In 2007, the United States economy entered a subprime mortgage crisis with the panic on the Wall Street and caused the financial stock market crash of global proportions. From the Great Depression there have been numerous crises with serious consequences, but the last one could be argued as the most severe.
Historically, the United States financial sector was very heavily regulated by the Glass–Steagall Act which separated commercial and investment banks. It also set strict limits on banks interest rates and loans. Starting in the 1980s, substantial deregulation took place in banking sector.
The Gramm–Leach–Bliley Act of 1999 allowed commercial and investment banks to merge, which led to the existence of many risky products. Greed and fraud that played important parts in the Great Depression, once again overcame the rational expectations.
Strong economic growth caused the housing bubble and set up the foundations for the subprime mortgage crisis. Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing market boom and encouraging debt-financed consumption. The United States home ownership rate increased from 64% in 1994 to an all-time high of 69.2% in 2004. Subprime lending was a major contributor to this increase in home ownership rates and in the overall demand for housing, which drove prices higher.
The housing bubble and mortgage issues
The mortgage crisis was a result of too much borrowing and flawed financial modeling, largely based on the assumption that home prices will go up. Owning a home is part of the American culture, allowing the people to take pride in a property and engage in a community for the long term. However, homes are expensive and most people need to borrow money to get one. Between 1997 and 2006, the price of the typical American house increased by 124%. In the history of banking, banks would usually refuse to lend money to people with poor credit history or no income. The qualification guidelines to get a mortgage were pretty tight.
In the early 2000s, mortgage interest rates were low, which allowed ordinary people to borrow more money at a lower monthly payment. Home prices increased steadily at the time, so buying a home seemed like a sure bet. To get cash out of their equity homeowners took second mortgages, in order to maintain a certain lifestyle or to invest it further. The housing bubble thus resulted in large numbers of homeowners refinancing their homes or financing consumer spending by taking out second mortgages.
United States household debt as a percentage of annual disposable personal income was 127% at the end of 2007. The bubble was here alive and well, but it is common knowledge that everything in life has limits. Subprime mortgage crisis started in 2007 with the collapse of the housing bubble, when all the risky financial derivatives crashed the Wall Street. It pushed the United States economy into recession, as well as most of the economies worldwide.