How did the housing bubble and subprime crisis turn into the financial crisis?
The deflation of the housing bubble led to the subprime crisis. During the housing bubble, when the market was growing, banks began to take on excessive mortgage risk, with particular exposure to subprime securities. When home prices started to decrease and it became increasingly difficult to sell a house, subprime borrowers were unable to avoid increased interest rates and payments on their adjustable-rate mortgages. This led to the beginning of increased delinquencies, foreclosures, and home abandonments. And the defaults led to value decline for many of the mortgage-backed securities (see Q4). As the value of mortgage-backed securities began to fall, and delinquencies and foreclosures began to rise, financial institutions became more conservative and started to accumulate reserves. No one was sure what the mortgage-backed securities in the marketplace were worth, and no one was sure how much “toxic debt” was hidden on bank balance sheets. The host of unknowns combined with lenders’
