The United States faced one of its worst recessions in history during the latter half of the first decade of the twenty first century. Termed as the Great Recession, this period rivaled the Great Depression of the 1930s and had such an impact on the entire world that international economies were severely affected, and several national governments had to work together to get their countries out of the crisis. The crisis initially began as a decline in the financial sector, but quickly spread over to other sectors as well, thereby impacting the entire economy of the United States. In this case study, I shall attempt to explain some of the factors that played a role in this crisis.
The Great Recession has widely been attributed to the burst of the U.S. housing bubble and the subprime mortgage crisis. It started with the gradual increase in the housing market around the year 2000. House prices started to rise rapidly, and lenders started offering low interest rates. With a competitive environment, mortgage lenders started relaxing their standards on lending mortgages. This meant that, families that were earlier considered not worthy of a mortgage loan, were now able to get a loan, and purchase a house. As this trend continued, the demand for housing increased, and as a result, house prices went up.
With the rapidly growing prices in the housing market, lenders were forced to come up with incentives to enable buyers to take loans. The concept of Adjustable Rate Mortgages was introduced where the lender would offer a minimal interest rate (called a teaser rate) for a couple of years, which would rise significantly after the teaser period. As mentioned earlier, mortgage lenders relaxed their standards for a loan greatly, which led to “liar loans”, where the individual applying for the loan often falsified information on the application in order to secure the loan. Although lenders were partly aware of the issue, the security of foreclosure if the buying party defaulted on the loan caused lenders to turn a blind eye to these risky loans. These mortgages where there is the risk of the buyer not being able to fulfill the loan are termed as “subprime mortgages”.
This trend of lax mortgage processes and risky loan applications caused house prices to shoot up to an all-time high by the year 2006. However, starting from 2006, house prices started to fall down. This is termed as the “burst of the housing bubble”. The reason for this was twofold – firstly, as the prices for houses went up dramatically, the demand started to go down. Moreover, the danger of the Adjustable Rate Mortgages became obvious to buyers when their teaser period expired. Several families realized that they could no longer sustain the monthly payment for their loans and defaulted on the loan. Especially buyers that had borrowed nearly the entire value of the house realized that they ended up with negative equity, and decided to default on the loan. As a result, the over-leveraged lending...