An Introduction to the Subprime Mortgage Market and the 2008-2009 Financial Crisis

Abstract

Since the beginning of summer 2008, the subprime mortgage market has become a contributing drag on the financial sector, with the S&P index dropping to its lowest level in more than a decade, and the Dow Jones Industrial Average falling below 10,000 for the first time since October 2004. The financial sector turmoil, in turn, worsened the already dreadful situation in mortgage and credit markets. Losses on the subprime mortgage market arose from a two stage process. First, financial intermediaries drove the expansion of the subprime mortgage market. Second, borrowers stopped making payments when default was optimal for their situation.

We often see and hear new stories where the repetition of the terminology convinces us of the importance of the issues. Many do not have the background or knowledge of the evolution of the issues, or lack the framework with which to develop a meaningful understanding. Subprime lending and its significance to current events is one such issue. A primer on subprime lending and its relationship to current events in 2008-2009, it seems, would appear to be a timely exposition.

This paper explores origins of the subprime mortgage lending crisis and gives insights of the impacts subprime mortgages have on the recent financial issues. Finally, some policy options aimed at preventing the crisis from worsening in the future are offered.

Keywords: subprime, lending, crisis, mortgage

JEL Classification: G2, G21