Do Economic Crashes Happen Overnight?

Digital representation of an economic crashThe subprime mortgage crash in April 2007 was not a sudden event. There were warning signs that it was going to happen, even though it seemed like it happened overnight.

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So, what happened with subprime mortgages in 2007? Here are some of the key factors that contributed to the subprime crash:

1. Easy access to credit. In the early 2000s, banks and other lenders began offering easy credit to borrowers, including those with poor credit histories. This led to a rapid expansion of the subprime mortgage market and fueled a housing bubble.

2. High-risk mortgages. Many subprime mortgages were high-risk loans that had low initial interest rates that would later reset to higher rates. Borrowers who took out these loans often did not fully understand the terms and risks involved, and arguably the banks created these kinds of loans knowing they could never be paid back.

3. Securitization of mortgages. Lenders began pooling together large numbers of mortgages and selling them as mortgage-backed securities to investors. This allowed lenders to offload the risk of default onto investors and encouraged the creation of more high-risk mortgages. Additionally, there was usually no paper trail showing that these loans were actually transferred to the mortgage backed security.

4. Housing bubble. As demand for homes increased and easy credit continued to flow, home prices began to soar. However, the rapid increase in home prices was not sustainable and ultimately led to a housing bubble.

5. Financial crisis. The subprime mortgage crisis was triggered by a wave of defaults and foreclosures, which began in 2006 and accelerated in 2007. The collapse of the housing market and the high rates of mortgage defaults led to a broader financial crisis that impacted the global economy.

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