1. Housing prices increased, then fell, due to the subprime mortgage crisis
During the housing boom in the early- to mid-2000s, many mortgage lenders began to expand their definition of credit-worthy and extend mortgages to buyers with poor credit histories who didn’t fit the previous definition of a desirable borrower.
Banks seized on these high-risk loans and began to buy them as “mortgage-backed securities” (investments secured by mortgages), a product that became very popular and yet was largely misunderstood by average investors. High demand for this new investment product led to an increase in risky lending practices and a subsequent increase in the housing market. But while housing prices were escalating, the Federal Reserve Bank also began raising interest rates—eventually rising to 5.25 percent by June 2006.
While those with fixed-rate mortgages were unaffected, millions of new borrowers had mortgages with adjustable rates, which meant that they had lower, affordable payments initially, but their monthly interest payments soon skyrocketed along with the new interest rates.
Unable to make their payments or sell their homes for a profit, many defaulted on their loans. That brought more inventory into the housing market and prices continued to plummet. Ultimately, the housing market hit a low in December 2008.
2. Banks went into crisis
With home prices faltering and mortgage-backed securities clearly no longer the solid-gold investment they had appeared to be, banks stopped lending to each other in fear of being stuck with subprime mortgages as collateral. The Fed made a deep cut in the interest rate in August 2007 in an attempt to restore confidence, but it wasn’t enough.
In November 2007, the U.S. Treasury attempted to assuage the pa
nic by creating a superfund for buying distressed portfolios of subprime mortgages, designed to provide liquidity to banks and hedge funds. Then in December 2007, the Fed created the Term Auction Facility (TAF), which supplied short-term credit to banks with subprime mortgages. Again, it was too little, too late.
Esteemed institutions such as Bear Stearns and Lehman Brothers collapsed, and mortgage giants Fannie Mae and Freddie Mac were on the brink.
3. The stock market plummeted, erasing wealth
Foreclosures continued to rise, and this housing bust caused the stock market to dive and eventually crash in September 2008, ultimately losing more than half its value. The double whammy of the falling housing market and stock market meant that Americans suffered staggering losses. Between 2007 and 2011, one-quarter of American families lost at least 75 percent of their wealth, and more than half of all families lost at least 25 percent of their wealth.
The aftermath of 2008’s recession
Fortunately, all bad things come to an end, and such was the case with the Great Recession in 2008 as the government initiated two key programs designed to provide relief for those in the throes of the economic downturn:
