Chapter 1: Global Financial Crises
Benton E. Gup INTRODUCTION Subprime mortgages refer to high risk mortgage loans made to borrowers with low credit scores and other high-risk characteristics.1 Another factor adding to their risk is that many subprime mortgage loans have adjustable rates of interest (adjustable rate mortgages, ARMs) that can change over time resulting in higher monthly payments. Subprime mortgage loans were packaged (that is, securitized) and sold to banks, government sponsored enterprises (GSEs, that is, Fannie Mae, Freddie Mac, Ginnie Mae), and to other investors throughout the world. The delinquency rate on subprime mortgage loans in the United States increased from 11.5 percent in 2005 to 21.88 percent in the fourth quarter, 2008.2 The high delinquency rates and subsequent foreclosures contributed to losses on subprime and other real estate loans. The losses caused a ‘liquidity crunch’ in August 2007.3 Mortgage-backed securities became illiquid, and companies had problems borrowing funds. The liquidity crunch became widespread and adversely affected other markets. For example, French bank BNP Paribas halted redemptions on some of its funds because of concerns about mortgage values.4 The losses and liquidity crunch also contributed to the Federal Housing Finance Authority (FHFA) putting Fannie Mae and Freddie Mac into conservatorship in September 2007.5 How and why did the delinquencies and foreclosures on real estate loans, and a deep recession in the United States spread losses around the world? And what caused the crises? To answer these questions, this chapter proceeds as follows. Section 2 explains how the crises became ‘global’. Section 3 examines...
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