressure on housing Main article: Speculation
prices, which further lowered homeowners’ equity. The
decline in mortgage payments also reduced the value of
Speculative borrowing in residential real estate has been
mortgage-backed securities, which eroded the net worth
cited as a contributing factor to the subprime mortgage
and financial health of banks. This vicious cycle was at
crisis.[77] During 2006, 22% of homes purchased (1.65
the heart of the crisis.[65]
million units) were for investment purposes, with an ad-
By September 2008, average U.S. housing prices had ditional 14% (1.07 million units) purchased as vacation
declined by over 20% from their mid-2006 peak.[66][67] homes. During 2005, these figures were 28% and 12%,
This major and unexpected decline in house prices means respectively. In other words, a record level of nearly 40%
that many borrowers have zero or negative equity in their of homes purchased were not intended as primary res-
homes, meaning their homes were worth less than their idences. David Lereah, National Association of Real-
mortgages. As of March 2008, an estimated 8.8 million tors's chief economist at the time, stated that the 2006
borrowers – 10.8% of all homeowners – had negative eq- decline in investment buying was expected: “Speculators
uity in their homes, a number that is believed to have risenleft the market in 2006, which caused investment sales to
to 12 million by November 2008. By September 2010, fall much faster than the primary market.”[78]
23% of all U.S. homes were worth less than the mortgage
Housing prices nearly doubled between 2000 and 2006,
loan.[68]
a vastly different trend from the historical apprecia-
Borrowers in this situation have an incentive to default tion at roughly the rate of inflation. While homes had
on their mortgages as a mortgage is typically nonrecourse not traditionally been treated as investments subject to
debt secured against the property.[69] Economist Stan Lei- speculation, this behavior changed during the housing
bowitz argued in the Wall Street Journal that although boom. Media widely reported condominiums being pur-
only 12% of homes had negative equity, they comprised chased while under construction, then being “flipped”
47% of foreclosures during the second half of 2008. He (sold) for a profit without the seller ever having lived in
concluded that the extent of equity in the home was the them.[79] Some mortgage companies identified risks in-
key factor in foreclosure, rather than the type of loan, herent in this activity as early as 2005, after identifying
credit worthiness of the borrower, or ability to pay.[70] investors assuming highly leveraged positions in multiple
properties.[80]
2.3 Housing market 7

Nicole Gelinas of the Manhattan Institute described the


negative consequences of not adjusting tax and mort-
gage policies to the shifting treatment of a home from
conservative inflation hedge to speculative investment.[81]
Economist Robert Shiller argued that speculative bubbles
are fueled by “contagious optimism, seemingly impervi-
ous to facts, that often takes hold when prices are rising.
Bubbles are primarily social phenomena; until we under-
stand and address the psychology that fuels them, they're
going to keep forming.”[82] Keynesian economist Hyman
Minsky described how speculative borrowing contributed
to rising debt and an eventual collapse of asset values.[83]
Warren Buffett testified to the Financial Crisis Inquiry
Commission: “There was the greatest bubble I've ever
seen in my life...The entire American public eventually Historically less than 2% of homebuyers lost their homes to fore-
closure. But by 2009 over 40% of subprime adjustable rate mort-
was caught up in a belief that housing prices could not
gages were past due. (source: Financial Crisis Inquiry Report,
fall dramatically.”[38] p.217, figure 11.2)

2.3.3 High-risk mortgage loans and lend- had offered progressively riskier loan options and borrow-
ing/borrowing practices ing incentives. In 2005, the median down payment for
first-time home buyers was 2%, with 43% of those buy-
ers making no down payment whatsoever.[91] By compar-
ison, China has down payment requirements that exceed
20%, with higher amounts for non-primary residences.[92]

25000
25000

forecast
20000
20000

15000
15000

10000
10000

actual
5000
5000

1998
1997
1996
2003
2002
2001
2006
2000
1999
2005
2004 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

A mortgage brokerage in the US advertising subprime mortgages


Growth in mortgage loan fraud based upon US Department of
in July 2008.
the Treasury Suspicious Activity Report Analysis

In the years before the crisis, the behavior of lenders To produce more mortgages and more securities, mort-
changed dramatically. Lenders offered more and
gage qualification guidelines became progressively looser.
more loans to higher-risk borrowers,[6][84] including First, “stated income, verified assets” (SIVA) loans re-
undocumented immigrants.[85] Lending standards dete-
placed proof of income with a “statement” of it. Then,
riorated particularly between 2004 and 2007, as the “no income, verified assets” (NIVA) loans eliminated
government-sponsored enterprise (GSE) mortgage mar- proof of employment requirements. Borrowers needed
ket share (i.e. the share of Fannie Mae and Freddie only to show proof of money in their bank accounts. “No
Mac, which specialized in conventional, conforming, Income, No Assets” (NINA) or Ninja loans loans elimi-
non-subprime mortgages) declined and private securitiz- nated the need to prove, or even to state any owned assets.
ers share grew, rising to more than half of mortgage All that was required for a mortgage was a credit score.[93]
securitizations.[6]
Types of mortgages became more risky as well. The
Subprime mortgages grew from 5% of total originations interest-only adjustable-rate mortgage (ARM), allowed
($35 billion) in 1994,[86][86][87] to 20% ($600 billion) in
the homeowner to pay only the interest (not principal)
2006.[87][88][89] Another indicator of a “classic” boom- of the mortgage during an initial “teaser” period. Even
bust credit cycle, was a closing in the difference between looser was the “payment option” loan, in which the home-
subprime and prime mortgage interest rates (the “sub- owner has the option to make monthly payment that do
prime markup”) between 2001 and 2007.[90] not even cover the interest for the first two or three year
In addition to considering higher-risk borrowers, lenders initial period of the loan. Nearly one in 10 mortgage bor-
8 2 CAUSES

rowers in 2005 and 2006 took out these “option ARM” ing to those throughout the mortgage supply chain, from
loans,[61] and an estimated one-third of ARMs originated the mortgage broker selling the loans, to small banks that
between 2004 and 2006 had “teaser” rates below 4%. Af- funded the brokers, to the giant investment banks behind
ter the initial period, monthly payments might double[87] them. By approximately 2003, the supply of mortgages
or even triple.[94] originated at traditional lending standards had been ex-
The proportion of subprime ARM loans made to people hausted. However, continued strong demand for MBS
with credit scores high enough to qualify for conventional and CDO began to drive down lending standards, as long
mortgages with better terms increased from 41% in 2000 as mortgages could still be sold along the supply chain.
Eventually, this speculative bubble proved unsustainable.
to 61% by 2006. In addition, mortgage brokers in some
cases received incentives from lenders to offer subprime NPR described it this way:[101]
ARM’s even to those with credit ratings that merited a
conforming (i.e., non-subprime) loan.[95] The problem was that even though hous-
ing prices were going through the roof, people
Mortgage underwriting standards declined precipitously
weren't making any more money. From 2000
during the boom period. The use of automated loan ap-
to 2007, the median household income stayed
provals allowed loans to be made without appropriate re-
flat. And so the more prices rose, the more ten-
view and documentation.[96] In 2007, 40% of all sub-
uous the whole thing became. No matter how
prime loans resulted from automated underwriting.[97][98]
lax lending standards got, no matter how many
The chairman of the Mortgage Bankers Association
exotic mortgage products were created to shoe-
claimed that mortgage brokers, while profiting from the
horn people into homes they couldn't possibly
home loan boom, did not do enough to examine whether
afford, no matter what the mortgage machine
borrowers could repay.[99] Mortgage fraud by lenders and
tried, the people just couldn't swing it. By late
borrowers increased enormously.[100]
2006, the average home cost nearly four times
The Financial Crisis Inquiry Commission reported in Jan- what the average family made. Historically it
uary 2011 that many mortgage lenders took eager bor- was between two and three times. And mort-
rowers’ qualifications on faith, often with a “willful dis- gage lenders noticed something that they'd al-
regard” for a borrower’s ability to pay. Nearly 25% most never seen before. People would close on
of all mortgages made in the first half of 2005 were a house, sign all the mortgage papers, and then
“interest-only” loans. During the same year, 68% of “op- default on their very first payment. No loss of
tion ARM” loans originated by Countrywide Financial a job, no medical emergency, they were under-
and Washington Mutual had low- or no-documentation water before they even started. And although
requirements.[61] no one could really hear it, that was probably
So why did lending standards decline? At least one study the moment when one of the biggest specula-
has suggested that the decline in standards was driven by a tive bubbles in American history popped.
shift of mortgage securitization from a tightly controlled
duopoly to a competitive market in which mortgage orig- 2.3.4 Subprime mortgage market
inators held the most sway.[6] The worst mortgage vin-
tage years coincided with the periods during which Gov-
ernment Sponsored Enterprises (specifically Fannie Mae
and Freddie Mac) were at their weakest, and mortgage
originators and private label securitizers were at their
strongest.[6]
Why was there a market for these low quality private la-
bel securitizations? In a Peabody Award winning pro-
gram, NPR correspondents argued that a “Giant Pool of
Money” (represented by $70 trillion in worldwide fixed
income investments) sought higher yields than those of-
fered by U.S. Treasury bonds early in the decade. Fur-
ther, this pool of money had roughly doubled in size from
2000 to 2007, yet the supply of relatively safe, income
generating investments had not grown as fast. Investment
banks on Wall Street answered this demand with financial
Number of U.S. residential properties subject to foreclosure ac-
innovation such as the mortgage-backed security (MBS)
tions by quarter (2007–2012).
and collateralized debt obligation (CDO), which were as-
signed safe ratings by the credit rating agencies.
Subprime borrowers typically have weakened credit
In effect, Wall Street connected this pool of money to the histories and reduced repayment capacity. Subprime
mortgage market in the U.S., with enormous fees accru- loans have a higher risk of default than loans to prime
2.4 Financial markets 9

borrowers.[102] If a borrower is delinquent in making an important credit risk of nonprime mortgage lending,
timely mortgage payments to the loan servicer (a bank which, they said, could lead to “a problem that could have
or other financial firm), the lender may take possession as much impact as the S&L crisis”.[123][124][125][126] De-
of the property, in a process called foreclosure. spite this, the Bush administration prevented states from
The value of American subprime mortgages was esti- investigating and prosecuting predatory lenders by invok-
mated at $1.3 trillion as of March 2007,[103] with over 7.5 ing a banking law from 1863 “to issue formal opinions
million first-lien subprime mortgages outstanding.[104] preempting all state predatory [127]
lending laws, thereby ren-
Between 2004 and 2006 the share of subprime mort- dering them inoperative.”
gages relative to total originations ranged from 18%– The Financial Crisis Inquiry Commission reported in Jan-
21%, versus less than 10% in 2001–2003 and during uary 2011 that: "... mortgage fraud... flourished in an en-
2007.[105][106] The majority of subprime loans were is- vironment of collapsing lending standards and lax regula-
sued in California.[107] The boom in mortgage lending, tion. The number of suspicious activity reports – reports
including subprime lending, was also driven by a fast ex- of possible financial crimes filed by depository banks
pansion of non-bank independent mortgage originators and their affiliates – related to mortgage fraud grew 20-
which despite their smaller share (around 25 percent in fold between 1996 and 2005 and then more than dou-
2002) in the market have contributed to around 50 per- bled again between 2005 and 2009. One study places the
cent of the increase in mortgage credit between 2003 and losses resulting from fraud on mortgage loans made be-
2005.[108] In the third quarter of 2007, subprime ARMs tween 2005 and 2007 at $112 billion.
making up only 6.9% of US mortgages outstanding also "Predatory lending describes unfair, deceptive, or fraudu-
accounted for 43% of the foreclosures which began dur- lent practices of some lenders during the loan origination
ing that quarter.[109] process."Lenders made loans that they knew borrowers
By October 2007, approximately 16% of subprime could not afford and that could cause massive losses to
adjustable-rate mortgages (ARM) were either 90-days investors in mortgage securities.”[61]
delinquent or the lender had begun foreclosure proceed-
ings, roughly triple the rate of 2005.[110] By January
2008, the delinquency rate had risen to 21%[111] and by 2.4 Financial markets
May 2008 it was 25%.[112]
2.4.1 Boom and collapse of the shadow banking sys-
According to RealtyTrac, the value of all outstanding res- tem
idential mortgages, owed by U.S. households to purchase
residences housing at most four families, was US$9.9
trillion as of year-end 2006, and US$10.6 trillion as of
midyear 2008.[113] During 2007, lenders had begun fore-
closure proceedings on nearly 1.3 million properties, a
79% increase over 2006.[114] This increased to 2.3 mil-
lion in 2008, an 81% increase vs. 2007,[115] and again to
2.8 million in 2009, a 21% increase vs. 2008.[116]
By August 2008, 9.2% of all U.S. mortgages outstanding
were either delinquent or in foreclosure.[117] By Septem-
ber 2009, this had risen to 14.4%.[118] Between August
2007 and October 2008, 936,439 US residences com-
pleted foreclosure.[119] Foreclosures are concentrated in
particular states both in terms of the number and rate
of foreclosure filings.[120] Ten states accounted for 74%
of the foreclosure filings during 2008; the top two (Cal-
ifornia and Florida) represented 41%. Nine states were Comparison [128]
of the growth of traditional banking and shadow
above the national foreclosure rate average of 1.84% of banking
households.[121]
The Financial Crisis Inquiry Commission reported in Jan-
uary 2011:
2.3.5 Mortgage fraud and predatory lending
“In the early part of the 20th century, we
“The FBI defines mortgage fraud as 'the intentional mis- erected a series of protections – the Federal
statement, misrepresentation, or omission by an applicant Reserve as a lender of last resort, federal de-
or other interest parties, relied on by a lender or under- posit insurance, ample regulations – to provide
writer to provide funding for, to purchase, or to insure a a bulwark against the panics that had regularly
mortgage loan.'"[122] In 2004, the Federal Bureau of In- plagued America’s banking system in the 20th
vestigation warned of an “epidemic” in mortgage fraud, century. Yet, over the past 30-plus years, we
10 2 CAUSES

permitted the growth of a shadow banking sys- made the Great Depression possible – and they
tem – opaque and laden with short term debt – should have responded by extending regula-
that rivaled the size of the traditional banking tions and the financial safety net to cover these
system. Key components of the market – for new institutions. Influential figures should have
example, the multitrillion-dollar repo lending proclaimed a simple rule: anything that does
market, off-balance-sheet entities, and the use what a bank does, anything that has to be res-
of over-the-counter derivatives – were hidden cued in crises the way banks are, should be reg-
from view, without the protections we had con- ulated like a bank.”
structed to prevent financial meltdowns. We
had a 21st-century financial system with 19th- He referred to this lack of controls as “malign
century safeguards.”[61] neglect.”[130][131]
In a June 2008 speech, President of the NY Federal Re- The securitization markets supported by the shadow
serve Bank Timothy Geithner, who later became Sec- banking system started to close down in the spring of
retary of the Treasury, placed significant blame for the 2007 and nearly shut-down in the fall of 2008. More than
freezing of credit markets on a “run” on the entities in the a third of the private credit markets thus became unavail-
“parallel” banking system, also called the shadow banking able as a source of funds.[132] According to the Brookings
system. These entities became critical to the credit mar- Institution, the traditional banking system does not have
kets underpinning the financial system, but were not sub- the capital to close this gap as of June 2009: “It would
ject to the same regulatory controls as depository banks. take a number of years of strong profits to generate suf-
Further, these entities were vulnerable because they bor- ficient capital to support that additional lending volume.”
rowed short-term in liquid markets to purchase long- The authors also indicate that some forms of securitiza-
term, illiquid and risky assets. This meant that disrup- tion are “likely to vanish forever, having been an artifact
tions in credit markets would make them subject to rapid of excessively loose credit conditions.”[133]
deleveraging, selling their long-term assets at depressed Economist Gary Gorton wrote in May 2009:
prices.[19]
Repo and other forms of shadow banking accounted for “Unlike the historical banking panics of
an estimated 60% of the “overall US banking system,” the 19th and early 20th centuries, the current
according to Paul Krugman,.[129] Geithner described its banking panic is a wholesale panic, not a retail
“entities": panic. In the earlier episodes, depositors ran to
their banks and demanded cash in exchange for
“In early 2007, asset-backed commercial their checking accounts. Unable to meet those
paper conduits, in structured investment vehi- demands, the banking system became insol-
cles, in auction-rate preferred securities, tender vent. The current panic involved financial firms
option bonds and variable rate demand notes, “running” on other financial firms by not re-
had a combined asset size of roughly $2.2 tril- newing sale and repurchase agreements (repo)
lion. Assets financed overnight in triparty repo or increasing the repo margin (“haircut”), forc-
grew to $2.5 trillion. Assets held in hedge ing massive deleveraging, and resulting in the
funds grew to roughly $1.8 trillion. The com- banking system being insolvent.”[18]
bined balance sheets of the then five major in-
vestment banks totaled $4 trillion. In compar-
Fed Chair Ben Bernanke stated in an interview with the
ison, the total assets of the top five bank hold-
FCIC during 2009 that 12 of the 13 largest U.S. finan-
ing companies in the United States at that point
cial institutions were at risk of failure during 2008. The
were just over $6 trillion, and total assets of the
FCIC report did not identify which of the 13 firms was
entire banking system were about $10 trillion.”
not considered by Bernanke to be in danger of failure.[134]
He stated that the “combined effect of these factors was a Economist Mark Zandi testified to the Financial Crisis
financial system vulnerable to self-reinforcing asset price Inquiry Commission in January 2010:
and credit cycles.”[19]
Nobel laureate economist Paul Krugman described the “The securitization markets also remain
run on the shadow banking system as the “core of what impaired, as investors anticipate more loan
happened” to cause the crisis. losses. Investors are also uncertain about com-
ing legal and accounting rule changes and reg-
“As the shadow banking system expanded ulatory reforms. Private bond issuance of res-
to rival or even surpass conventional banking idential and commercial mortgage-backed se-
in importance, politicians and government of- curities, asset-backed securities, and CDOs
ficials should have realized that they were re- peaked in 2006 at close to $2 trillion...In 2009,
creating the kind of financial vulnerability that private issuance was less than $150 billion, and
2.4 Financial markets 11

almost all of it was asset-backed issuance sup- 1970s, when Government Sponsored Enterprises (GSEs)
ported by the Federal Reserve’s TALF pro- began to pool relatively safe, conventional, "conforming"
gram to aid credit card, auto and small-business or “prime” mortgages, create "mortgage-backed securi-
lenders. Issuance of residential and commer- ties" (MBS) from the pool, sell them to investors, guar-
cial mortgage-backed securities and CDOs re- anteeing these securities/bonds against default on the un-
mains dormant.”[135] derlying mortgages.[6][137] This “originate-to-distribute”
model had advantages over the old “originate-to-hold”
The Economist reported in March 2010: “Bear Stearns model,[138] where a bank originated a loan to the bor-
and Lehman Brothers were non-banks that were crip- rower/homeowner and retained the credit (default) risk.
pled by a silent run among panicky overnight "repo" Securitization removed the loans from a bank’s books,
lenders, many of them money market funds uncertain enabling the bank to remain in compliance with capi-
about the quality of securitized collateral they were hold- tal requirement laws. More loans could be made with
ing. Mass redemptions from these funds after Lehman’s proceeds of the MBS sale. The liquidity of a national
failure froze short-term funding for big firms.”[136] and even international mortgage market allowed capital to
flow where mortgages were in demand and funding short.
However, securitization created a moral hazard — the
2.4.2 Securitization bank/institution making the loan no longer had to worry
if the mortgage was paid off[139] — giving them incentive
to process mortgage transactions but not to ensure their
credit quality.[140][141] Bankers were no longer around to
work out borrower problems and minimize defaults dur-
ing the course of the mortgage.[3]
With the high down payments and credit scores of the
conforming mortgages used by GSE, this danger was
minimal.[142] Investment banks however, wanted to en-
ter the market and avoid competing with the GSEs.[139]
They did so by developing mortgage-backed securities
in the riskier non-conforming subprime and Alt-A mar-
ket. Unlike the GSEs[143] the issuers generally did not
guarantee the securities against default of the underlying
mortgages.[6]
What these “private label” or “non-agency” originators
did do was to use "structured finance" to create secu-
rities. Structuring involved “slicing” the pooled mort-
Borrowing under a securitization structure.
gages into “tranches”, each having a different priority in
the stream of monthly or quarterly principal and inter-
est stream.[144][145] Tranches were compared to “buck-
ets” catching the “water” of principle and interest. More
senior buckets didn't share water with those below un-
til they were filled to the brim and overflowing.[146] This
gave the top buckets/tranches considerable creditworthi-
ness (in theory) that would earn the highest “triple A”
credit ratings, making them salable to money market and
pension funds that would not otherwise deal with sub-
prime mortgage securities.
To use up the MBS tranches lower in payback priority
that could not be rated triple-A and that a conservative
fixed income market would not buy, investment banks
developed another security—known as the collateralized
debt obligation (CDO). Although the CDO market was
IMF diagram of CDO and RMBS. smaller, it was crucial because unless buyers were found
for the non-triple-A or “mezzanine” tranches, it would not
Further information: Securitization and Mortgage- be profitable to make a mortgage-backed security in the
backed security first place.[147][148] These CDOs pooled the leftover BBB,
A-, etc. rated tranches, and produced new tranches —
[149]
Securitization — the bundling of bank loans to create 70% to 80%[150] of which were rated triple A by rat-
tradeable bonds — started in the mortgage industry in the ing agencies. The 20-30% remaining mezzanine tranches
12 2 CAUSES

were sometimes bought up by other CDOs, to make so- housing market was peaking, GSE securitization mar-
called "CDO-Squared" securities which also produced ket share declined dramatically, while higher-risk sub-
tranches rated mostly triple A.[151] prime and Alt-A mortgage private label securitization
[6]
This process was later disparaged as “ratings grew sharply. As mortgage defaults began to rise, it was
laundering”[152] or a way of transforming “dross among mortgages securitized by the private banks. GSE
into gold”[153] by some business journalists, but was mortgages — securitized or not —[6][164] continued to perform
justified at the time by the belief that home prices would better than the rest of the market. Picking up the
[165]
always rise. [154][155]
The model used by underwriters, slack for the dwindling cash CDO market synthetics
were the dominant form of CDO’s by 2006,[166] valued
rating agencies and investors to estimate the probability [167]
of mortgage default was based on the history of credit "notionally" at an estimated $5 trillion.[166]
default swaps, which unfortunately went back “less than By the autumn of 2008, when the securitization market
a decade, a period when house prices soared”.[156] “seized up” and investors would “no longer lend at any
In addition the model — which postulated that the corre- price”, securitized lending made up about $10 trillion
lation of default risks among loans in securitization pools of the roughly $25 trillion American credit market, (i.e.
could be measure in a simple, stable, tractable number, what “American homeowners, consumers, and corpora-
[132][133]
suitable for risk management or valuation [156]
— also pur- tions owed”). In February 2009, Ben Bernanke
ported to show that the mortgages in CDO pools were stated that securitization markets remained effectively
well diversified or “uncorrelated”. Defaults on mortgages shut, with the exception of conforming mortgages, which
in Orlando, for example, were thought to have no effect could be sold to Fannie Mae and Freddie Mac.[168]
on — i.e. were uncorrelated with — the real estate mar- According to economist A. Michael Spence: “when for-
ket across the country in Laguna Beach. When prices merly uncorrelated risks shift and become highly corre-
corrected (i.e. the bubble collapsed), the resulting de- lated ... diversification models fail.” “An important chal-
faults were not only larger in number than predicted but lenge going forward is to better understand these dynam-
far more correlated.[156] ics as the analytical underpinning of an early warning sys-
[169]
Still another innovative security criticized after the bub- tem with respect to financial instability.”
ble burst was the synthetic CDO. Cheaper and easier to Criticizing the argument that complex structured invest-
create than original “cash” CDOs, synthetics did not pro- ment securitization was instrumental in the mortgage cri-
vide funding for housing, rather synthetic CDO-buying sis, Paul Krugman points out that the Wall Street firms
investors were in effect providing insurance (in the form issuing the securities “kept the riskiest assets on their
of "credit default swaps") against mortgage default. The own books”, and that neither of the equally disastrous
mortgages they insured were those in “cash” CDOs the bubbles in European housing or US commercial prop-
synthetics “referenced”. So instead of providing investors erty used complex structured securities. Krugman does
with interest and principal payments from MBS tranches, agree that it is “arguable is that financial innovation ...
payments were the equivalent of insurance premiums spread the bust to financial institutions around the world”
from the insurance “buyers”.[157] If the referenced CDOs and its inherent fragmentation of loans has made post-
defaulted, investors lost their investment, which was paid bubble “cleanup” through debt renegotiation extremely
out to the insurance buyers.[158] difficult.[129]
Unlike true insurance, credit default swaps were not reg-
ulated to insure that providers had the reserves to pay set- 2.4.3 Financial institution debt levels and incentives
tlements, or that buyers owned the property (MBSs) they
were insuring, i.e. were not simply making a bet a secu-
rity would default.[159] Because synthetics “referenced”
another (cash) CDO, more than one — in fact numer-
ous — synthetics could be made to reference the same
original, multiplying the effect if a referenced security
defaulted.[160][161] As with MBS and other CDOs, triple
A ratings for “large chunks”[162] of synthetics were crucial
to the securities’ success, because of the buyer/investors’
ignorance of the mortgage security market and trust in the
credit rating agencies ratings.[163]
Securitization began to take off in the mid-1990s. The
total amount of mortgage-backed securities issued almost
tripled between 1996 and 2007, to $7.3 trillion. The se-
curitized share of subprime mortgages (i.e., those passed Leverage ratios of investment banks increased significantly be-
tween 2003 and 2007.
to third-party investors via MBS) increased from 54%
in 2001, to 75% in 2006.[90] In the mid-2000s as the
The Financial Crisis Inquiry Commission reported in Jan-
2.4 Financial markets 13

uary 2011 that: “From 1978 to 2007, the amount of debt losses during the crisis. New accounting guidance will
held by the financial sector soared from $3 trillion to $36 require them to put some of these assets back onto their
trillion, more than doubling as a share of gross domes- books during 2009, which will significantly reduce their
tic product. The very nature of many Wall Street firms capital ratios. One news agency estimated this amount
changed – from relatively staid private partnerships to to be between $500 billion and $1 trillion. This effect
publicly traded corporations taking greater and more di- was considered as part of the stress tests performed by
verse kinds of risks. By 2005, the 10 largest U.S. com- the government during 2009.[173]
mercial banks held 55% of the industry’s assets, more Martin Wolf wrote in June 2009: "...an enormous part
than double the level held in 1990. On the eve of the
of what banks did in the early part of this decade –
crisis in 2006, financial sector profits constituted 27% of the off-balance-sheet vehicles, the derivatives and the
all corporate profits in the United States, up from 15% in
'shadow banking system' itself – was to find a way round
1980.”[61] regulation.”[174]
Many financial institutions, investment banks in partic- The New York State Comptroller’s Office has said that in
ular, issued large amounts of debt during 2004–2007, 2006, Wall Street executives took home bonuses totaling
and invested the proceeds in mortgage-backed securities $23.9 billion. “Wall Street traders were thinking of the
(MBS), essentially betting that house prices would con- bonus at the end of the year, not the long-term health of
tinue to rise, and that households would continue to make their firm. The whole system – from mortgage brokers
their mortgage payments. Borrowing at a lower inter- to Wall Street risk managers – seemed tilted toward tak-
est rate and investing the proceeds at a higher interest ing short-term risks while ignoring long-term obligations.
rate is a form of financial leverage. This is analogous to The most damning evidence is that most of the people at
an individual taking out a second mortgage on his resi- the top of the banks didn't really understand how those
dence to invest in the stock market. This strategy proved [investments] worked.”[51][175]
profitable during the housing boom, but resulted in large
losses when house prices began to decline and mortgages The incentive compensation of traders was focused on
began to default. Beginning in 2007, financial institutions fees generated from assembling financial products, rather
and individual investors holding MBS also suffered sig- than the performance of those products and profits gen-
nificant losses from mortgage payment defaults and the erated over time. Their bonuses were heavily skewed to-
resulting decline in the value of MBS.[170] wards cash rather than stock and not subject to “claw-
back” (recovery of the bonus from the employee by the
A 2004 U.S. Securities and Exchange Commission (SEC) firm) in the event the MBS or CDO created did not per-
decision related to the net capital rule allowed US invest- form. In addition, the increased risk (in the form of finan-
ment banks to issue substantially more debt, which was cial leverage) taken by the major investment banks was
then used to purchase MBS. Over 2004–07, the top five not adequately factored into the compensation of senior
US investment banks each significantly increased their fi- executives.[176]
nancial leverage (see diagram), which increased their vul-
nerability to the declining value of MBSs. These five in-
stitutions reported over $4.1 trillion in debt for fiscal year 2.4.4 Credit default swaps
2007, about 30% of US nominal GDP for 2007. Further,
the percentage of subprime mortgages originated to to- Credit default swaps (CDS) are financial instruments used
tal originations increased from below 10% in 2001–2003 as a hedge and protection for debtholders, in particular
to between 18–20% from 2004 to 2006, due in-part to MBS investors, from the risk of default, or by specula-
financing from investment banks.[105][106] tors to profit from default. As the net worth of banks and
During 2008, three of the largest U.S. investment banks other financial institutions deteriorated because of losses
either went bankrupt (Lehman Brothers) or were sold at related to subprime mortgages, the likelihood increased
fire sale prices to other banks (Bear Stearns and Merrill that those providing the protection would have to pay
Lynch). These failures augmented the instability in the their counterparties. This created uncertainty across the
global financial system. The remaining two investment system, as investors wondered which companies would be
banks, Morgan Stanley and Goldman Sachs, opted to be- required to pay to cover mortgage defaults.
come commercial banks, thereby subjecting themselves Like all swaps and other financial derivatives, CDS may
to more stringent regulation.[171][172] either be used to hedge risks (specifically, to insure credi-
In the years leading up to the crisis, the top four U.S. tors against default) or to profit from speculation. The vol-
depository banks moved an estimated $5.2 trillion in as- ume of CDS outstanding increased 100-fold from 1998
sets and liabilities off-balance sheet into special purpose to 2008, with estimates of the debt covered by CDS con-
vehicles or other entities in the shadow banking system. tracts, as of November 2008, ranging from US$33 to $47
This enabled them to essentially bypass existing regula- trillion. CDS are lightly regulated, largely because of the
tions regarding minimum capital ratios, thereby increas- Commodity Futures Modernization Act of 2000. As of
ing leverage and profits during the boom but increasing 2008, there was no central clearing house to honor CDS
in the event a party to a CDS proved unable to perform
14 2 CAUSES

his obligations under the CDS contract. Required dis- of office would expire.[185] Ultimately, it was the collapse
closure of CDS-related obligations has been criticized as of a specific kind of derivative, the mortgage-backed se-
inadequate. Insurance companies such as American In- curity, that triggered the economic crisis of 2008.[186]
ternational Group (AIG), MBIA, and Ambac faced rat- In addition, Chicago Public Radio, Huffington Post, and
ings downgrades because widespread mortgage defaults ProPublica reported in April 2010 that market partici-
increased their potential exposure to CDS losses. These pants, including a hedge fund called Magnetar Capital,
firms had to obtain additional funds (capital) to offset this encouraged the creation of CDO’s containing low qual-
exposure. AIG’s having CDSs insuring $440 billion of ity mortgages, so they could bet against them using CDS.
MBS resulted in its seeking and obtaining a Federal gov-
NPR reported that Magnetar encouraged investors to pur-
ernment bailout.[177] The monoline insurance companies chase CDO’s while simultaneously betting against them,
went out of business in 2008–2009.
without disclosing the latter bet.[161][187][188] Instruments
When investment bank Lehman Brothers went bankrupt called synthetic CDO, which are portfolios of credit de-
in September 2008, there was much uncertainty as fault swaps, were also involved in allegations by the SEC
to which financial firms would be required to honor against Goldman-Sachs in April 2010.[189]
the CDS contracts on its $600 billion of bonds The Financial Crisis Inquiry Commission reported in Jan-
outstanding.[178][179] Merrill Lynch's large losses in 2008 uary 2011 that CDS contributed significantly to the cri-
were attributed in part to the drop in value of its unhedged sis. Companies were able to sell protection to investors
portfolio of collateralized debt obligations (CDOs) after against the default of mortgage-backed securities, help-
AIG ceased offering CDS on Merrill’s CDOs. The loss ing to launch and expand the market for new, complex
of confidence of trading partners in Merrill Lynch’s sol- instruments such as CDO’s. This further fueled the hous-
vency and its ability to refinance its short-term debt led to ing bubble. They also amplified the losses from the col-
its acquisition by the Bank of America.[180][181] lapse of the housing bubble by allowing multiple bets on
Economist Joseph Stiglitz summarized how credit default the same securities and helped spread these bets through-
swaps contributed to the systemic meltdown: “With this out the financial system. Companies selling protection,
complicated intertwining of bets of great magnitude, no such as AIG, were not required to set aside sufficient cap-
one could be sure of the financial position of anyone else- ital to cover their obligations when significant defaults
or even of one’s own position. Not surprisingly, the creditoccurred. Because many CDS were not traded on ex-
markets froze.”[182] changes, the obligations of key financial institutions be-
Author Michael Lewis wrote that CDS enabled specula- came hard to measure, creating uncertainty in the finan-
[61]
tors to stack bets on the same mortgage bonds and CDO’s. cial system.
This is analogous to allowing many persons to buy insur-
ance on the same house. Speculators that bought CDS 2.4.5 Inaccurate credit ratings
insurance were betting that significant defaults would oc-
cur, while the sellers (such as AIG) bet they would not. Main article: Credit rating agencies and the subprime cri-
A theoretically infinite amount could be wagered on the sis
same housing-related securities, provided buyers and sell- Credit rating agencies — firms which rate debt
ers of the CDS could be found.[183]
Derivatives such as CDS were unregulated or barely
regulated. Several sources have noted the failure
of the US government to supervise or even require
transparency of the financial instruments known as
derivatives[184][185][186] A 2008 investigative article in
the Washington Post found that leading government offi-
cials at the time (Federal Reserve Board Chairman Alan
Greenspan, Treasury Secretary Robert Rubin, and SEC
Chairman Arthur Levitt) vehemently opposed any regu-
lation of derivatives. In 1998 Brooksley E. Born, head of
the Commodity Futures Trading Commission, put forth
a policy paper asking for feedback from regulators, lob-
byists, legislators on the question of whether derivatives
should be reported, sold through a central facility, or
whether capital requirements should be required of their MBS credit rating downgrades, by quarter
buyers. Greenspan, Rubin, and Levitt pressured her to
withdraw the paper and Greenspan persuaded Congress instruments/securities according to the debtor’s ability to
to pass a resolution preventing CFTC from regulating pay lenders back — have come under scrutiny during
derivatives for another six months — when Born’s term and after the financial crisis for having given investment-
grade ratings to MBSs and CDOs based on risky sub-
2.4 Financial markets 15

prime mortgage loans that later defaulted. Dozens of paid for the ratings, the relentless drive for market share,
lawsuits have been filed by investors against the "Big the lack of resources to do the job despite record profits,
Three" rating agencies — Moody’s Investors Service, and the absence of meaningful public oversight.”.[61]
Standard & Poor’s, and Fitch Ratings.[190] The Financial Structured investment was very profitable to the agen-
Crisis Inquiry Commission (FCIC)[191] concluded the cies and by 2007 accounted for just under half of
“failures” of the Big Three rating agencies were “es- Moody’s total ratings revenue and all of the revenue
sential cogs in the wheel of financial destruction” and growth.[210] But profits were not guaranteed, and issuers
“key enablers of the financial meltdown”.[192] Economist played the agencies off one another, 'shopping' around
Joseph Stiglitz called them “one of the key culprits” of
to find the best ratings, sometimes openly threatening to
the financial crisis.[193] Others called their ratings “catas- cut off business after insufficiently generous ratings.[211]
trophically misleading”, (the U.S. Securities and Ex-
Thus there was a conflict of interest between accom-
change Commissioner[194] ), their performance “horren- modating clients—for whom higher ratings meant higher
dous” (The Economist magazine[195] ). There are indica-
earnings—and accurately rating the debt for the benefit
tions that some involved in rating subprime-related se- of the debt buyer/investors—who provided zero revenue
curities knew at the time that the rating process was
to the agencies.[212]
faulty.[196][197]
Despite the profitability of the three big credit agen-
The position of the three agencies “between the issuers cies — Moody’s operating margins were consistently
and the investors of securities”[198] “transformed” them over 50%, higher than famously successful Exxon Mo-
into “key” players in the housing bubble and financial cri- bil or Microsoft[213] — salaries and bonuses for non-
sis according to the Financial Crisis Inquiry Report. Most management were significantly lower than at Wall Street
investors in the fixed income market had no experience banks, and its employees complained of overwork.
with the mortgage business—let alone dealing with the
complexity of pools of mortgages and tranche priority of This incentivized agency rating analysts to seek employ-
MBS and CDO securities[198] —and were simply looking ment at those Wall Street banks who were issuing mort-
for an independent party who could rate securities.[199] gage securities, and who were particularly interested in
The putatively independent parties meanwhile were paid the analysts’ knowledge of what criteria their former em-
“handsome fees” by investment banks “to obtain the de- ployers used to rate securities.[214][215] Inside knowledge
sired ratings”, according to one expert.[199] of interest to security issuers eager to find loopholes in-
cluded the fact that rating agencies looked at the aver-
In addition, a large section of the debt securities market age credit score of a pool of borrowers, but not how dis-
— many money markets and pension funds — were re- persed it was; that agencies ignored borrower’s household
stricted in their bylaws to holding only the safest securities income or length of credit history (explaining the large
— i.e securities the rating agencies designated “triple-A”. numbers of low income immigrants given mortgages—
Hence non-prime securities could not be sold without rat- people “who had never failed to repay a debt, because they
ings by (usually two of) the three agencies.[200] had never been given a loan”); that agencies were indif-
From 2000 to 2007, one of the largest agencies— ferent to credit worthiness issues of adjustable-rate mort-
Moody’s -- rated nearly 45,000 mortgage-related gages with low teaser rates, “silent second” mortgages, or
securities[201] —more than half of those it rated—as no-documentation mortgages.[216]
triple-A.[202] By December 2008, there were over $11 As of 2010, virtually all of the investigations of rat-
trillion structured finance securities outstanding in the ing agencies, criminal as well as civil, are in their early
U.S. bond market debt.[201] But as the boom matured, stages.[217] In New York, state prosecutors are exam-
mortgage underwriting standards deteriorated. By 2007 ining whether eight banks[218] duped the credit ratings
an estimated $3.2 trillion in loans were made to home- agencies into inflating the grades of subprime-linked
buyers and owners with bad credit and undocumented investments.[219] In the dozens of suits filed against them
incomes, bundled into MBSs and CDOs, and given top by investors involving claims of inaccurate ratings[190] the
ratings[203] to appeal to global investors.
rating agencies have defended themselves using the First
As these mortgages began to default, the three agencies Amendment defense—that a credit rating is an opinion
were compelled to go back and redo their ratings. Be- protected as free speech.[220] In 2013, McClatchy News-
tween autumn of 2007 and the middle of 2008, agen- papers found that “little competition has emerged” since
cies downgraded nearly $2 trillion in MBS tranches.[204] the Credit Rating Agency Reform Act of 2006 was passed
By the end of 2008, 80% of the CDOs by value[205] “in rating the kinds of complex home-mortgage securities
rated “triple-A” were downgraded to junk.[206] [207] Bank whose implosion led to the 2007 financial crisis”. The
writedowns and losses on these investments totaled $523 Big Three’s market share of outstanding credit rating has
billion.[203][208][209] barely shrunk, moving from 98% to 97%.[221]
Critics such as the Financial Crisis Inquiry Commission
argue the mistaken credit ratings stemmed from “flawed
computer models, the pressure from financial firms that
16 2 CAUSES

2.5 Governmental policies the Gramm-Leach-Bliley Act. Economist Joseph Stiglitz


criticized the repeal of Glass Steagall because, in his
Main article: Government policies and the subprime opinion, it created a risk-taking culture of investment
mortgage crisis banking dominated the more conservative commercial
Government over-regulation, failed regulation and dereg- banking culture, leading to increased levels of risk-taking
and leverage during the boom period.[227] President Bill
Clinton, who signed the legislation, dismissed its connec-
tion to the subprime mortgage crisis, stating (in 2008): “I
don't see that signing that bill had anything to do with the
current crisis.”[228]
The Commodity Futures Modernization Act of 2000 was
bi-partisan legislation that formally exempted derivatives
from regulation, supervision, trading on established ex-
changes, and capital reserve requirements for major par-
ticipants. It “provided a legal safe harbor for treatment
already in effect.”[229] Concerns that counterparties to
derivative deals would be unable to pay their obligations
caused pervasive uncertainty during the crisis. Particu-
larly relevant to the crisis are credit default swaps (CDS),
a derivative in which Party A pays Party B what is es-
U.S. Subprime lending expanded dramatically 2004–2006. sentially an insurance premium, in exchange for payment
should Party C default on its obligations. Warren Buffett
ulation have all been claimed as causes of the crisis. famously referred to derivatives as “financial weapons of
Increasing home ownership has been the goal of sev- mass destruction” in early 2003.[230][231]
eral presidents including Roosevelt, Reagan, Clinton and
George W. Bush.[222] Some analysts believe the subprime mortgage crisis was
due, in part, to a 2004 decision of the SEC that affected 5
large investment banks. The critics believe that changes
2.5.1 Decreased regulation of financial institutions in the capital reserve calculation rules enabled investment
banks to substantially increase the level of debt they were
Several steps were taken to reduce the regulation applied taking on, fueling the growth in mortgage-backed secu-
to banking institutions in the years leading up to the crisis. rities supporting subprime mortgages. These banks dra-
Further, major investment banks which collapsed during matically increased their risk taking from 2003 to 2007.
the crisis were not subject to the regulations applied to By the end of 2007, the largest five U.S. investment banks
depository banks. In testimony before Congress both the had over $4 trillion in debt with high ratios of debt to eq-
Securities and Exchange Commission (SEC) and Alan uity, meaning only a small decline in the value of their
Greenspan claimed failure in allowing the self-regulation assets would render them insolvent.[232][233] However, in
of investment banks.[223][224] an April 9, 2009 speech, Erik Sirri, then Director of the
In 1982, Congress passed the Alternative Mortgage SEC’s Division of Trading and Markets, argued that the
Transactions Parity Act (AMTPA), which allowed non- regulatory weaknesses in leverage restrictions originated
federally chartered housing creditors to write adjustable- in the late 1970s: “The Commission did not undo any
rate mortgages. This bi-partisan legislation was, accord- leverage restrictions in[234] 2004,” nor did it intend to make a
ing to the Urban Institute, intended to “increase the vol- substantial reduction.
ume of loan products that reduced the up-front costs
to borrowers in order to make homeownership more
2.5.2 Policies to promote affordable housing
affordable.”[225] Among the new mortgage loan types cre-
ated and gaining in popularity in the early 1980s were Several administrations, both Democratic and Republi-
adjustable-rate, option adjustable-rate, balloon-payment can, advocated affordable housing policies in the years
and interest-only mortgages. Subsequent widespread leading up to the crisis. The Housing and Community
abuses of predatory lending occurred with the use of Development Act of 1992 established, for the first time,
adjustable-rate mortgages.[34][226] Approximately 90% of an affordable housing loan purchase mandate for Fannie
subprime mortgages issued in 2006 were adjustable-rate Mae and Freddie Mac, a mandate to be regulated by the
mortgages.[4] Department of Housing and Urban Development (HUD).
The Glass-Steagall Act was enacted after the Great De- Initially, the 1992 legislation required that 30 percent
pression. It separated commercial banks and investment or more of Fannie’s and Freddie’s loan purchases be re-
banks, in part to avoid potential conflicts of interest be- lated to affordable housing. However, HUD was given
tween the lending activities of the former and rating activ- the power to set future requirements, and eventually (un-
ities of the latter. In 1999 Glass-Steagall was repealed by der the Bush Administration) a 56 percent minimum was
2.5 Governmental policies 17

established.[235] To fulfill the requirements, Fannie Mae borrowers, and allowed the securitization of CRA-
and Freddie Mac established programs to purchase $5 regulated mortgages, even though a fair number of them
trillion in affordable housing loans,[236] and encouraged were subprime.[249][250]
lenders to relax underwriting standards to produce those In its “Conclusions” submitted January 2011, the
loans.[235] Financial Crisis Inquiry Commission reported that
“The National Homeownership Strategy: Partners in the
American Dream”, was compiled in 1995 by Henry Cis- “the CRA was not a significant factor in
neros, President Clinton’s HUD Secretary. This 100- subprime lending or the crisis. Many subprime
page document represented the viewpoints of HUD, Fan- lenders were not subject to the CRA. Research
nie Mae, Freddie Mac, leaders of the housing indus- indicates only 6% of high-cost loans—a proxy
try, various banks, numerous activist organizations such for subprime loans—had any connection to the
as ACORN and La Raza, and representatives from sev- law. Loans made by CRA-regulated lenders in
eral state and local governments.”[237] In 2001, the inde- the neighborhoods in which they were required
pendent research company, Graham Fisher & Company, to lend were half as likely to default as similar
stated: “While the underlying initiatives of the [strategy] loans made in the same neighborhoods by in-
were broad in content, the main theme … was the relax- dependent mortgage originators not subject to
ation of credit standards.”[238] the law.”[61]
“Members of the Right tried to blame the seeming mar-
ket failures on government; in their mind the government Critics claim that the use of the high-interest-rate proxy
effort to push people with low incomes into home own- distorts results because government programs generally
ership was the source of the problem. Widespread as this promote low-interest rate loans—even when the loans
belief has become in conservative circles, virtually all se- are to borrowers who are clearly subprime.[251] How-
rious attempts to evaluate the evidence have concluded ever, several economists maintain that Community Rein-
that there is little merit in this view.” vestment Act loans outperformed other “subprime” mort-
gages, and GSE mortgages performed better than private
Joseph Stiglitz[239] label securitizations.[6][108]
The Financial Crisis Inquiry Commission (majority re- However, economists at the National Bureau of Eco-
port), Federal Reserve economists, and several academic nomic Research concluded that banks undergoing CRA-
researchers have stated that government affordable hous- related regulatory exams took additional mortgage lend-
ing policies were not the major cause of the financial ing risk. The authors of a study entitled “Did the Com-
crisis.[6][108] They also state that Community Reinvest- munity Reinvestment Act Lead to Risky Lending?" com-
ment Act loans outperformed other “subprime” mort- pared “the lending behavior of banks undergoing CRA
gages, and GSE mortgages performed better than private exams within a given census tract in a given month (the
label securitizations. treatment group) to the behavior of banks operating in
the same census tract-month that did not face these ex-
ams (the control group). This comparison clearly indi-
Community Reinvestment Act The Community cates that adherence to the CRA led to riskier lending
Reinvestment Act (CRA) was originally enacted under by banks.” They concluded: “The evidence shows that
President Jimmy Carter in 1977 in an effort to encourage around CRA examinations, when incentives to conform
banks to halt the practice of lending discrimination. In to CRA standards are particularly high, banks not only in-
1995 the Clinton Administration issued regulations that crease lending rates but also appear to originate loans that
added numerical guidelines, urged lending flexibility, are markedly riskier.” Loan delinquency averaged 15%
and instructed bank examiners to evaluate a bank’s higher in the treatment group than the control group one
responsiveness to community activists (such as ACORN) year after mortgage origination.[252]
when deciding whether to approve bank merger or
expansion requests.[240] Critics claim that the 1995
2.5.3 State and local governmental programs
changes to CRA signaled to banks that relaxed lending
standards were appropriate and could minimize potential As part of the 1995 National Homeownership Strategy,
risk of governmental sanctions. HUD advocated greater involvement of state and local or-
Conservatives and libertarians have debated the pos- ganizations in the promotion of affordable housing.[253]
sible effects of the CRA, with detractors claim- In addition, it promoted the use of low or no-down pay-
ing that the Act encouraged lending to uncreditwor- ment loans and second, unsecured loans to the borrower
thy borrowers,[241][242][243][244] and defenders claim- to pay their down payments (if any) and closing costs.[254]
ing a thirty-year history of lending without increased This idea manifested itself in “silent second” loans that
risk.[245][246][247][248] Detractors also claim that amend- became extremely popular in several states such as Cali-
ments to the CRA in the mid-1990s, raised the amount fornia, and in scores of cities such as San Francisco.[255]
of mortgages issued to otherwise unqualified low-income Using federal funds and their own funds, these states and
18 2 CAUSES

cities offered borrowers loans that would defray the cost cause”,[261] or that since “credit spreads declined not just
of the down payment. The loans were called “silent” be- for housing, but also for other asset classes like com-
cause the primary lender was not supposed to know about mercial real estate ... problems with U.S. housing pol-
them. A Neighborhood Reinvestment Corporation (affil- icy or markets [could] not by themselves explain the U.S.
iated with HUD) publicity sheet explicitly described the housing bubble.”[262] According to the Commission, GSE
desired secrecy: “[The NRC affiliates] hold the second mortgage securities essentially maintained their value
mortgages. Instead of going to the family, the monthly throughout the crisis and did not contribute to the sig-
voucher is paid to [the NRC affiliates]. In this way the nificant financial firm losses that were central to the fi-
voucher is “invisible” to the traditional lender and the nancial crisis. The GSEs participated in the expansion of
family (emphasis added)[256] subprime and other risky mortgages, but they followed
rather than led Wall Street and other lenders into sub-
prime lending.[61]
2.6 Role of Fannie Mae and Freddie Mac
Several studies by the Government Accountability Office
(GAO), Harvard Joint Center for Housing Studies, the
Federal Housing Finance Agency, and several academic
institutions summarized by economist Mike Konczal of
the Roosevelt Institute, indicate Fannie and Freddie were
not to blame for the crisis.[263] A 2011 statistical com-
parisons of regions of the US which were subject to GSE
regulations with regions that were not, done by the Fed-
eral Reserve, found that GSEs played no significant role
in the subprime crisis.[264] In 2008, David Goldstein and
Kevin G. Hall reported that more than 84 percent of the
subprime mortgages came from private lending institu-
tions in 2006, and the share of subprime loans insured by
Fannie Mae and Freddie Mac decreased as the bubble got
bigger (from a high of insuring 48 percent to insuring 24
percent of all subprime loans in 2006).[265] In 2008, an-
other source found estimates by some analysts that Fan-
nie’s share of the subprime mortgage-backed securities
market dropped from a peak of 44% in 2003 to 22% in
2005, before rising to 33% in 2007.[260]
The estimates above, which were often based directly or
indirectly upon loan data originally published by Fannie
and Freddie, were called into question in December 2011.
In that month, the Securities and Exchange Commission
(SEC) charged 3 executives at Fannie Mae and 3 execu-
tives at Freddie Mac with securities fraud. Significantly,
they were accused of only reporting 10 percent or less
Franklin Raines earned $90 million in salary and bonuses while of their substandard loans. In other words, in the view
he was head of Fannie Mae.[257] of the SEC their actual substandard loans were ten times
higher than reported. Using that information, Peter Wal-
Fannie Mae and Freddie Mac are government spon- lison and Edward Pinto estimated that the two GSEs held
sored enterprises (GSE) that purchase mortgages, buy over 13 million substandard loans with a face value of
and sell mortgage-backed securities (MBS), and guaran- over $2 trillion. Those amounts exceed the original esti-
tee nearly half of the mortgages in the U.S. A variety of mates of Edward Pinto. The case is pending.[266]
political and competitive pressures resulted in the GSEs
Whether GSEs played a small role in the crisis because
ramping up their purchase and guarantee of risky mort- they were legally barred from engaging in subprime lend-
gages in 2005 and 2006, just as the housing market was ing is disputed.[267] Economist Russell Roberts[268] cites
peaking.[258][259] Fannie and Freddie were both under po-
a June 2008 Washington Post article which stated that
litical pressure to expand purchases of higher-risk afford-
"[f]rom 2004 to 2006, the two [GSEs] purchased $434
able housing mortgage types, and under significant com- billion in securities backed by subprime loans, creating a
petitive pressure from large investment banks and mort-market for more such lending.”[269] Furthermore, a 2004
gage lenders.[260] HUD report admitted that while trading securities that
Nine of the ten members of the Financial Crisis In- were backed by subprime mortgages was something that
quiry Commission reported in 2011 that Fannie & Fred- the GSEs officially disavowed,
[270]
they nevertheless partici-
die “contributed to the crisis, but were not a primary pated in the market.
2.6 Role of Fannie Mae and Freddie Mac 19

Insofar as Fannie and Freddie did purchase substandard markets do not by themselves explain the U.S. housing
loans, some analysts question whether government man- bubble.”[275] Economist Paul Krugman wrote in January
dates for affordable housing were the motivation. In De- 2010 that Fannie Mae, Freddie Mac, CRA, or predatory
cember 2011 the Securities and Exchange Commission lending were not primary causes of the bubble/bust in res-
charged the former Fannie Mae and Freddie Mac exec- idential real estate because there was a bubble of similar
utives, accusing them of misleading investors about risks magnitude in commercial real estate in America.[276]
of subprime-mortgage loans and about the amount of sub- Countering the analysis of Krugman and members of the
prime mortgage loans they held in portfolio.[271] Accord- FCIC, Peter Wallison argues that the crisis was caused
ing to one analyst, “The SEC’s facts paint a picture in
by the bursting of a real estate bubble that was sup-
which it wasn’t high-minded government mandates that ported largely by low or no-down-payment loans, which
did the GSEs wrong, but rather the monomaniacal focus
was uniquely the case for U.S. residential housing loans.
of top management on marketshare. With marketshare He states: “It is not true that every bubble—even a large
came bonuses and with bonuses came risk-taking, under-
bubble—has the potential to cause a financial crisis when
stood or not.”[272] However, there is evidence suggesting it deflates.” As an example, Wallison notes that other de-
that governmental housing policies were a motivational veloped countries had “large bubbles during the 1997–
factor. Daniel H. Mudd, the former CEO of Fannie Mae, 2007 period” but “the losses associated with mortgage
stated: “We were afraid that lenders would be selling delinquencies and defaults when these bubbles deflated
products we weren't buying and Congress would feel like were far lower than the losses suffered in the United States
we weren't fulfilling our mission.” Another senior Fan- when the 1997–2007 [bubble] deflated.”[277][277]
nie Mae executive stated: “Everybody understood that
we were now buying loans that we would have previously Other analysis calls into question the validity of compar-
rejected, and that the models were telling us that we were ing the residential loan crisis to the commercial loan cri-
charging way too little, but our mandate was to stay rel- sis. After researching the default of commercial loans
evant and to serve low-income borrowers. So that’s what during the financial crisis, Xudong An and Anthony B.
we did.”[273] Sanders reported (in December 2010): “We find limited
evidence that substantial deterioration in CMBS [com-
In his lone dissent to the majority and minority opin- mercial mortgage-backed securities] loan underwriting
ions of the FCIC, Peter J. Wallison of the American En- occurred prior to the crisis.”[278] Other analysts support
terprise Institute (AEI) blamed U.S. housing policy, in- the contention that the crisis in commercial real estate
cluding the actions of Fannie & Freddie, primarily for and related lending took place after the crisis in residen-
the crisis, writing: “When the bubble began to deflate
tial real estate. Business journalist Kimberly Amadeo re-
in mid-2007, the low quality and high risk loans engen- ports: “The first signs of decline in residential real estate
dered by government policies failed in unprecedented
occurred in 2006. Three years later, commercial real es-
numbers. The effect of these defaults was exacerbated by tate started feeling the effects.[279] Denice A. Gierach, a
the fact that few if any investors—including housing mar-
real estate attorney and CPA, wrote:
ket analysts—understood at the time that Fannie Mae and
Freddie Mac had been acquiring large numbers of sub-
prime and other high risk loans in order to meet HUD’s
affordable housing goals.” His dissent relied heavily on ...most of the commercial real estate loans
the research of fellow AEI member Edward Pinto, the were good loans destroyed by a really bad
former Chief Credit Officer of Fannie Mae. Pinto esti- economy. In other words, the borrowers did
mated that by early 2008 there were 27 million higher- not cause the loans to go bad, it was the
risk, “non-traditional” mortgages (defined as subprime economy.[280]
and Alt-A) outstanding valued at $4.6 trillion. Of these,
Fannie & Freddie held or guaranteed 12 million mort-
gages valued at $1.8 trillion. Government entities held or A second counter-argument to Wallison’s dissent is that
guaranteed 19.2 million or $2.7 trillion of such mortgages the definition of “non-traditional mortgages” used in
total.[274] Pinto’s analysis overstated the number of risky mortgages
One counter-argument to Wallison and Pinto’s analysis in the system by including Alt-A, which was not neces-
is that the credit bubble was global and also affected the sarily high-risk. Krugman explained in July 2011 that the
U.S. commercial real estate market, a scope beyond U.S. data provided by Pinto significantly overstated the num-
government housing policy pressures. The three Republi- ber of subprime loans, citing the work of economist Mike
can authors of the dissenting report to the FCIC majority Konczal: “As Konczal says, all of this stuff relies on a
opinion wrote in January 2011: “Credit spreads declined form of three-card monte: you talk about “subprime and
not just for housing, but also for other asset classes like other high-risk” loans, lumping subprime with other loans
commercial real estate. This tells us to look to the credit that are not, it turns out, anywhere near as risky as actual
bubble as an essential cause of the U.S. housing bubble. subprime; then use this essentially fake aggregate to make
It also tells us that problems with U.S. housing policy or it seem as if Fannie/Freddie were actually at the core of
the problem.”[281]
20 2 CAUSES

2.7 Other contributing factors men of the Federal Reserve — disagree, arguing deci-
sions on purchasing a home depends on long-term inter-
2.7.1 Policies of central banks est rates on mortgages not the short-term rates controlled
by the Fed. According to Greenspan, “between 1971 and
2002, the fed funds rate and the mortgage rate moved
in lock-step,” but when the Fed started to raise rates in
2004,[287][288][289] mortgage rates diverged, continuing to
fall (or at least rise) for another year (see “Fed Funds Rate
& Mortgage Rates” graph). Construction of new homes
didn't peak until January 2006.[290] Bernanke speculates
that a world wide “saving glut” pushed capital or savings
into the United States, keeping long-term interest rates
low and independent of Central Bank action.[291]
Agreeing with Fisher that the low interest rate policy of
the Greenspan Fed both allowed and motivated investors
to seek out risk investments offering higher returns, is fi-
nance economist Raghuram Rajan who argues that the
underlying causes of the American economy’s tendency
Federal funds rate and various mortgage rates to go “from bubble to bubble” fueled by unsustainable
monetary stimulation, are the “weak safety nets” for the
unemployed, which made “the US political system ...
Central banks manage monetary policy and may target
acutely sensitive to job growth";[292] and attempts to com-
the rate of inflation. They have some authority over
pensate for the stagnant income of the middle and lower
commercial banks and possibly other financial institu-
classes with easy credit to boost their consumption.[293]
tions. They are less concerned with avoiding asset price
bubbles, such as the housing bubble and dot-com bubble. Economist Thomas Sowell wrote that the Fed’s decision
Central banks have generally chosen to react after such to steadily raise interest rates was a key factor that ended
bubbles burst so as to minimize collateral damage to the the housing bubble. The Fed raised rates from the un-
economy, rather than trying to prevent or stop the bub- usually low level of one percent in 2004 to a more typical
ble itself. This is because identifying an asset bubble and 5.25 percent in 2006. By driving mortgage rates higher,
determining the proper monetary policy to deflate it are the Fed “made monthly mortgage payments more expen-
matters of debate among economists.[282][283] sive and therefore reduced the demand for housing.” He
referred to the Fed action as the “nudge” that collapsed
Some market observers have been concerned that Federal
the “house of cards” created by lax lending standards, af-
Reserve actions could give rise to moral hazard.[35] A
fordable housing policies, and the preceding period of
Government Accountability Office critic said that the
low interest rates.[44]
Federal Reserve Bank of New York's rescue of Long-
Term Capital Management in 1998 would encourage
large financial institutions to believe that the Federal Re- 2.7.2 Mark-to-market accounting rule
serve would intervene on their behalf if risky loans went
sour because they were “too big to fail.”[284] Main article: Fair value accounting and the subprime
A contributing factor to the rise in house prices was the mortgage crisis
Federal Reserve’s lowering of interest rates early in the
decade. From 2000 to 2003, the Federal Reserve lowered
Former Federal Deposit Insurance Corporation Chair
the federal funds rate target from 6.5% to 1.0%.[285] This William Isaac placed much of the blame for the sub-
was done to soften the effects of the collapse of the dot- prime mortgage crisis on the Securities and Exchange
com bubble and of the September 2001 terrorist attacks, Commission and its fair-value accounting rules, espe-
and to combat the perceived risk of deflation.[282] cially the requirement for banks to mark their assets
The Fed believed that interest rates could be lowered to market, particularly mortgage-backed securities.[294]
safely primarily because the rate of inflation was low; Whether or not this is true has been the subject of on-
it disregarded other important factors. According to going debate.[295][296]
Richard W. Fisher, President and CEO of the Federal Re- The debate arises because this accounting rule requires
serve Bank of Dallas, the Fed’s interest rate policy during companies to adjust the value of marketable securities
the early 2000s (decade) was misguided, because mea- (such as the mortgage-backed securities (MBS) at the
sured inflation in those years was below true inflation, center of the crisis) to their market value. The intent of
which led to a monetary policy that contributed to the the standard is to help investors understand the value of
housing bubble.[286] these assets at a point in time, rather than just their histor-
Ben Bernanke and Alan Greenspan — both former chair- ical purchase price. Because the market for these assets
21

is distressed, it is difficult to sell many MBS at other than pact of the crisis. American households, on the other
prices which may (or may not) be reflective of market hand, used funds borrowed from foreigners to finance
stresses, which may be below the value that the mortgage consumption or to bid up the prices of housing and finan-
cash flow related to the MBS would merit. As initially cial assets. Financial institutions invested foreign funds
interpreted by companies and their auditors, the typically in mortgage-backed securities. American housing and
lower sale value was used as the market value rather than financial assets dramatically declined in value after the
the cash flow value. Many large financial institutions rec- housing bubble burst.[298][299]
ognized significant losses during 2007 and 2008 as a re-Economist Joseph Stiglitz wrote in October 2011 that the
sult of marking-down MBS asset prices to market value.
recession and high unemployment of the 2009–2011 pe-
riod was years in the making and driven by: unsustainable
consumption; high manufacturing productivity outpacing
2.7.3 Globalization, technology and the trade deficit
demand thereby increasing unemployment; income in-
equality that shifted income from those who tended to
spend it (i.e., the middle class) to those who do not (i.e.,
the wealthy); and emerging market’s buildup of reserves
(to the tune of $7.6 trillion by 2011) which was not spent.
These factors all led to a “massive” shortfall in aggregate
demand, which was “papered over” by demand related to
the housing bubble until it burst.[300]

3 Subprime mortgage crisis phases

3.1 January 2007 to March 2008


Further information: List of writedowns due to subprime
crisis
U.S. current account or trade deficit through 2012
Financial market stresses became apparent during 2007
In 2005, Ben Bernanke addressed the implications of the
United States’s high and rising current account deficit,
resulting from U.S. investment exceeding its savings, or
imports exceeding exports.[297] Between 1996 and 2004,
the U.S. current account deficit increased by $650 bil-
lion, from 1.5% to 5.8% of GDP. The U.S. attracted a
great deal of foreign investment, mainly from the emerg-
ing economies in Asia and oil-exporting nations. The
balance of payments identity requires that a country (such
as the U.S.) running a current account deficit also have a
capital account (investment) surplus of the same amount.
Foreign investors had these funds to lend, either because
they had very high personal savings rates (as high as 40%
in China), or because of high oil prices.
Bernanke referred to this as a "saving glut"[291] that may Securitization markets were impaired during the crisis.
have pushed capital into the United States, a view differ-
ing from that of some other economists, who view such that resulted in sizable losses across the financial sys-
capital as having been pulled into the U.S. by its high con- tem, the bankruptcy of over 100 mortgage lenders and
sumption levels. In other words, a nation cannot consume the emergency sale of investment bank Bear Stearns in
more than its income unless it sells assets to foreigners, March 2008 to depository bank JP Morgan Chase. Some
or foreigners are willing to lend to it. Alternatively, if writers began calling the events in the financial markets
a nation wishes to increase domestic investment in plant during this period the “Subprime Mortgage Crisis” or the
and equipment, it will also increase its level of imports to “Mortgage crisis”.[170][301]
maintain balance if it has a floating exchange rate. As U.S. housing prices began to fall from their 2006
Regardless of the push or pull view, a “flood” of funds peak, global investors became less willing to invest in
(capital or liquidity) reached the U.S. financial market. mortgage-backed securities (MBS). The crisis began to
Foreign governments supplied funds by purchasing U.S. affect the financial sector in February 2007, when HSBC,
Treasury bonds and thus avoided much of the direct im- one of the world’s largest banks, wrote down its holdings
22 3 SUBPRIME MORTGAGE CRISIS PHASES

of subprime-related mortgage securities by $10.5 billion, Chase with the help of $29 billion of guarantees from the
the first major subprime related loss to be reported.[302] Federal Reserve.”[170]
By April 2007, over 50 mortgage companies had de-
clared bankruptcy, many of which had specialized in sub-
prime mortgages, the largest of which was New Cen- 3.2 April to December 2008
tury Financial.[303] At least 100 mortgage companies ei-
ther shut down, suspended operations or were sold dur-
ing 2007.[304] These mortgage companies made money TED Spread (LIBOR-US Treasuries)

on the origination and sale of mortgages, rather than in- 5


LIBOR (3 m)
terest from holding the mortgage. They had relied on 4.5
T-bill (3 m)

continuing access to this global pool of investor capital 4 TED Spread

to continue their operations; when investor capital dried- 3.5

up, they were forced into bankruptcy. 3

2.5
Other parts of the shadow banking system also encoun- 2

tered difficulty. Legal entities known as structured in- 1.5

vestment vehicles (SIV) and hedge funds had borrowed 1

from investors and bought MBS. When mortgage defaults 0.5

rose along with the fall in housing prices, the value of 0

9
00

00

00

00

00

00

00

00

00

00

00

00

00
the MBS declined. Investors demanded that these enti-
/2

/2

/2

/2

/2

/2

/2

/2

/2

/2

/2

/2

/2
01

02

03

04

05

06

07

08

09

10

11

12

01
ties put up additional collateral or be forced to pay back
the investors immediately, a form of margin call. This
The TED spread (the difference between the interest rates on in-
resulted in further sales of MBS, which lowered MBS terbank loans and on the safer short-term U.S. government debt)
prices further. This dynamic of margin call and price re- – an indicator of credit risk – increased dramatically during
ductions contributed to the collapse of two Bear Stearns September 2008.
hedge funds in July 2007, an event which economist Mark
Zandi referred to as “arguably the proximate catalyst” Further information: Indirect economic effects of the
of the crisis in financial markets.[4] On August 9, 2007 subprime mortgage crisis
French bank BNP Paribas announced that it was halting
redemptions on three investment funds due to subprime
problems, another “beginning point” of the crisis to some Financial market conditions continued to worsen during
observers.[305][306] 2008. By August 2008, financial firms around the globe
had written down their holdings of subprime related se-
Investment banks such as Bear Stearns had legal obliga- curities by US$501 billion.[308] The IMF estimated that
tions to provide financial support to these entities, which financial institutions around the globe would eventually
created a cash drain. Bear Stearns reported the first have to write off $1.5 trillion of their holdings of sub-
quarterly loss in its history during November 2007 and prime MBSs. About $750 billion in such losses had
obtained additional financing from a Chinese sovereign been recognized as of November 2008. These losses
wealth fund. Investment banks Merrill Lynch and Mor- wiped out much of the capital of the world banking sys-
gan Stanley had also obtained additional capital from tem. Banks headquartered in nations that have signed the
sovereign wealth funds in Asia and the Middle East dur- Basel Accords must have so many cents of capital for
ing late 2007.[301] every dollar of credit extended to consumers and busi-
The major investment banks had also increased their own nesses. Thus the massive reduction in bank capital just
borrowing and investing as the bubble expanded, taking described has reduced the credit available to businesses
on additional risk in the search for profit. For example, and households.[309]
as of November 30, 2006, Bear Stearns reported $383.6 The crisis hit a critical point in September 2008 with
billion in liabilities and $11.8 billion in equity, a leverage the failure, buyout or bailout of the largest entities in the
ratio of approximately 33.[307] This high leverage ratio U.S. shadow banking system. Investment bank Lehman
meant that only a 3% reduction in the value of its assets Brothers failed, while Merrill Lynch was purchased by
would render it insolvent. Bank of America. Investment banks Goldman Sachs and
Unable to withstand the combination of high leverage, re- Morgan Stanley obtained depository bank holding char-
duced access to capital, loss in the value of its MBS se- ters, which gave them access to emergency lines of credit
curities portfolio, and claims from its hedge funds, it col- from the Federal Reserve.[310] Government-sponsored
lapsed during March 2008. Historian Robin Blackburn enterprises Fannie Mae and Freddie Mac were taken over
wrote: “The Wall Street investment banks and brokerages by the federal government. Insurance giant AIG, which
hemorrhaged $175 billion of capital in the period July had sold insurance-like protection for mortgage-backed
2007 to March 2008, and Bear Stearns, the fifth largest, securities, did not have the capital to honor its commit-
was ‘rescued’ in March, at a fire-sale price, by JP Morgan ments; U.S. taxpayers covered its obligations instead in a
bailout that exceeded $100 billion.[311]
4.1 Impact in the U.S. 23

Further, there was the equivalent of a bank run on other 4.1 Impact in the U.S.
parts of the shadow system, which severely disrupted the
ability of non-financial institutions to obtain the funds to
run their daily operations. During a one-week period in
September 2008, $170 billion were withdrawn from US
money funds, causing the Federal Reserve to announce
that it would guarantee these funds up to a point.[312] The
money market had been a key source of credit for banks
(CDs) and nonfinancial firms (commercial paper). The
TED spread (see graph above), a measure of the risk of
interbank lending, quadrupled shortly after the Lehman
failure. This credit freeze brought the global financial sys-
tem to the brink of collapse.
In a dramatic meeting on September 18, 2008, Trea-
sury Secretary Henry Paulson and Fed Chairman Ben
Bernanke met with key legislators to propose a $700 bil-
lion emergency bailout of the banking system. Bernanke Impacts from the crisis on key wealth measures
reportedly told them: “If we don't do this, we may not
have an economy on Monday.”[313] The Emergency Eco-
nomic Stabilization Act, also called the Troubled Asset
Relief Program (TARP), was signed into law on October
3, 2008.[314]
In a nine-day period from Oct. 1-9, the S&P 500 fell a
staggering 251 points, losing 21.6% of its value.[315] The
week of Oct. 6-10 saw the largest percentage drop in the
history of the Dow Jones Industrial Average - even worse
than any single week in the Great Depression.[316]
The response of the US Federal Reserve, the European
Central Bank, and other central banks was dramatic.
During the last quarter of 2008, these central banks pur-
chased US$2.5 trillion of government debt and troubled
private assets from banks. This was the largest liquidity
injection into the credit market, and the largest monetary U.S. Real GDP – Contributions to percent change by component
policy action, in world history. The governments of Eu- 2007–2009
ropean nations and the US also raised the capital of their Between June 2007 and November 2008, Americans lost
national banking systems by $1.5 trillion, by purchasing more than a quarter of their net worth. By early Novem-
newly issued preferred stock in their major banks.[309] On ber 2008, a broad U.S. stock index, the S&P 500, was
Dec. 16, 2008, the Federal Reserve cut the Federal funds down 45 percent from its 2007 high. Housing prices had
rate to 0-0.25%, where it remained until December 2015; dropped 20% from their 2006 peak, with futures markets
this period of zero interest-rate policy was unprecedented signaling a 30–35% potential drop. Total home equity in
in U.S. history.[317] the United States, which was valued at $13 trillion at its
peak in 2006, had dropped to $8.8 trillion by mid-2008
and was still falling in late 2008.[319] Total retirement as-
4 Impacts sets, Americans’ second-largest household asset, dropped
by 22 percent, from $10.3 trillion in 2006 to $8 trillion in
mid-2008. During the same period, savings and invest-
Main article: Financial crisis of 2007–08
ment assets (apart from retirement savings) lost $1.2 tril-
lion and pension assets lost $1.3 trillion. Taken together,
The International Monetary Fund estimated that large these losses total $8.3 trillion.[319]
U.S. and European banks lost more than $1 trillion on
toxic assets and from bad loans from January 2007 to • Real gross domestic product (GDP) began contract-
September 2009. These losses were expected to top $2.8 ing in the third quarter of 2008 and did not return to
trillion from 2007 to 2010. U.S. banks losses were fore- growth until Q1 2010.[320] CBO estimated in Febru-
cast to hit $1 trillion and European bank losses will reach ary 2013 that real U.S. GDP remained 5.5% below
$1.6 trillion. The IMF estimated that U.S. banks were its potential level, or about $850 billion. CBO pro-
about 60 percent through their losses, but British and eu- jected that GDP would not return to its potential
rozone banks only 40 percent.[318] level until 2017.[321]
24 4 IMPACTS

• The unemployment rate rose from 5% in 2008 pre-


crisis to 10% by late 2009, then steadily declined
to 7.6% by March 2013.[322] The number of unem-
ployed rose from approximately 7 million in 2008
pre-crisis to 15 million by 2009, then declined to 12
million by early 2013.[323]

• Residential private investment (mainly housing) fell


from its 2006 pre-crisis peak of $800 billion, to
$400 billion by mid-2009 and has remained de-
pressed at that level. Non-residential investment
(mainly business purchases of capital equipment)
peaked at $1,700 billion in 2008 pre-crisis and fell to
$1,300 billion in 2010, but by early 2013 had nearly
recovered to this peak.[324] Public debt to GDP ratio for selected European countries - 2008
• Housing prices fell approximately 30% on aver- to 2012. Source Data: Eurostat
age from their mid-2006 peak to mid-2009 and
remained at approximately that level as of March
2013.[325]

• Stock market prices, as measured by the S&P 500


index, fell 57% from their October 2007 peak of
1,565 to a trough of 676 in March 2009. Stock
prices began a steady climb thereafter and returned
to record levels by April 2013.[326]

• The net worth of U.S. households and non-profit or-


ganizations fell from a peak of approximately $67
trillion in 2007 to a trough of $52 trillion in 2009, a
decline of $15 trillion or 22%. It began to recover Relationship between fiscal tightening (austerity) in Eurozone
thereafter and was $66 trillion by Q3 2012.[327] countries with their GDP growth rate, 2008–2012[336]
• U.S. total national debt rose from 66% GDP in 2008
pre-crisis to over 103% by the end of 2012.[328] system crises to sovereign debt crises, as many countries
Martin Wolf and Paul Krugman argued that the rise elected to bail out their banking systems using taxpayer
in private savings and decline in investment fueled money. Greece was different in that it concealed large
a large private sector surplus, which drove sizable public debts in addition to issues within its banking sys-
budget deficits.[329][330] tem. Several countries received bailout packages from
the “troika” (European Commission, European Central
Members of US minority groups received a dispropor- Bank, International Monetary Fund), which also imple-
tionate number of subprime mortgages, and so have mented a series of emergency measures.
experienced a disproportionate level of the resulting Many European countries embarked on austerity pro-
foreclosures.[331][332][333] Recent research shows that grams, reducing their budget deficits relative to GDP
complex mortgages were chosen by prime borrowers from 2010 to 2011. For example, according to the
with high income levels seeking to purchase expensive CIA World Factbook Greece improved its budget deficit
houses relative to their incomes. Borrowers with complex from 10.4% GDP in 2010 to 9.6% in 2011. Ice-
mortgages experienced substantially higher default rates land, Italy, Ireland, Portugal, France, and Spain also im-
than borrowers with traditional mortgages with similar proved their budget deficits from 2010 to 2011 relative to
characteristics.[334] The crisis had a devastating effect on GDP.[337][338]
the U.S. auto industry. New vehicle sales, which peaked
at 17 million in 2005, recovered to only 12 million by However, with the exception of Germany, each of these
2010.[335] countries had public-debt-to-GDP ratios that increased
(i.e., worsened) from 2010 to 2011, as indicated in the
chart shown here. Greece’s public-debt-to-GDP ratio in-
4.2 Impact on Europe creased from 143% in 2010 to 165% in 2011.[337] This
indicates that despite improving budget deficits, GDP
Further information: European sovereign-debt crisis and growth was not sufficient to support a decline (improve-
Austerity ment) in the debt-to-GDP ratio for these countries dur-
The crisis in Europe generally progressed from banking ing this period. Eurostat reported that the debt to GDP
4.3 Sustained effects 25

ratio for the 17 Euro area countries together was 70.1% From February 2010 to September 2012, approximately
in 2008, 79.9% in 2009, 85.3% in 2010, and 87.2% in 4.3 million jobs were added, offsetting roughly half the
2011.[338][339] losses.[344][345]
Unemployment is another variable that might be con- In Spring 2011 there were about a million homes in fore-
sidered in evaluating austerity measures. According to closure in the United States, several million more in the
the CIA World Factbook, from 2010 to 2011, the unem- pipeline, and 872,000 previously foreclosed homes in the
ployment rates in Spain, Greece, Ireland, Portugal, and hands of banks. Sales were slow; economists estimated
the UK increased. France and Italy had no significant that it would take three years to clear the backlogged in-
changes, while in Germany and Iceland the unemploy- ventory. According to Mark Zandi, of Moody’s Analyt-
ment rate declined.[337] Eurostat reported that Eurozone ics, home prices were falling and could be expected to
unemployment reached record levels in September 2012 fall further during 2011. However, the rate of new bor-
at 11.6%, up from 10.3% the prior year. Unemployment rowers falling behind in mortgage payments had begun to
varied significantly by country.[340] decrease.[346]
Economist Martin Wolf analyzed the relationship be- The NYT reported in January 2015 that: “About 17% of
tween cumulative GDP growth from 2008 to 2012 and all homeowners are still 'upside down' on their mortgages
total reduction in budget deficits due to austerity policies ... That’s down from 21% in the third quarter of 2013,
(see chart) in several European countries during April and the 2012 peak of 31%.” Foreclosures as of Octo-
2012. He concluded that: “In all, there is no evidence ber 2014 were down 26% from the prior year, at 41,000
here that large fiscal contractions [budget deficit reduc- completed foreclosures. That was 65% below the peak
tions] bring benefits to confidence and growth that offset in September 2010 (roughly 117,000), but still above the
the direct effects of the contractions. They bring exactly pre-crisis (2000-2006) average of 21,000 per month.[347]
what one would expect: small contractions bring reces-
Research indicates recovery from financial crises can
sions and big contractions bring depressions.” Changes in be protracted, with lengthy periods of high unemploy-
budget balances (deficits or surpluses) explained approxi-
ment and substandard economic growth.[348] Economist
mately 53% of the change in GDP, according to the equa- Carmen Reinhart stated in August 2011: “Debt de-
tion derived from the IMF data used in his analysis.[341]
leveraging [reduction] takes about seven years ... And
Economist Paul Krugman analyzed the relationship be- in the decade following severe financial crises, you tend
tween GDP and reduction in budget deficits for several to grow by 1 to 1.5 percentage points less than in the
European countries in April 2012 and concluded that aus- decade before, because the decade before was fueled by a
terity was slowing growth, similar to Martin Wolf. He boom in private borrowing, and not all of that growth was
also wrote: “this also implies that 1 euro of austerity real. The unemployment figures in advanced economies
yields only about 0.4 euros of reduced deficit, even in the after falls are also very dark. Unemployment remains an-
short run. No wonder, then, that the whole austerity en- chored about five percentage points above what it was in
terprise is spiraling into disaster.”[342] the decade before.”[349]

4.3 Sustained effects 4.3.1 Savings surplus or investment deficit

This chart compares U.S. potential GDP under two CBO forecasts
(one from 2007 and one from 2016) versus the actual real GDP.
It is based on a similar diagram from economist Larry Summers
from 2014.[343]

The crisis had a significant and long-lasting impact on U.S. savings and investment; savings less investment is the private
U.S. employment. During the Great Recession, 8.5 mil- sector financial surplus
lion jobs were lost from the peak employment in early
2008 of approximately 138 million to the trough in Febru- During the crisis and ensuing recession, U.S. consumers
ary 2010 of 129 million, roughly 6% of the workforce. increased their savings as they paid down debt (“delever-
26 5 RESPONSES

aged”) but corporations simultaneously were reducing sectoral balances in the U.S. economy, the others being
their investment. In a healthy economy, private sector the foreign financial sector and the private financial sec-
savings placed into the banking system is borrowed and tor. The sum of the surpluses or deficits across these three
invested by companies. This investment is one of the ma- sectors must be zero by definition. In the U.S., a foreign
jor components of GDP. A private sector financial deficit financial surplus (or capital surplus) exists because capital
from 2004 to 2008 transitioned to a large surplus of sav- is imported (net) to fund the trade deficit. Further, there
ings over investment that exceeded $1 trillion by early is a private sector financial surplus due to household sav-
2009 and remained above $800 billion as of September ings exceeding business investment. By definition, there
2012. Part of this investment reduction related to the must therefore exist a government budget deficit so all
housing market, a major component of investment in the three net to zero. The government sector includes fed-
GDP computation. This surplus explains how even sig- eral, state and local. For example, the government budget
nificant government deficit spending would not increase deficit in 2011 was approximately 10% GDP (8.6% GDP
interest rates and how Federal Reserve action to increase of which was federal), offsetting a capital surplus of 4%
the money supply does not result in inflation, because the GDP and a private sector surplus of 6% GDP.[329]
economy is awash with savings with no place to go.[330]
Wolf argued that the sudden shift in the private sector
Economist Richard Koo described similar effects for from deficit to surplus forced the government balance into
several of the developed world economies in Decem- deficit, writing: “The financial balance of the private sec-
ber 2011: “Today private sectors in the U.S., the U.K., tor shifted towards surplus by the almost unbelievable cu-
Spain, and Ireland (but not Greece) are undergoing mas- mulative total of 11.2 per cent of gross domestic product
sive deleveraging in spite of record low interest rates. This between the third quarter of 2007 and the second quar-
means these countries are all in serious balance sheet re- ter of 2009, which was when the financial deficit of US
cessions. The private sectors in Japan and Germany are government (federal and state) reached its peak...No fis-
not borrowing, either. With borrowers disappearing and cal policy changes explain the collapse into massive fiscal
banks reluctant to lend, it is no wonder that, after nearly deficit between 2007 and 2009, because there was none
three years of record low interest rates and massive liq- of any importance. The collapse is explained by the mas-
uidity injections, industrial economies are still doing so sive shift of the private sector from financial deficit into
poorly. Flow of funds data for the U.S. show a massive surplus or, in other words, from boom to bust.”[329]
shift away from borrowing to savings by the private sec-
tor since the housing bubble burst in 2007. The shift for
the private sector as a whole represents over 9 percent 5 Responses
of U.S. GDP at a time of zero interest rates. Moreover,
this increase in private sector savings exceeds the increase
Further information: Subprime mortgage crisis solutions
in government borrowings (5.8 percent of GDP), which
debate
suggests that the government is not doing enough to offset
private sector deleveraging.”[350]
Various actions have been taken since the crisis became
apparent in August 2007. In September 2008, major in-
4.3.2 Sectoral financial balances stability in world financial markets increased awareness
and attention to the crisis. Various agencies and regula-
Main article: Sectoral financial balances tors, as well as political officials, began to take additional,
Economist Martin Wolf explained in July 2012 that gov- more comprehensive steps to handle the crisis.

To date, various government agencies have committed or


spent trillions of dollars in loans, asset purchases, guar-
antees, and direct spending. For a summary of U.S. gov-
ernment financial commitments and investments related
to the crisis, see CNN – Bailout Scorecard.

5.1 Federal Reserve and central banks


Main article: Federal Reserve responses to the subprime
crisis
Sectoral financial balances in US economy 1990–2015. By def- The central bank of the US, the Federal Reserve, in part-
inition, the three balances must net to zero. Since 2009, the US nership with central banks around the world, took several
[351]
capital surplus and private sector surplus have driven a govern- steps to address the crisis. Federal Reserve Chair-
ment budget deficit. man Ben Bernanke stated in early 2008: “Broadly, the
Federal Reserve’s response followed two tracks: efforts
ernment fiscal balance is one of three major financial to support market liquidity and functioning and the pur-
5.2 Economic stimulus 27

purchase up to $300 billion of longer-term Treasury


securities during 2009.[358]

According to Ben Bernanke, expansion of the Fed bal-


ance sheet means the Fed is electronically creating
money, necessary “because our economy is very weak
and inflation is very low. When the economy begins to re-
cover, that will be the time that we need to unwind those
programs, raise interest rates, reduce the money supply,
and make sure that we have a recovery that does not in-
volve inflation.”[359]
The New York Times reported in February 2013 that the
Fed continued to support the economy with various mon-
etary stimulus measures: “The Fed, which has amassed
Federal Reserve holdings of treasury (blue) and mortgage-
backed securities (red)
almost $3 trillion in Treasury and mortgage-backed secu-
rities to promote more borrowing and lending, is expand-
ing those holdings by $85 billion a month until it sees
suit of our macroeconomic objectives through monetary clear improvement in the labor market. It plans to hold
policy.”[111] short-term interest rates near zero even longer, at least
until the unemployment rate falls below 6.5 percent.”[360]
The Federal Reserve Bank:

• Lowered the target for the Federal funds rate from 5.2 Economic stimulus
5.25% to 2%, and the discount rate from 5.75%
to 2.25%. This took place in six steps occur- Main articles: Economic Stimulus Act of 2008 and
ring between 18 September 2007 and 30 April American Recovery and Reinvestment Act of 2009
2008;[352][353] In December 2008, the Fed further
lowered the federal funds rate target to a range of On 13 February 2008, President George W. Bush signed
0–0.25% (25 basis points).[354] into law a $168 billion economic stimulus package,
mainly taking the form of income tax rebate checks
• Undertook, along with other central banks, open
mailed directly to taxpayers.[361] Checks were mailed
market operations to ensure member banks remain
starting the week of 28 April 2008. However, this rebate
liquid. These are effectively short-term loans to
coincided with an unexpected jump in gasoline and food
member banks collateralized by government secu-
prices. This coincidence led some to wonder whether
rities. Central banks have also lowered the interest
the stimulus package would have the intended effect, or
rates (called the discount rate in the US) they charge
whether consumers would simply spend their rebates to
member banks for short-term loans;[355]
cover higher food and fuel prices.
• Created a variety of lending facilities to enable the On 17 February 2009, U.S. President Barack Obama
Fed to lend directly to banks and non-bank insti- signed the American Recovery and Reinvestment Act of
tutions, against specific types of collateral of vary- 2009, an $787 billion stimulus package with a broad spec-
ing credit quality. These include the Term Auction trum of spending and tax cuts.[362] Over $75 billion of
Facility (TAF) and Term Asset-Backed Securities the package was specifically allocated to programs which
Loan Facility (TALF).[356] help struggling homeowners. This program is referred to
as the Homeowner Affordability and Stability Plan.[363]
• In November 2008, the Fed announced a $600 bil-
lion program to purchase the MBS of the GSE, to The U.S. government continued to run large deficits post-
help lower mortgage rates.[357] crisis, with the national debt rising from $10.0 trillion as
of September 2008 to $16.1 trillion by September 2012.
• In March 2009, the Federal Open Market Commit- The debt increases were $1.89 trillion in fiscal year 2009,
tee decided to increase the size of the Federal Re- $1.65 trillion in 2010, $1.23 trillion in 2011, and $1.26
serve’s balance sheet further by purchasing up to trillion in 2012.[364]
an additional $750 billion of government-sponsored
enterprise mortgage-backed securities, bringing its
total purchases of these securities to up to $1.25 tril- 5.3 Bank solvency and capital replenish-
lion this year, and to increase its purchases of agency ment
debt this year by up to $100 billion to a total of up to
$200 billion. Moreover, to help improve conditions Main article: Emergency Economic Stabilization Act of
in private credit markets, the Committee decided to 2008
28 5 RESPONSES

See also: 2008 United Kingdom bank rescue package 5.4 Bailouts and failures of financial firms
Losses on mortgage-backed securities and other assets
Further information: List of bankrupt or acquired
banks during the financial crisis of 2007–2008, Federal
takeover of Fannie Mae and Freddie Mac, National City
acquisition by PNC, Government intervention during the
subprime mortgage crisis, and Bailout
Several major financial institutions either failed, were

Common equity to total assets ratios for major US banks

purchased with borrowed money have dramatically re-


duced the capital base of financial institutions, rendering
People queuing outside a Northern Rock bank branch in
many either insolvent or less capable of lending. Govern-
Birmingham, United Kingdom on September 15, 2007, to
ments have provided funds to banks. Some banks have withdraw their savings because of the subprime crisis.
taken significant steps to acquire additional capital from
private sources. bailed out by governments, or merged (voluntarily or oth-
The U.S. government passed the Emergency Economic erwise) during the crisis. While the specific circum-
Stabilization Act of 2008 (EESA or TARP) during Octo- stances varied, in general the decline in the value of
ber 2008. This law included $700 billion in funding for mortgage-backed securities held by these companies re-
the "Troubled Assets Relief Program" (TARP). Follow- sulted in either their insolvency, the equivalent of bank
ing a model initiated by the United Kingdom bank res- runs as investors pulled funds from them, or inability to
cue package,[365][366] $205 billion was used in the Capital secure new funding in the credit markets. These firms had
Purchase Program to lend funds to banks in exchange for typically borrowed and invested large sums of money rel-
dividend-paying preferred stock.[367][368] ative to their cash or equity capital, meaning they were
highly leveraged and vulnerable to unanticipated credit
Another method of recapitalizing banks is for govern- market disruptions.[170]
ment and private investors to provide cash in exchange
for mortgage-related assets (i.e., “toxic” or “legacy” as- The five largest U.S. investment banks, with combined
sets), improving the quality of bank capital while reduc- liabilities or debts of $4 trillion, either went bankrupt
ing uncertainty regarding the financial position of banks. (Lehman Brothers), were taken over by other compa-
U.S. Treasury Secretary Timothy Geithner announced a nies (Bear Stearns and Merrill Lynch), or were bailed
plan during March 2009 to purchase “legacy” or “toxic” out by the U.S. government (Goldman Sachs and Morgan
[371]
assets from banks. The Public-Private Partnership Invest- Stanley) during 2008. Government-sponsored enter-
ment Program involves government loans and guarantees prises (GSE) Fannie Mae and Freddie Mac either directly
to encourage private investors to provide funds to pur- owed or guaranteed nearly $5 trillion in mortgage obli-
chase toxic assets from banks.[369] gations, with a similarly weak capital base, when they
were placed into receivership in September 2008.[372] For
As of April 2012, the government had recovered $300 scale, this $9 trillion in obligations concentrated in seven
billion of the $414 billion that was ultimately distributed highly leveraged institutions can be compared to the $14
to them via TARP. Some elements of TARP such as fore- trillion size of the U.S. economy (GDP)[373] or to the total
closure prevention aid will not be paid back. Estimated national debt of $10 trillion in September 2008.[374]
taxpayer losses were $60 billion.[370]
Major depository banks around the world had also used
For a summary of U.S. government financial commit- financial innovations such as structured investment ve-
ments and investments related to the crisis, see CNN – hicles to circumvent capital ratio regulations.[375] No-
Bailout Scorecard. table global failures included Northern Rock, which was
For a summary of TARP funds provided to U.S. banks as nationalized at an estimated cost of £87 billion ($150
of December 2008, see Reuters-TARP Funds. billion).[376] In the U.S., Washington Mutual (WaMu)
5.5 Homeowner assistance 29

was seized in September 2008 by the US Office of Thrift million in a typical year.[386] At roughly U.S. $50,000
Supervision (OTS).[377] This would be followed by the per foreclosure according to a 2006 study by the Chicago
"shotgun wedding" of Wells Fargo and Wachovia after Federal Reserve Bank, 9 million foreclosures represents
it was speculated that without the merger Wachovia was $450 billion in losses.[387]
also going to fail. Dozens of U.S. banks received funds as A variety of voluntary private and government-
part of the TARP or $700 billion bailout.[378] The TARP administered or supported programs were implemented
funds gained some controversy after PNC Financial Ser- during 2007–2009 to assist homeowners with case-by-
vices received TARP money, only to turn around hours case mortgage assistance, to mitigate the foreclosure
later and purchase the struggling National City Corp.,
crisis engulfing the U.S. One example is the Hope Now
which itself had become a victim of the subprime crisis. Alliance, an ongoing collaborative effort between the
As a result of the financial crisis in 2008, twenty-five US Government and private industry to help certain
U.S. banks became insolvent and were taken over by the subprime borrowers.[388] In February 2008, the Alliance
FDIC.[379] As of August 14, 2009, an additional 77 banks reported that during the second half of 2007, it had
became insolvent.[380] This seven-month tally surpasses helped 545,000 subprime borrowers with shaky credit,
the 50 banks that were seized in all of 1993, but is still or 7.7% of 7.1 million subprime loans outstanding as
much smaller than the number of failed banking institu- of September 2007. A spokesperson for the Alliance
tions in 1992, 1991, and 1990.[381] The United States has acknowledged that much more must be done.[389]
lost over 6 million jobs since the recession began in De- During late 2008, major banks and both Fannie Mae
cember 2007.[382] and Freddie Mac established moratoriums (delays) on
The FDIC deposit insurance fund, supported by fees foreclosures, to give homeowners time to work towards
on insured banks, fell to $13 billion in the first quar- refinancing.[390][391][392]
ter of 2009.[383] That is the lowest total since September
Critics have argued that the case-by-case loan modifi-
1993.[383] cation method is ineffective, with too few homeowners
According to some, the bailouts could be traced directly assisted relative to the number of foreclosures and with
to Alan Greenspan’s efforts to reflate the stock market nearly 40% of those assisted homeowners again becom-
and the economy after the tech stock bust, and specifi- ing delinquent within 8 months.[393][394][395] In Decem-
cally to a February 23, 2004 speech Mr. Greenspan made ber 2008, the U.S. FDIC reported that more than half
to the Mortgage Bankers Association where he suggested of mortgages modified during the first half of 2008 were
that the time had come to push average American borrow- delinquent again, in many cases because payments were
ers into more exotic loans with variable rates, or deferred not reduced or mortgage debt was not forgiven. This is
interest.[384] This argument suggests that Mr. Greenspan further evidence that case-by-case loan modification is
sought to enlist banks to expand lending and debt to stim- not effective as a policy tool.[396]
ulate asset prices and that the Federal Reserve and US In February 2009, economists Nouriel Roubini and Mark
Treasury Department would back any losses that might Zandi recommended an “across the board” (systemic) re-
result. As early as March 2007 some commentators pre- duction of mortgage principal balances by as much as 20–
dicted that a bailout of the banks would exceed $1 tril- 30%. Lowering the mortgage balance would help lower
lion, at a time when Ben Bernanke, Alan Greenspan and monthly payments and also address an estimated 20 mil-
Henry Paulson all claimed that mortgage problems were lion homeowners that may have a financial incentive to
“contained” to the subprime market and no bailout of the enter voluntary foreclosure because they are “underwa-
financial sector would be necessary.[384] ter” (i.e. the mortgage balance is larger than the home
value).[397][398]
5.5 Homeowner assistance A study by the Federal Reserve Bank of Boston indi-
cated that banks were reluctant to modify loans. Only 3%
Both lenders and borrowers may benefit from avoiding of seriously delinquent homeowners had their mortgage
foreclosure, which is a costly and lengthy process. Some payments reduced during 2008. In addition, investors
lenders have offered troubled borrowers more favorable who hold MBS and have a say in mortgage modifications
mortgage terms (e.g. refinancing, loan modification or have not been a significant impediment; the study found
loss mitigation). Borrowers have also been encouraged to no difference in the rate of assistance whether the loans
contact their lenders to discuss alternatives.[385] were controlled by the bank or by investors. Comment-
ing on the study, economists Dean Baker and Paul Willen
The Economist described the issue this way in February
both advocated providing funds directly to homeowners
2009: “No part of the financial crisis has received so
instead of banks.[399]
much attention, with so little to show for it, as the tidal
wave of home foreclosures sweeping over America. Gov- The Los Angeles Times reported the results of a study
ernment programmes have been ineffectual, and private that found homeowners with high credit scores at the
efforts not much better.” Up to 9 million homes may en- time of entering the mortgage are 50% more likely to
ter foreclosure over the 2009–2011 period, versus one "strategically default" – abruptly and intentionally pull the
30 6 REGULATORY PROPOSALS AND LONG-TERM SOLUTIONS

plug and abandon the mortgage – compared with lower- Failure to securitize When the mortgage loan securiti-
scoring borrowers. Such strategic defaults were heavily zation scheme collapsed in 2008, and foreclosures spiked
concentrated in markets with the highest price declines. dramatically, the investors in the private label REMICs
An estimated 588,000 strategic defaults occurred nation- increasingly demanded to see the contents of these trusts.
wide during 2008, more than double the total in 2007. Since 2008, when trust content is discussed in the main-
They represented 18% of all serious delinquencies that stream media, there has been a fixation solely on the qual-
extended for more than 60 days in the fourth quarter of ity of the loans (more specifically, the poor quality). On
2008.[400] the fringes of the media, there has been a different but
more relevant discussion: one of loan quantity rather than
quality. The banks did not anticipate that by failing to
5.5.1 Homeowners Affordability and Stability Plan execute those mortgage assignments to the private label
REMICs, foreclosures in the future could not legally be
Main article: Homeowners Affordability and Stability accomplished. Many of these REMICs were devoid of
Plan loans when they were created and sold in shares; and they
never were populated with loans after the shares were all
On 18 February 2009, U.S. President Barack Obama an- sold. When that fact eventually came to light in 2008 or
nounced a $73 billion program to help up to nine million so, the media message was that these failures to assign
homeowners avoid foreclosure, which was supplemented were oversights or sloppy accounting or something of that
by $200 billion in additional funding for Fannie Mae and nature. The drumbeat of that message continues to this
Freddie Mac to purchase and more easily refinance mort- day. However, this process had all the earmarks of a clas-
gages. The plan is funded mostly from the EESA’s $700 sic Ponzi scheme.[406]
billion financial bailout fund. It uses cost sharing and
incentives to encourage lenders to reduce homeowner’s
monthly payments to 31 percent of their monthly income. 6 Regulatory proposals and long-
Under the program, a lender would be responsible for re-
ducing monthly payments to no more than 38 percent of
term solutions
a borrower’s income, with government sharing the cost
to further cut the rate to 31 percent. The plan also in- Further information: Subprime mortgage crisis solutions
volves forgiving a portion of the borrower’s mortgage bal- debate and Regulatory responses to the subprime crisis
ance. Companies that service mortgages will get incen-
tives to modify loans and to help the homeowner stay President Barack Obama and key advisers introduced a
current.[401][402][403] series of regulatory proposals in June 2009. The propos-
als address consumer protection, executive pay, bank fi-
nancial cushions or capital requirements, expanded reg-
Loan modifications ulation of the shadow banking system and derivatives,
and enhanced authority for the Federal Reserve to safely
Untold thousands of people have com- wind-down systemically important institutions, among
plained in recent years that they were subjected others.[407][408][409] The Dodd–Frank Wall Street Reform
to a nightmare experience of lost paperwork, and Consumer Protection Act was signed into law in July
misapplied fees and Kafkaesque phone calls 2010 to address some of the causes of the crisis.
with clueless customer service representatives
as they strived to avoid foreclosures they say U.S. Treasury Secretary Timothy Geithner testified be-
were preventable. These claims are backed up fore Congress on October 29, 2009. His testimony in-
by a swelling number of academic studies and cluded five elements he stated as critical to effective re-
insider accounts of misconduct and abuse.[404] form:

1. Expand the Federal Deposit Insurance Corporation


Now it’s becoming clear just how chaotic bank resolution mechanism to include non-bank fi-
the whole system became. Depositions from nancial institutions;
employees working for the banks or their law
firms depict a foreclosure process in which it 2. Ensure that a firm is allowed to fail in an orderly way
was standard practice for employees with vir- and not be “rescued";
tually no training to masquerade as vice pres-
3. Ensure taxpayers are not on the hook for any losses,
idents, sometimes signing documents on be-
by applying losses to the firm’s investors and creat-
half of as many as 15 different banks. To-
ing a monetary pool funded by the largest financial
gether, the banks and their law firms created a
institutions;
quick-and-dirty foreclosure machine that was
designed to rush through foreclosures as fast as 4. Apply appropriate checks and balances to the FDIC
possible.[405] and Federal Reserve in this resolution process;
31

5. Require stronger capital and liquidity positions for Fargo ($9.8B), Citigroup ($6.2B) and Goldman-Sachs
financial firms and related regulatory authority.[410] ($0.9B).[420] Bloomberg reported that from the end of
2010 to October 2013, the six largest Wall St. banks had
[421]
The Dodd-Frank Act addressed these elements, but agreed to pay $67 billion. CNBC reported in April
stopped short of breaking up the largest banks, which 2015 that banking fines and penalties totaled $150 billion
grew larger due to mergers of investment banks at the between 2007 and 2014, versus $700 billion in profits
[422]
core of the crisis with depository banks (e.g., JP Mor- over that time.
gan Chase acquired Bear Stearns and Bank of America Many of these fines were obtained via the efforts of Pres-
acquired Merrill Lynch in 2008). Assets of five largest ident Obama’s Financial Fraud Enforcement Task Force
banks as a share of total commercial banking assets rose (FFETF), which was created in November 2009 to in-
then stabilized in the wake of the crisis.[411] During 2013, vestigate and prosecute financial crimes. The FFETF in-
Senators John McCain (Republican) and Elizabeth War- volves over 20 federal agencies, 94 U.S. Attorney’s of-
ren (Democratic) proposed a bill to separate investment fices, and state and local partners. One of its eight work-
and depository banking, to insulate depository banks ing groups, the Residential Mortgage Backed Securities
from higher risk activities. These were separated prior (RMBS) Working Group, was created in 2012 and is in-
to the 1999 repeal of the Glass-Steagall Act.[412] volved in investigating and negotiating many of the fines
and penalties described above.[423]

6.1 Law investigations, judicial and other


responses
7 In popular culture
Significant law enforcement action and litigation re-
sulted from the crisis. The U.S. Federal Bureau of Several books written about the crisis were made into
Investigation probed the possibility of fraud by mort- movies. Examples include The Big Short by Michael
gage financing companies Fannie Mae and Freddie Mac, Lewis and Too Big to Fail by Andrew Ross Sorkin. The
Lehman Brothers, and insurer American International former tells the story from the perspective of several in-
Group, among others.[413] New York Attorney Gen- vestors who bet against the housing market, while the lat-
eral Andrew Cuomo sued Long Island based Ameri- ter follows key government and banking officials focus-
mod, one of the nation’s largest loan modification cor- ing on the critical events of September 2008, when many
porations for fraud, and issued numerous subpoenas to large financial institutions faced or experienced collapse.
other similar companies.[414] The FBI assigned more
agents to mortgage-related crimes and its caseload dra-
matically increased.[415][416] The FBI began a probe of 8 Implications
Countrywide Financial in March 2008 for possible fraud-
ulent lending practices and securities fraud.[417]
Several hundred civil lawsuits were filed in federal courts
beginning in 2007 related to the subprime crisis. The
number of filings in state courts was not quantified but
was also believed to be significant.[418] In August 2014,
Bank of America agreed to a near-$17 billion deal to set-
tle claims against it relating to the sale of toxic mortgage-
linked securities including subprime home loans, in what
was believed to be the largest settlement in U.S. corpo-
rate history. The deal with the U.S. Justice Department
topped a deal the regulator made the previous year with
JPMorgan Chase over similar issues.[419] Morgan Stanley
paid $2.6 billion to settle claims in February 2015, with-
out reaching closure on homeowner relief and state claim

VOA Special English Economics Report from October 2010 de-


6.2 Bank fines and penalties scribing how millions of foreclosed homes were seized by banks

U.S. banks have paid considerable fines from legal Estimates of impact have continued to climb. During
settlements due to mortgage-related activities. The April 2008, International Monetary Fund (IMF) esti-
Economist estimated that from 2008 through October mated that global losses for financial institutions would
2013, U.S. banks had agreed to $95 billion in mortgage- approach $1 trillion.[424] One year later, the IMF esti-
related penalties. Settlement amounts included Bank of mated cumulative losses of banks and other financial in-
America ($47.2B), JP Morgan Chase ($22.3B), Wells stitutions globally would exceed $4 trillion.[425]
32 10 REFERENCES

Francis Fukuyama has argued that the crisis represents progressed, the Fed has expanded the collateral against
the end of Reaganism in the financial sector, which was which it is willing to lend to include higher-risk assets.[434]
characterized by lighter regulation, pared-back govern- The Economist wrote in May 2009: “Having spent a for-
ment, and lower taxes. Significant financial sector regu- tune bailing out their banks, Western governments will
latory changes are expected as a result of the crisis.[426] have to pay a price in terms of higher taxes to meet the
Fareed Zakaria believes that the crisis may force Amer- interest on that debt. In the case of countries (like Britain
icans and their government to live within their means. and America) that have trade as well as budget deficits,
Further, some of the best minds may be redeployed from those higher taxes will be needed to meet the claims of
financial engineering to more valuable business activities, foreign creditors. Given the political implications of such
or to science and technology.[427] austerity, the temptation will be to default by stealth, by
Roger Altman wrote that “the crash of 2008 has inflicted letting their currencies depreciate. Investors are increas-
profound damage on [the U.S.] financial system, its econ- ingly alive to this danger...”[435]
omy, and its standing in the world; the crisis is an impor- The crisis has cast doubt on the legacy of Alan Greenspan,
tant geopolitical setback...the crisis has coincided with the Chairman of the Federal Reserve System from 1986
historical forces that were already shifting the world’s to January 2006. Senator Chris Dodd claimed that
focus away from the United States. Over the medium Greenspan created the "perfect storm".[436] When asked
term, the United States will have to operate from a smaller to comment on the crisis, Greenspan spoke as follows:[282]
global platform – while others, especially China, will have
a chance to rise faster.”[309] The current credit crisis will come to an
GE CEO Jeffrey Immelt has argued that U.S. trade end when the overhang of inventories of newly
deficits and budget deficits are unsustainable. America built homes is largely liquidated, and home
must regain its competitiveness through innovative prod- price deflation comes to an end. That will sta-
ucts, training of production workers, and business lead- bilize the now-uncertain value of the home eq-
ership. He advocates specific national goals related to en- uity that acts as a buffer for all home mortgages,
ergy security or independence, specific technologies, ex- but most importantly for those held as collat-
pansion of the manufacturing job base, and net exporter eral for residential mortgage-backed securities.
status.[428] “The world has been reset. Now we must lead Very large losses will, no doubt, be taken as a
an aggressive American renewal to win in the future.” Of consequence of the crisis. But after a period of
critical importance, he said, is the need to focus on tech- protracted adjustment, the U.S. economy, and
nology and manufacturing. “Many bought into the idea the world economy more generally, will be able
that America could go from a technology-based, export- to get back to business.
oriented powerhouse to a services-led, consumption-
based economy – and somehow still expect to prosper,”
Jeff said. “That idea was flat wrong.”[429] 9 See also
Economist Paul Krugman wrote in 2009: “The prosperity
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[406] Campbell, James P. (2014-03-26). “The Independent [427] “Zakaria: A More Disciplined America | Newsweek Busi-
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[414] “Cuomo: I'll Sue Foreclosure-Relief Scam Artists”. vil- 11 Further reading
lagevoice.com. 2009-06-09. Retrieved 2009-06-09.
• Fried, Joseph, Who Really Drove the Economy into
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2008-06-19.
2012) ISBN 978-0-87586-942-1.
[416] “FBI – Mortgage Fraud Takedown – Press Room – Head-
• Wallison, Peter, Bad History, Worse Policy (Wash-
line Archives 06–19–08”. Fbi.gov. Retrieved 2008-10-
ington, D.C.: AEI Press, 2013) ISBN 978-0-8447-
26.
7238-7.
[417] “FBI probes Countrywide for possible fraud”.
Money.cnn.com. 2008-03-08. Retrieved 2009-02- • Fengbo Zhang (2008): 1. Perspective on the United
27. States Sub-prime Mortgage Crisis , 2. Accurately
Forecasting Trends of the Financial Crisis , 3. Stop
[418] “Subprime lawsuits on pace to top S&L cases – The Arguing about Socialism versus Capitalism .
Boston Globe”. 2008-02-15. Archived from the original
on September 21, 2008. Retrieved 2008-05-19. • Archaya and Richardson. Financial Stability: How
to Repair a Failed System NYU Stern Project-
[419] “Bank of America to pay nearly $17 bn to settle mortgage Executive Summaries of 18 Crisis-Related Papers
claims”. Philadelphia Herald. 21 August 2014. Retrieved
22 August 2014. • Committee for a Responsible Federal Budget
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[420] The Economist-Payback Time for Subprime-October 26,
2013 • Blackburn, Robin (March–April 2008). “The Sub-
[421] Bloomberg-Nick Summers-Banks Finally Pay for Their prime Crisis”. New Left Review. New Left Review.
Sins, Five Years After the Crisis-October 31, 2013 II (50).

[422] CNBC-John W. Schoen-Seven years on from crisis, $150 • Demyanyk, Yuliya (FRB St. Louis), and Otto Van
billion in bank fines and penalties-April 30, 2015 Hemert (NYU Stern School) (2008) "Understanding
the Subprime Mortgage Crisis," Working paper cir-
[423] DOJ-Press Release-RMBS Working Group Members An- culated by the Social Science Research Network.
nounce First Legal Action-October 2, 2012
• DiMartino, D., and Duca, J. V. (2007) "The Rise
[424] “IMF says worldwide losses stemming from the US sub- and Fall of Subprime Mortgages," Federal Reserve
prime mortgage crisis could run to $945 billion”.
Bank of Dallas Economic Letter 2(11).
[425] IMF Summary
• Dominique Doise, Subprime: Price of infringe-
[426] “Fukuyama: The End of America Inc | Newsweek Busi- ments/Subprime : le prix des transgressions, Revue
ness | Newsweek.com”. Newsweek.com. Retrieved 2008- de droit des affaires internationales (RDAI) / Inter-
10-24. national Business Law Journal (IBLJ), N° 4, 2008
45

• Ely, Bert (2009) “Bad Rules Produce Bad Out- 12 External links
comes: Underlying Public-Policy Causes of the U.S.
Financial Crisis,” Cato Journal 29(1). • Financial Crisis Inquiry Commission – Homepage
• Don Tapscott, 2010. Macrowikinomics, Publisher
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January 2011
• Gold, Gerry, and Feldman, Paul (2007) A House of
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• Michael Lewis, "The End," Portfolio Magazine • PBS Frontline – Inside the Meltdown
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Doomsday Machine. London: Allen Lane. ISBN • “Government warned of mortgage meltdown Regu-
0-393-07223-1. lators ignored warnings about risky mortgages, de-
layed regulations on the industry”. CNN. December
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1, 2008. Archived from the original on December
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West.
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combe and B. W. Powell, eds., Housing America:
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Building out of a Crisis. Oakland CA: The Indepen-
Allocations & Payments
dent Institute.
• Muolo, Paul & Padilla, Matthew (2008). Chain of • Barth, Li, Lu, Phumiwasana and Yago. 2009. The
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ISBN 978-0-470-29277-8. Meltdown. Amazon

• Woods, Thomas E. (2009) Meltdown: A Free- • Financial Times – In depth: Subprime fall-out
Market Look at Why the Stock Market Collapsed,
the Economy Tanked, and Government Bailouts Will • The Crisis of Credit Visualized – Infographic by
Make Things Worse / Washington DC: Regnery Pub- Jonathan Jarvis
lishing ISBN 1-59698-587-9
• The Economic Crisis: Its Origins and the Way For-
• Reinhart, Carmen M., and Kenneth Rogoff (2008) ward Video of lecture given by Marshall Carter,
"Is the 2007 U.S. Sub-Prime Financial Crisis So chairman of the New York Stock Exchange, at
Different? An International Historical Compari- Boston University, April 15, 2009
son," Harvard University working paper.
• The True American Dream Home Ownership, the
• Stewart, James B., “Eight Days: the battle to save the Subprime Lending Crisis, and Financial Instabil-
American financial system”, The New Yorker mag- ity by Masum Momaya – International Museum of
azine, September 21, 2009. Women
• Clark, Kenneth E. “Legacy of Greed: The Story Be-
• The Financial Crisis: What Happened and Why –
hind the Mortgage and Housing Meltdown”, Pub-
Lecture 2 Video of lecture given in July 2009, by
lisher: Author Solutions ISBN 978-1-4520-5439-1
Yaron Brook, professor of finance and executive di-
http://www.kennetheclark.com
rector of the Ayn Rand Center for Individual Rights
• Review of Mark Zandi’s book Financial Shock: A
360° Look at the Subprime Mortgage Implosion, and • Lectures by Ben Bernanke to an economics class at
How to Avoid the Next Financial Crisis from The New George Washington University March, 2012
York Review of Books
• “Chairman Ben Bernanke Lecture Series Part
• Zandi, Mark Book Excerpt: Financial Shock- 1” Recorded live on March 20, 2012 10:35am
Chapter 1 MST
46 12 EXTERNAL LINKS

• “Chairman Ben Bernanke Lecture Series Part


2” Recorded live on March 22, 2012 10:35am
MST
• “Chairman Ben Bernanke Lecture Series Part
3” Recorded live on March 27, 2012 10:38am
MST
• “Chairman Ben Bernanke Lecture Series Part
4” Recorded live on March 29, 2012 10:38am
MST
47

13 Text and image sources, contributors, and licenses


13.1 Text
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Derksen, Zundark, Manning Bartlett, Roadrunner, Heron, Stevertigo, Edward, Fred Bauder, Pnm, Delirium, Ronz, Julesd, BenKovitz,
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Bkell, Mervyn, David Edgar, Seano1, Anthony, Mattflaschen, Javidjamae, Ancheta Wis, JamesMLane, DocWatson42, Mporter, Peru-
vianllama, Beardo, Gilgamesh~enwiki, Pascal666, Horatio, Chowbok, ConradPino, Antandrus, Beland, PFHLai, ErikNY, FashionNugget,
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tle, Rumping, Cdip150, Boodlesthecat, Wikievil666, The Thing That Should Not Be, Meisterkoch, Rjd0060, Muritai07, Shittingnipple,
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13.2 Images
• File:Bank_Common_Equity_to_Assets_Ratios_2004_-_2008.png Source: https://upload.wikimedia.org/wikipedia/commons/1/18/
Bank_Common_Equity_to_Assets_Ratios_2004_-_2008.png License: CC BY-SA 3.0 Contributors: Annual Reports of each entity Origi-
nal artist: Farcaster (talk) 05:12, 4 May 2009 (UTC)
• File:Birmingham_Northern_Rock_bank_run_2007.jpg Source: https://upload.wikimedia.org/wikipedia/commons/e/e5/
Birmingham_Northern_Rock_bank_run_2007.jpg License: CC BY-SA 2.0 Contributors: Flickr Original artist: Lee Jordan
• File:Borrowing_Under_a_Securitization_Structure.png Source: https://upload.wikimedia.org/wikipedia/commons/b/bc/Borrowing_
Under_a_Securitization_Structure.png License: Public domain Contributors: US Federal Deposit Insurance Corporation http://www.fdic.
gov/news/news/speeches/archives/2007/chairman/spapr1707.html Original artist: Sheila C. Bair, Chairman
• File:CDO_-_FCIC_and_IMF_Diagram.png Source: https://upload.wikimedia.org/wikipedia/commons/1/12/CDO_-_FCIC_and_
IMF_Diagram.png License: Public domain Contributors: Transferred from en.wikipedia to Commons by SreeBot. Original artist: Farcaster
at en.wikipedia
• File:Commons-logo.svg Source: https://upload.wikimedia.org/wikipedia/en/4/4a/Commons-logo.svg License: CC-BY-SA-3.0 Contribu-
tors: ? Original artist: ?
• File:Effects_of_Crisis_on_U.S._Household_Wealth_v1.png Source: https://upload.wikimedia.org/wikipedia/commons/3/31/
Effects_of_Crisis_on_U.S._Household_Wealth_v1.png License: CC BY-SA 3.0 Contributors: Federal Reserve Flow of Funds Report
Data; Chart Created by Contributor Original artist: Farcaster (talk) 06:11, 8 July 2009 (UTC)
• File:Emblem-money.svg Source: https://upload.wikimedia.org/wikipedia/commons/f/f3/Emblem-money.svg License: GPL Contribu-
tors: http://www.gnome-look.org/content/show.php/GNOME-colors?content=82562 Original artist: perfectska04
• File:Eurozone-structural1.jpg Source: https://upload.wikimedia.org/wikipedia/commons/a/a5/Eurozone-structural1.jpg License: Pub-
lic domain Contributors: [1] from “The impact of fiscal austerity in the eurozone” Financial Times Original artist: Martin Wolf, from
International Monetary Fund data
• File:Eurozone_Countries_Public_Debt_to_GDP_Ratio_2010_vs._2011.png Source: https://upload.wikimedia.org/wikipedia/
commons/d/da/Eurozone_Countries_Public_Debt_to_GDP_Ratio_2010_vs._2011.png License: CC BY-SA 3.0 Contributors: Eurostat
Previously published: None Original artist: Farcaster
• File:Existing_Home_Sales_Chart_-_Mar_09b.png Source: https://upload.wikimedia.org/wikipedia/commons/2/2a/Existing_Home_
Sales_Chart_-_Mar_09b.png License: CC BY-SA 3.0 Contributors: Source Data: NAR existing home sales report (see links below) Original
artist: Farcaster (talk) 03:44, 27 April 2009 (UTC)
• File:FCIC_-_Housing_Bubbles_in_Multiple_Countries_2002-2008.png Source: https://upload.wikimedia.org/wikipedia/commons/
3/34/FCIC_-_Housing_Bubbles_in_Multiple_Countries_2002-2008.png License: Public domain Contributors: http://fcic.law.stanford.
edu/report/conclusions Original artist: Financial Crisis Inquiry Commission
• File:Fed_Funds_Rate_&_Mortgage_Rates_2001_to_2008.png Source: https://upload.wikimedia.org/wikipedia/commons/e/e6/Fed_
Funds_Rate_%26_Mortgage_Rates_2001_to_2008.png License: CC BY-SA 3.0 Contributors: I created this work entirely by myself using
government data Original artist: Farcaster (talk) 05:59, 2 March 2009 (UTC)
• File:Franklin_Raines_July_2002.jpg Source: https://upload.wikimedia.org/wikipedia/commons/4/49/Franklin_Raines_July_2002.jpg
License: Public domain Contributors: Federal Deposit Insurance Corporation [1] Original artist: w:Federal Deposit Insurance Corporation
• File:Lending_&_Borrowing_Decisions_-_10_19_08.png Source: https://upload.wikimedia.org/wikipedia/commons/2/24/Lending_
%26_Borrowing_Decisions_-_10_19_08.png License: CC BY-SA 3.0 Contributors: Own work (Original text: I created this work entirely
by myself.) Original artist: Farcaster (talk) 01:39, 20 October 2008 (UTC)
• File:Leverage_ratios_for_major_investment_banks.svg Source: https://upload.wikimedia.org/wikipedia/commons/d/d1/Leverage_
ratios_for_major_investment_banks.svg License: CC BY-SA 3.0 Contributors: Own work Original artist: Ben Moore
• File:MBS_Downgrades_Chart.png Source: https://upload.wikimedia.org/wikipedia/commons/2/25/MBS_Downgrades_Chart.png Li-
cense: CC BY-SA 3.0 Contributors: Transferred from en.wikipedia
Original artist: Farcaster (talk). Original uploader was Farcaster at en.wikipedia
• File:Mortgage_delinquencies_by_loan_type_-_1998-2010.GIF Source: https://upload.wikimedia.org/wikipedia/commons/e/e0/
Mortgage_delinquencies_by_loan_type_-_1998-2010.GIF License: Public domain Contributors: Final Report of the National Commis-
sion on the Causes of the Financial and Economic Crisis in the United States, p.217, figure 11.2 Original artist: National Commission on
the Causes of the Financial and Economic Crisis in the United States
• File:Mortgage_loan_fraud.svg Source: https://upload.wikimedia.org/wikipedia/commons/e/e7/Mortgage_loan_fraud.svg License: Pub-
lic domain Contributors:
• Mortgage_loan_fraud.png Original artist:
• derivative work: Emok (<a href='//commons.wikimedia.org/wiki/User_talk:Emok' title='User talk:Emok'>talk</a>)
13.2 Images 49

• File:Put-Backs,_Robo-Signers_Put_New_Pressure_on_US_Housing_Market_VOALearningEnglish.ogv Source:
https://upload.wikimedia.org/wikipedia/commons/7/73/Put-Backs%2C_Robo-Signers_Put_New_Pressure_on_US_Housing_Market_
VOALearningEnglish.ogv License: Public domain Contributors: http://www.youtube.com/watch?v=-SAxxaqPR7o Original artist: Alex
Villareal, VOALearningEnglish
• File:Sectoral_Financial_Balances_in_U.S._Economy.png Source: https://upload.wikimedia.org/wikipedia/commons/3/33/Sectoral_
Financial_Balances_in_U.S._Economy.png License: CC BY-SA 3.0 Contributors: I created this file using Federal Reserve data (FRED
Database) Original artist: Farcaster
• File:Securitization_Market_Activity.png Source: https://upload.wikimedia.org/wikipedia/commons/3/37/Securitization_Market_
Activity.png License: Public domain Contributors: http://www.fcic.gov/hearings/pdfs/2010-0113-Zandi.pdf Original artist: Farcaster
(talk) 04:36, 10 October 2010 (UTC)
• File:Shadow_banking.GIF Source: https://upload.wikimedia.org/wikipedia/commons/4/46/Shadow_banking.GIF License: Public do-
main Contributors: Financial Crisis Inquiry Commission Report, figure 2.1, p.32, data from Federal Reserve Flow of Funds Report Original
artist: Financial Crisis Inquiry Commission
• File:Subprime_Crisis_Diagram_-_X1.png Source: https://upload.wikimedia.org/wikipedia/en/1/13/Subprime_Crisis_Diagram_-_X1.
png License: CC-BY-SA-3.0 Contributors:
I created this work entirely by myself.
Original artist:
Farcaster (talk) 05:18, 10 October 2008 (UTC)
• File:Subprime_Mortgage_Offer.jpeg Source: https://upload.wikimedia.org/wikipedia/commons/d/d5/Subprime_Mortgage_Offer.
jpeg License: CC BY-SA 2.0 Contributors: http://www.flickr.com/photos/thetruthabout/2681354792/ Original artist: The Truth About
• File:Subprime_crisis_-_Foreclosures_&_Bank_Instability.png Source: https://upload.wikimedia.org/wikipedia/commons/f/fc/
Subprime_crisis_-_Foreclosures_%26_Bank_Instability.png License: CC BY-SA 3.0 Contributors: Own work (Original text: I created
this work entirely by myself.) Original artist: Farcaster (talk) 17:06, 26 December 2008 (UTC)
• File:Subprime_mortgage_originations,_1996-2008.GIF Source: https://upload.wikimedia.org/wikipedia/commons/e/e0/Subprime_
mortgage_originations%2C_1996-2008.GIF License: Public domain Contributors: Final Report of the National Commission on the Causes
of the Financial and Economic Crisis in the United States, p.70 figure 5.2 Original artist: National Commission on the Causes of the Financial
and Economic Crisis in the United States
• File:TED_spread_2008.svg Source: https://upload.wikimedia.org/wikipedia/commons/8/8a/TED_spread_2008.svg License: CC BY-SA
4.0 Contributors: Own work, data from St. Louis Fed Original artist: Kopiersperre (<a href='//commons.wikimedia.org/wiki/User_talk:
Kopiersperre' title='User talk:Kopiersperre'>talk</a>)
• File:U.S._Federal_Reserve_-_Treasury_and_Mortgage-Backed_Securities_Held.png Source: https://upload.wikimedia.org/
wikipedia/commons/5/50/U.S._Federal_Reserve_-_Treasury_and_Mortgage-Backed_Securities_Held.png License: CC BY-SA 3.0
Contributors: I used the FRED database to create the chart
Previously published: None Original artist: Farcaster
• File:U.S._Fixed_Investment_as_Pct_GDP.png Source: https://upload.wikimedia.org/wikipedia/commons/5/5e/U.S._Fixed_
Investment_as_Pct_GDP.png License: Public domain Contributors: https://research.stlouisfed.org/fred2/graph/?graph_id=117234&
category_id= Original artist: Federal Reserve Economic Database (FRED)
• File:U.S._GDP_-_Real_vs._Potential_Per_CBO_Forecasts_of_2007_and_2016.png Source: https://upload.wikimedia.org/
wikipedia/commons/4/47/U.S._GDP_-_Real_vs._Potential_Per_CBO_Forecasts_of_2007_and_2016.png License: CC BY-SA 4.0
Contributors: Own work Original artist: Farcaster
• File:U.S._GDP_Contribution_to_Change_2007-2009.png Source: https://upload.wikimedia.org/wikipedia/commons/1/17/U.S.
_GDP_Contribution_to_Change_2007-2009.png License: CC BY-SA 3.0 Contributors: Source Data: http://bea.gov/iTable/iTable.cfm?
ReqID=9&step=1#reqid=9&step=3&isuri=1&903=2 Original artist: Farcaster
• File:U.S._Home_Ownership_and_Subprime_Origination_Share.png Source: https://upload.wikimedia.org/wikipedia/commons/e/
ef/U.S._Home_Ownership_and_Subprime_Origination_Share.png License: CC BY-SA 3.0 Contributors: Transferred from en.wikipedia
to Commons. Original artist: Farcaster at English Wikipedia
• File:U.S._Household_Debt_Relative_to_Disposable_Income_and_GDP.png Source: https://upload.wikimedia.org/wikipedia/
commons/1/1e/U.S._Household_Debt_Relative_to_Disposable_Income_and_GDP.png License: CC BY-SA 3.0 Contributors: Trans-
ferred from en.wikipedia to Commons by Sfan00_IMG using CommonsHelper.

(Original text : Created this diagram using public data

Original artist: Farcaster


• File:U.S._Private_Sector_Financial_Surplus.png Source: https://upload.wikimedia.org/wikipedia/commons/d/d6/U.S._Private_
Sector_Financial_Surplus.png License: CC BY-SA 3.0 Contributors: I created this graphic using data from the Federal Reserve Economic
Database (FRED) Original artist: Farcaster
• File:U.S._Properties_with_Foreclosure_Activity.png Source: https://upload.wikimedia.org/wikipedia/commons/0/01/U.S.
_Properties_with_Foreclosure_Activity.png License: CC BY-SA 3.0 Contributors: I used Realty Trac data from their press releases
Original artist: Farcaster
• File:U.S._Trade_Deficit_2011.png Source: https://upload.wikimedia.org/wikipedia/commons/4/4c/U.S._Trade_Deficit_2011.png Li-
cense: CC BY-SA 3.0 Contributors: I (Farcaster (talk)) created this work entirely by myself. Original artist: Farcaster (talk) 19:46, 15
October 2011 (UTC)
• File:US_Private_Debt_to_GDP_by_Sector.png Source: https://upload.wikimedia.org/wikipedia/commons/e/e2/US_Private_Debt_
to_GDP_by_Sector.png License: CC BY-SA 3.0 Contributors: Area chart created from FRED data using Excel Original artist: Farcaster
50 13 TEXT AND IMAGE SOURCES, CONTRIBUTORS, AND LICENSES

• File:Wiki_letter_w_cropped.svg Source: https://upload.wikimedia.org/wikipedia/commons/1/1c/Wiki_letter_w_cropped.svg License:


CC-BY-SA-3.0 Contributors: This file was derived from Wiki letter w.svg: <a href='//commons.wikimedia.org/wiki/File:
Wiki_letter_w.svg' class='image'><img alt='Wiki letter w.svg' src='https://upload.wikimedia.org/wikipedia/commons/thumb/6/6c/Wiki_
letter_w.svg/50px-Wiki_letter_w.svg.png' width='50' height='50' srcset='https://upload.wikimedia.org/wikipedia/commons/thumb/6/6c/
Wiki_letter_w.svg/75px-Wiki_letter_w.svg.png 1.5x, https://upload.wikimedia.org/wikipedia/commons/thumb/6/6c/Wiki_letter_w.svg/
100px-Wiki_letter_w.svg.png 2x' data-file-width='44' data-file-height='44' /></a>
Original artist: Derivative work by Thumperward

13.3 Content license


• Creative Commons Attribution-Share Alike 3.0