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What caused the subprime mortgage crisis?
“Subprime” refers to mortgages made to borrowers considered higher risk than borrowers in the prime market. In the early and mid-2000s, lenders expanded this kind of credit. Many loans were pooled and sold as private-label mortgage-backed securities, which became a major source of funding for subprime lending. That structure connected mortgage performance to investors and financial firms well beyond the original lender.
Rising home prices helped make the risks look manageable. A borrower who struggled with payments might be able to sell the home or refinance; lenders and investors could expect the home’s value to limit losses. But when housing activity peaked and prices fell, selling or refinancing became harder. More borrowers struggled to make payments, and mortgage losses prompted downgrades of securities and growing concern about exposure to subprime debt. Funding became more difficult, lenders pulled back, and foreclosures added homes to a weakening market.
The result was a feedback loop rather than a single triggering event: falling prices increased losses and foreclosures; losses weakened confidence and funding; tighter credit and additional foreclosures put further pressure on prices. The Financial Crisis Inquiry Commission concluded that the crisis was avoidable and resulted from human actions, inactions and misjudgments. That is the Commission’s assessment, not a claim that one cause alone explains the crisis.
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How the crisis unfolded
| Period | What happened |
|---|---|
| Early to mid-2000s | Riskier mortgage credit expanded, with private-label mortgage-backed securities providing much of the funding for subprime lending. Rising home prices supported expectations that borrowers could sell or refinance if payments became difficult. |
| 2005 | Subprime loans accounted for about one-fifth of new mortgage originations at their peak, according to Federal Reserve History, drawing on HUD (2000) and Avery, Brevoort and Canner (2007). |
| 2006 | U.S. housing activity peaked and residential construction began to decline. Federal Reserve History reports that average U.S. home prices more than doubled between 1998 and 2006, the sharpest increase recorded in the history described in that account. |
| April 2007 | New Century Financial, a major subprime lender, filed for bankruptcy. Mortgage-backed securities were downgraded and other subprime lenders closed. |
| August 2007 | Funding-market stress surfaced, including in asset-backed commercial paper, as investors grew wary of exposure to subprime mortgages. |
| December 2007 | The U.S. recession began, according to the National Bureau of Economic Research chronology reported by Federal Reserve History. |
| Spring 2008 | Bear Stearns was acquired by JPMorgan Chase with Federal Reserve assistance. |
| Summer 2008 | Fannie Mae and Freddie Mac suffered large losses and were seized by the federal government, as recounted in Federal Reserve History’s account of the subprime crisis. |
| September 2008 | Lehman Brothers filed for bankruptcy; the Federal Reserve provided support to AIG the following day. |
| Late 2008 | The Federal Reserve lowered its federal funds target range to 0–0.25 percent and began large-scale asset purchases, including agency mortgage-backed securities and longer-term Treasury securities. |
| June 2009 | The Great Recession ended. Economic weakness and a slow recovery continued. |
| 2010 | Congress enacted the Dodd-Frank Act, adding financial oversight and resolution provisions for large, systemically important firms. The wider crisis and aftermath are often dated through 2010, beyond the recession’s endpoint. |
How the crisis differed from the Great Recession
The terms describe related but distinct things. The subprime mortgage crisis began with a high-risk segment of the housing market; the financial crisis involved broader funding disruptions and stress at major institutions. The Great Recession is the specific U.S. economic contraction dated by the National Bureau of Economic Research.
| Term | What it describes | Time frame used here |
|---|---|---|
| Subprime mortgage crisis | Problems originating in higher-risk mortgage lending and the housing market. | Its effects unfolded through the broader financial turmoil; accounts often discuss the crisis and aftermath as extending through 2010. |
| Financial crisis | Wider funding-market and institutional stress as mortgage losses and uncertainty spread. | Intensified in 2007–08; its effects and policy response continued after the recession ended. |
| Great Recession | The dated U.S. economic contraction. | December 2007 to June 2009. |
How the housing crisis affected the economy
Housing losses reached the wider economy through several reinforcing channels, as Federal Reserve History describes:
- Construction and related jobs: As housing activity weakened, residential construction declined, reducing work and income in construction and related industries.
- Household wealth and spending: Falling home values reduced household wealth. Households facing lower wealth and greater uncertainty cut spending, weakening demand for businesses.
- Financial-sector lending: Mortgage losses and uncertainty damaged financial firms’ balance sheets and confidence in counterparties. Weaker firms and tighter funding meant less capacity or willingness to lend.
- Business funding: Firms also faced reduced access to securities-market funding, making it harder to finance operations and investment.
The downturn was severe by several historical measures. Federal Reserve History’s 2013 account reports that real GDP fell 4.3 percent from its 2007 fourth-quarter peak to its 2009 second-quarter trough, and that the Great Recession lasted 18 months. In the same account, U.S. household and nonprofit net worth fell from about $69 trillion in 2007 to $55 trillion in 2009.
Unemployment rose from less than 5 percent to 10 percent during the downturn; Federal Reserve History’s recession account specifies that it reached 10 percent in October 2009, after the recession had ended. Average U.S. home prices fell by more than one-fifth from the first quarter of 2007 to the second quarter of 2011, according to Federal Reserve History’s account of the recession and aftermath.
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What policymakers did—and what followed
The Federal Reserve lowered short-term interest rates, provided liquidity through lending programs and bought agency mortgage-backed securities and longer-term Treasury securities. These steps were intended to support housing and broader financial conditions. By late 2008, the federal funds target range had reached 0–0.25 percent.
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Congress’s 2010 Dodd-Frank Act added oversight of systemically important financial institutions and tools for handling the failure of large firms. Federal Reserve History identifies orderly liquidation authority and “living wills” among the new provisions. These measures addressed the risks posed by large financial firms; they did not make the recession’s effects disappear. Although the recession ended in June 2009, unemployment remained elevated and recovery was slow.
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The Financial Crisis Inquiry Commission’s official report is a book-length investigation with chapters on subprime lending, funding disruptions, institutional failures and takeovers, economic fallout and foreclosures. Its conclusions page states: “The Commission concluded that this crisis was avoidable—the result of human actions, inactions, and misjudgments.”
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