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Background & the Real Estate "Bubble"

Real Estate Market History 

  • Post WWII, the US govt. looked to rebolster the domestic economy. 
  • The government decided to introduce the idea of mortgages from England. 
  • Loans from mortgages only benefited those in the upper/middle class that could afford the loan requirements. 
  • 1992: implementation of a new lending policy to increase homeownership of lower income Americans. Involved FANNIE MAE and other government agencies. 
    • This sparked the intitial creation of the subprime mortgage lending market. 
      • more relaxed standards enabled this market. 
  • Late 1990s: the Fed decreases the interest rate in order to encourage more people to buy homes (increasing demand) and increasing housing prices. 
  • Major banks/ investors saw the drop in interest rates and began to borrow at these low rates so that they could create their own mortages (and a new market).

Bubble Growth & the buildup to the Crisis 

  • Banks began creating their own subprime mortage markets. 
    • sold mortages as Mortgage-Backed Securities. 
  • Initially low default rates due to orginally high underwriting standards. 
    • Mortgage-Backed Securities looked good because real estate prices were increasing. 
  • As demand continued to rise, all "prime" mortgages were bought up. 
  • In turn, banks began to issue subprime mortgages at lower underwriting standards than before, allowing for lower income owners to buy larger, more valuable homes for little downpayment. 
  • 2006: Real estate prices peaked (they were already very highly overvalued). 
    • people were no longer buying mortgages "for shelter, but to turn a profit."  
    • Over time, subprime mortgages began to default at higher rates as the lower income homeowners began to miss payments. 
    • When the interest rate was raised to 5.25%, default rates rose even more.  
    • By 2007, supply was outweighing demand and housing prices began to crash. 
    • The housing bubble had popped creating a dire domino effect that will be discussed in the next few sections. 
Background & the Real Estate "Bubble"