Subprime Mortgage Crisis

The U.S. subprime crisis of the late 2000s was the result of a shift from a predominantly risk-limited mortgage marketplace to a risk-loving one, a shift that took place, with some fits and starts, over twenty-five years. This change in market structure and regulation led to an increasingly fragile housing finance system. When this fragile system interacted with broader forces of global financial imbalances and higher levels of leverage among dominant financial institutions, it finally reached its breaking point. Once defaults were no longer being suppressed by unsustainable housing price appreciation, foreclosures increased, putting even more downward pressure on prices, and a virtuous cycle of subprime lending and housing price growth reversed quickly into a vicious cycle of foreclosures, tightened lending standards, and falling home values.

The structural shifts in the U.S. mortgage market were directly supported—and sometimes initiated—by policymakers in Washington. The growth of the political power of the financial sector, in turn, fed back into further deregulation and pro-financialization policies.

Much of the media coverage of the 2000s sub-prime crisis gave the impression that the problems of high-risk lending came as a surprise to policymakers. In fact, the modern development of high-risk mortgage lending in the United States went through two phases—a first boom in the late 1990s and a larger, second boom beginning in 2002. The first boom was marked by a surge in subprime refinance lending. Most of these loans were “cash-out” refinancings, in which owner equity is extracted out of the home. Many involved very high fees to brokers and third parties and were structured to encourage repeated refinancing over brief periods of time. By 1998, subprime lenders dominated the refinance market in Black neighborhoods across the country so that refinance borrowers in upper-income Black census tracts were 6 times more likely than borrowers in upper-income White tracts to receive subprime loans. After the first subprime crash in the late 1990s, subprime refinance lending dropped by more than 20% from 1999 to 2000. However, the impacts of this first subprime crisis were not felt heavily in the financial world and were largely contained in minority and lower income neighborhoods.

In the second subprime boom, which began after 2001, subprime home purchase loans—as well as refinance loans—grew rapidly, together with a new class of alternative or “exotic” mortgages aimed at prime borrowers. While subprime mortgages made during the first boom performed very poorly, the loans made during the second boom performed even worse.