What Caused The Financial Crisis? Essay

2264 Words 10 Pages
The roots of the financial crisis can be traced back to the property asset bubble in the US between 1997 and 2006. This asset bubble was enabled by a poorly regulated subprime mortgage industry and the assumption that property prices would continue to rise. The collapse of the property bubble and subsequent foreclosures led to many financial institutions suffering huge losses due to their exposure to the subprime market through a series of innovative and complex investment vehicles. While these investments carried extra risk, they also gave the opportunity for massive short term returns, and the move to these riskier and more complicated financial investments may have been facilitated by a ‘too big to fail’ mentality by many US financial …show more content…
While there is nothing inherently wrong with lending to borrowers who have a poorer credit rating, standards were relaxed to a point where mortgages were issued without full disclosure of documentation, with the “rationale for such risky lending that house prices were appreciating rapidly and had not fallen in the United States since the 1030’s” (Dodd & Mills 2008). As is the nature with bubbles, nobody noticed that what was happening in the proprty8 market and it was assumed that prices would continue to rise. Smaller down payments were required which increased the loan-to-value ratios and loans with high LTVs are extremely risky as the borrowers have no equity in their home and “have a strong incentive to default if it becomes difficult to maintain mortgage payments” (Jarsulic 2010). The relaxation of mortgage underwriting standards was helped by the house price bubble and the “rapid creation of borrower equity masked the underlying weakness of the loans that were being made” (Jarsulic 2010), if a borrower fell behind on their payments, the increased value of the house enabled a refinancing or they could simply sell off the house with the increased value covering any outstanding repayments and a move to a smaller house.
These risky loans and poor underwriting practices were enabled “through a distinct and lightly regulated

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