T he Le ndi ng

Cri si s:
Cau se an d Ef fect
 Be fore t he d own turn :
Th e Ho usi ng Bo om
 The introduction of exotic loans,
adjustable rate mortgages, and
relaxed standards allows for an
increase in subprime mortgage
lending.
 Low interest rates encourage Wall
Street investors to back subprime
loans in greater quantities.
 Hedge funds worldwide borrow
money to invest heavily in subprime
mortgages.
 Th e downturn b egin s:
 Interest rates rise and housing prices fall.
Monthly mortgage rates for subprime
borrowers skyrocket, but the post-2005
housing slump means they do not have
enough equity to refinance or sell.
 Lenders, rating agencies, and investors
underestimated the number of loans that
would default. Relaxed standards lured
borrowers into taking out loans they
couldn’t afford once initial interest rates
expired.
 This leads to a 113% increase in
foreclosures from July 2006 to July 2007.
Th e downturn
contin
 Delinquenciesues:
and foreclosures on subprime
mortgages force dozens of mortgage lenders to go out
of business, contract, or declare bankruptcy. Many
have stopped issuing subprime loans altogether. Even
borrowers with good credit history are forced to pay
higher interest rates.
 By the end of July/early August 2007, both National City and
Wells Fargo have stopped approving home-equity loans
through brokers, as well a subprime mortgage loans.
 Thursday, August 16th, 2007 Countrywide Financial, the
nation’s largest mortgage lender, borrows $11.5 billion so that
it can continue making loans.
 By August 21st, 2007, Countrywide Financial has laid off nearly
500 employees in the subprime mortgage lending unit.
He dge f unds a re h it
hard:
 Global Hedge funds that borrowed
money to invest in subprime
mortgages are forced to sell their
mortgages at extremely low prices
to pay off lenders and investors who
want out.
 To raise cash quickly, many hedge
funds dumped stock, causing stock
market prices to plunge worldwide.
 Ba nks pull back:
 Banks re-evaluate high-
risk loans in the face of
potential losses on
loans to hedge funds.
 As a result, credit is
tightened for borrowers
across the board,
affecting commercial
real estate, leveraged
buyouts, venture capital
lending, mergers and
acquisitions, etc.
Go vern me nt Ac tio n:
 To avoid complete market failure and to allow banks to
borrow money cheaply, the Federal Reserve,
European Central Bank, and their counterparts flood
the market with billions of dollars, euros, and yen in
August 2007.
 The injected government funds are designed to
encourage banks to continue making loans rather than
conserving cash and making the credit crunch worse.
 Analysts are concerned that rather than calming the
markets and biding time for the crisis to pass,
government action will lead to inflation and an
international credit crunch that would slow economic
growth worldwide.
Who is t o Bla me?
 Lenders: for their predatory lending practices focused
on subprime mortgage candidates
 Mortgage brokers: for steering borrowers to
unaffordable loans
 Appraisers: for inflating housing values
 Wall Street investors: for backing subprime mortgage
loans without first verifying the security of the portfolio
 Borrowers: for overstating income levels on loan
applications and entering into loan agreements they
could not afford
 Government: for lack of oversight
On goin g Effe cts :

 Subprime mortgage industry collapses, thousands of

jobs are lost
 Surge of foreclosure activity
 Housing prices and sales are both down
 Interest rates rise across the board as the effects of the
collapse of the subprime mortgage industry seep into
the near-prime and prime mortgage markets
 Investors lost billions of dollars in securities tied to the
subprime mortgage industry, resulting in upheavals
throughout the global financial market