Subprime Mortgage Crisis Begins
In 2007, the US housing bubble began to deflate, and defaults on subprime mortgages started to ripple through the financial system. What looked at first like a problem confined to one corner of American lending became the opening phase of the global financial crisis, which peaked in 2008 and produced the deepest worldwide recession since the Great Depression.
The roots lay in the years after 2000. Interest rates were low, global savings flowed into American assets, and house prices rose rapidly. Lenders extended more credit to borrowers with weak credit histories or limited documentation, often through adjustable-rate loans that began with low "teaser" payments. Many of these mortgages were sold to investment banks, which pooled them into mortgage-backed securities and more complex products such as collateralized debt obligations. Credit rating agencies gave many of these instruments high ratings, and investors around the world bought them believing they were safe. Meanwhile, regulators did not keep pace with a large "shadow banking" sector that relied on short-term borrowing and carried little capital.
US home prices peaked around 2006 and then began to fall. Borrowers who had counted on refinancing or rising values could no longer manage their payments as rates on adjustable loans reset, and delinquencies climbed. In 2007, several subprime lenders failed, and the problems spread to the securities built on their loans. Two Bear Stearns hedge funds heavily exposed to such assets collapsed that summer. In August, BNP Paribas froze withdrawals from some funds, and interbank lending seized up as banks became unsure which institutions held toxic assets. Central banks, including the Federal Reserve and the European Central Bank, began injecting liquidity. In Britain, Northern Rock suffered a run in September, the country's first major bank run in well over a century.
The crisis deepened over the following year. Bear Stearns was rescued through a sale to JPMorgan Chase in early 2008, and in September Lehman Brothers filed for bankruptcy while the US government took over Fannie Mae, Freddie Mac and later AIG. Credit markets froze, stock markets plunged, and governments launched large bailouts, including the US Troubled Asset Relief Program.
The consequences were far-reaching. Millions of Americans lost their homes and jobs, and many other countries fell into recession. Europe's sovereign debt troubles in the early 2010s were closely tied to the shock. Reforms followed, including the Dodd-Frank Act in the United States and the Basel III capital standards internationally. Economists still debate the relative weight of different causes, such as lax regulation, monetary policy, global imbalances and private-sector incentives, but the episode reshaped thinking about financial risk and the role of central banks.