What caused the financial Crisis?

Written by: Liwin Troy Lee

The current financial crisis started in September 2008 with the failure of some financial institutions like the Lehman Brothers. The cause was from people who brought homes and could no longer make payments on their subprime mortgage loans. The word "subprime" means loans that start out with low interest rates but after a few years, the interest rate goes up. Subprime loans do not require a lot of verification. For example, the lender does not check if the borrower has a job.

When the home prices were rising and the borrowers had difficulty paying back their loan, they could always sell their home for profit and pay the money back. However, when the home prices were falling, the homeowners would lose their homes to foreclosure. That is the lender takes back the home. As a result, the bank institution who lends the money loses revenue.

Investment firms who created mortgages for lenders bought mortgage-back securities. Mortgage-back securities are bundling of between 1000 to 1500 individual mortgages into one entity. Investment firms also borrowed money to buy bad debts. The use of the borrowed money is called leverage. As a result, when the mortgages went bad, some of these financial institutions went bankrupt. The collapses of companies like the Lehman Brothers caused investors to go into a panic. The impact of this is it caused the stock price to decline.

Many bank and lenders stopped offering loans because they feared that they would no be repaid. Without credit, businesses slowed down and companies laid off workers. Those workers reduce their spending and it hurts other businesses. These workers go to restaurants less and buy less clothes. As a result, those stores lose businesses and they have to lay off workers. This spread throughout the whole economy. Thus, the cause of the financial crisis.

Sources:

Global Financial Crisis 2008 to 2009

US financial crisis began with Subprime mortgages

What Caused the Economic Crisis of 2008?