The late 2000s mortgage crises, also known as the subprime mortgage crises, brought the global financial system down. In September 2009, 14.4% of all outstanding U.S. mortgages were delinquent or in foreclosure.
The global pool of money, which is sum total of all of the world’s savings, had about roughly $36 trillion by the year 2000 and by 2006, that money increased to $70 trillion. Since the number of good investment did not have enough time to keep up with the increased savings. Since the global pool of money could not invest its money in treasury bonds, which how it usually invested its money, due to the low interest rate, they turned to mortgages.
A system that developed that would start with a person needing mortgage and ending in the global pool of money. The way it worked was that a person would go to a mortgage broker with all of his or her proper tax documentation and credit checks and take out a mortgage. The mortgage broker would then sell the mortgage to a bank, which would then sell it to an investment firm on Wall Street, such as Bear Stern. The investment firm, Bear Stern, would then sell the mortgages it received from the bank and sell shares of them to the global pool of money.
This was great for the global pool of money until the mortgage brokers started running out of people to give a mortgage to. So mortgage brokers started luring in buyers with poor credit into accepting housing mortgages with little or no down payment and without proper tax documentation and credit checks, due to the amount of commission they were promised. Since the mortgage brokers were not the ones who were loaning out the money, they did not care as to what type of buyers they were giving housing mortgages to. These loans, usually adjustable rate mortgages (ARMs), which are a type of mortgage in which the interest rate paid on the outstanding balance varies according to a specific benchmark, were known as subprime mortgages.
The new homeowners saw a rising value of their previously foreclosed homes during the initial year or so of their mortgages, and frequently took out home equity loans for extra cash. In addition, banks and financial institutions often repackaged these debts with other high-risk debts and sold them to worldwide investors creating financial instruments called CDOs or collateralized debt obligations. What banks basically did was buy the mortgages and put them in a box. Now, every month the banks get payments from homeowners. Then the mortgages are split into three separate stacks, which are safe, okay, and risky. They then pack the three stacks back in the box and call it CDOs. A CDO works like three cascading trays; as money comes in, the top tray, safe, gets filled first, then the second try, okay, and finally, the third tray, risky. The money comes from homeowners who are paying off their mortgages and if some owners do not pay their mortgages or default, less money comes in. This makes the top tray safer and bottom tray a riskier. To compensate for the higher risk, the bottom tray receives a higher rate of return, while the top receives a lower rate. To make the top tray even safer, banks will ensure it for a small fee called a credit default swap (CDS). Then credit rating agency then rates the top tray with AAA and the okay tray with BBB, but they do not bother rating the risky tray. The banks would then sell the safe tray to investors, the okay tray to other bankers, and the risky tray to hedge funds and other risk takers.
Since mortgage brokers started given out subprime mortgages, more people stopped paying their mortgages. Now the banks’ monthly payments started turning into houses instead of money. Now there are many more houses for sale on the market creating more supply then there is demand that housing prices start to plummet. Now homeowners who are still paying their mortgage find out that the price of their house is plummeting and that their mortgage is worth more than house, they walk away from the house. Now the bank has all these worthless CDOs and no one wants to buy them. Now everyone is going bankrupt, including the investors, the brokers, and the lenders.
Losses on mortgage-backed securities and other assets purchased with borrowed money have dramatically reduced the capital base of financial institutions, rendering many either insolvent or less capable of lending. Governments have provided funds to banks. Some banks have taken significant steps to acquire additional capital from private sources.
The U.S. government passed the Emergency Economic Stabilization Act of 2008 (EESA or TARP) during October 2008. This law included $700 billion in funding for the "Troubled Assets Relief Program" (TARP), which was used to lend funds to banks in exchange for dividend-paying preferred stock.
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