Abstract
During the subprime mortgage crisis of 2007–2008, previously profitable loans to subprime borrowers turned sour and investments thought to be as safe as government debt sustained severe and unexpected losses. The crisis reconfigured the US financial services industry and helped spark the worst economic crisis since the 1930s. While the consequences of subprime losses for Wall Street are well understood, the reason that the crisis occurred is not. The fundamental outstanding question is why so many people made decisions that turned out to be so unprofitable. Millions of borrowers took out loans they could not repay. Thousands of lenders lent them money. And investors advanced billions of dollars, either to fund the firms involved in subprime lending, or to purchase the mortgage-backed securities that these firms created. This article outlines and evaluates two potential explanations for the subprime crisis. One is based on ‘insider/outsider’ frictions in the subprime lending industry. The other interprets the crisis as the consequence of a classic asset bubble, which in this case occurred in the US housing market. The article concludes by discussing the implications of these explanations for policies designed to prevent financial crises in the future.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Bibliography
Adrian, T., and H.S. Shin. 2010. The changing nature of financial intermediation and the financial crisis of 2007–2009. Annual Review of Economics 2: 603–618.
Akerlof, G.A. 1970. The market for ‘lemons:’ Quality uncertainty and the market mechanism. Quarterly Journal of Economics 84(3): 488–500.
Allen, F., and D. Gale. 2007. Understanding financial crises. New York: Oxford University Press.
Baker, D. 2002. The run-up in home prices: A bubble. Challenge 45(6): 93–119.
Barr, A. 2007. Subprime mortgage derviatives index plunges. MarketWatch, February 23. http://www.marketwatch.com/story/index-of-subprime-mortgage-derivatives-plunges-on-sector-woes
Brooks, R., and R. Simon. 2007. Subprime debacle traps even very credit worthy. Wall Street Journal, December 3.
Brunnermeier, M.K. 2008. Bubbles. In The new Palgrave dictionary of economics, 2nd ed., ed. S.N. Durlauf and L.E. Blume. Basingstoke: Palgrave MacMillan. http://www.dictionaryofeconomics.com/article?id=pde2008_S000278
Bubb, R., and A. Kaufman. 2009. Securitization and moral hazard: Evidence from a lender cutoff rule. Federal Reserve Bank of Boston Public Policy Discussion Paper No. 09-5. http://www.bos.frb.org/economic/ppdp/2009/ppdp0905.pdf. Accessed 6 June 2011.
Coval, J., J. Jurek, and E. Stafford. 2009. The economics of structured finance. Journal of Economic Perspectives 23(1): 3–25.
Favilukis, J., S.C. Ludvigson, and S. Van Nieuwerburgh. 2009. The macroeconomic effects of housing wealth, housing finance, and limited risk-sharing in general equilibrium Working paper, New York University.
Foote, C.L., K. Gerardi, L. Goette, and P.S. Willen. 2008a. Just the facts: An initial analysis of subprime’s role in the housing crisis. Journal of Housing Economics 17(4): 291–305.
Foote, C.L., K. Gerardi, and P.S. Willen. 2008b. Negative equity and foreclosure: Theory and evidence. Journal of Urban Economics 64(2): 234–245.
Gerardi, K., P. Willen, S.M. Sherlund, and A. Lehnert. 2009. Making sense of the subprime crisis. Brookings Papers on Economic Activity 2008(2): 69–159.
Gerardi, K. S., C.L. Foote, and P.S. Willen. 2010. Reasonable people did disagree: Optimism and pessimism about the U.S. housing market before the crash. Federal Reserve Bank of Boston Public Policy Discussion Paper No. 10-5. http://www.bos.frb.org/economic/ppdp/2010/ppdp1005.htm. Accessed 6 June 2011.
Greenlaw, D., J. Hatzius, A.K. Kashyap, and H.S. Shin. 2008. Leveraged losses: Lessons from the mortgage market meltdown. Proceedings of the U.S. Monetary Policy Forum. http://research.chicagobooth.edu/igm/events/docs/ USMPF-final.pdf. Accessed 6 June 2011.
Hilzenrath, D.S. 2008. Fannie’s perilous pursuit of subprime loans. Washington Post, August 19. http://www.washingtonpost.com/wp-dyn/content/article/2008/08/18/AR2008081802111_pf.html. Accessed 6 June 2011.
Himmelberg, C., C. Mayer, and T. Sinai. 2005. Assessing high house prices: Bubbles, fundamentals, and misperceptions. Journal of Economic Perspectives 19(4): 67–92.
Keys, Benjamin, Tanmoy Mukherjee, Amit Seru, and Vikrant Vig. 2010. Did securitization lead to lax screening? Evidence from subprime loans. Quarterly Journal of Economics 125(1): 307–362.
Kiyotaki, N., and J. Moore. 1997. Credit cycles. Journal of Political Economy 105(2): 211–248.
Lehman Brothers Fixed Income Research. 2005. U.S. ABS Weekly Outlook: HEL Bond Profile Across HPA Scenarios. August 15.
Lo, A.W., and A.C. MacKinlay 2001. A non-random walk down wall street. Princeton: Princeton University Press. http://press.princeton.edu/books/lo/
Mayer, C., K. Pence, and S.M. Sherlund. 2009. The rise in mortgage defaults. Journal of Economic Perspectives 23(1): 27–50.
Mian, A., and A. Sufi. 2009. The consequences of mortgage credit expansion: Evidence from the U.S. mortgage default crisis. Quarterly Journal of Economics 124(4): 1449–1496.
Muolo, P., and M. Padilla. 2010. Chain of blame: How wall street caused the mortgage and credit crisis. New York: Wiley.
Onaran, Y., and D. Pierson. 2008. Banks’ subprime-related losses surge to $591 billion: Table. Bloomberg, September 29. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSlW.imTKzY8. Accessed 6 June 2011.
Simon, R., and J.R. Hagerty. 2005. How American lenders shelter themselves. Wall Street Journal, September 22.
Smith, V.L., G.L. Suchanek, and A.W. Williams. 1988. Bubbles, crashes, and endogenous expectations in experimental spot asset markets. Econometrica 56(5): 1119–1151.
Sorkin, A.R. 2010. Too big to fail: The inside story of how wall street and Washington fought to save the financial system – and themselves. London: Penguin.
Stiglitz, J.E. 2010. Freefall: America, free markets, and the sinking of the world economy. New York: Norton.
Warren, E. 2010. Priorities for the New Consumer Financial Protection Bureau. Remarks at the Consumer Federation of America Financial Services Conference, December 2. http://www.treasury.gov/press-center/press-releases/Pages/tg987.aspx. Accessed 6 June 2011.
Zimmerman, T. 2005. Subprime home equities: It’s (almost) all about house prices. UBS Conference Call Presentation, September 26.
Acknowledgments
The views herein are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of Boston or the Federal Reserve System.
Author information
Authors and Affiliations
Editor information
Copyright information
© 2018 Macmillan Publishers Ltd.
About this entry
Cite this entry
Foote, C.L., Willen, P.S. (2018). Subprime Mortgage Crisis. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95189-5_2998
Download citation
DOI: https://doi.org/10.1057/978-1-349-95189-5_2998
Published:
Publisher Name: Palgrave Macmillan, London
Print ISBN: 978-1-349-95188-8
Online ISBN: 978-1-349-95189-5
eBook Packages: Economics and FinanceReference Module Humanities and Social SciencesReference Module Business, Economics and Social Sciences