Edited by Jan Toporowski and Jo Michell
Chapter 13: Financial crises
The Great Financial Crisis of 2008 was widely regarded as the most serious financial crisis since the Great Depression. It seriously challenged not only the stability of the global economy, but also the ability of standard economic theory to explain it. The crisis centered on the speculative boom in housing prices in major urban areas in the United States, but the speculative fervor spread more broadly as well. As housing prices escalated, loans were extended and houses were purchased on the assumption that housing prices would only continue to escalate. The speculation in housing prices would have put homes out of the reach of many borrowers if not for the development of the subprime market. Lenders who ordinarily would not have lent to these subprime borrowers (whose credit quality was less than ‘prime’) rushed to extend mortgages at high interest rates and with innovative repayment requirements. For instance, ‘option adjustable rate mortgages (ARMs)’ reduced initial monthly payments with low teaser rates (that adjusted upwards later) and allowed borrowers to choose the amount of monthly payment they would make (but with a corresponding increase in the total amount eventually owed).
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