Credit Crunch
2007: What Is At The Root Of Today's Economic Unrest?
If you are starting
to get curious as to how today's economic troubles all started, you are not alone.
To understand what went wrong requires a trip back in time to the origins of the
2007 credit crunch. There is one financial term
that you need to understand if you want to grasp why we are facing the economic
downturn that is happening right now: subprime lending. This lending practice
took effect in the 1990s as a new way for banks to pull in large profits in what
they believed was a safe market. As with anything in life, if you take it too
far the foundation will crack and everything will fall apart. That is exactly
what happened with subprime lending which led to the big credit crunch 2007. Subprime
lending is when a bank loans money to people who do not qualify under the regular
guidelines. Usually these people have bad credit, which makes them less likely
to pay back a future loan. Subprime lending takes on these risky loans but the
borrower must pay a higher interest rate, and with credit cards they usually face
much higher late payment fees. This was originally seen as a way for people with
bad credit to redeem themselves; allowing them to prove they can make payments
and then refinance under better terms later on. Unfortunately,
the lenders got carried away with this and started extended these risky loans
to more people than ever before. By 2006 an unprecedented number of loans were
subprime and by 2007 a large percentage of these loans were in default. Most
of these subprime loans were in the residential housing market. The price of housing
was on the rise in the late 1990s, as more and more of these loans were given
to people who did not have the credit or the income to qualify for normal loans.
When the price of housing started to drop homeowners found they owed more on their
loans than the property was worth and they started to default on the loans. In
addition, many subprime loans had adjustable rates, which means the monthly payments
increase with time. People were led to believe they could refinance their loans
into fixed rates before the payments got too high, but that did not work out for
a majority of them. When their monthly payments jumped far beyond their potential
to pay, the foreclosure crisis began. Today's economic
unrest actually began with the credit crunch of 2007. In turn, the credit crunch
2007 was caused by loose subprime lending practices by lenders who saw the potential
to make big profits off origination fees on these loans. They were able to collect
the fees from opening up the loans and then sell the loans to investors, bringing
in cash flow they could use without waiting for the loans to be paid back. The
foundation of all of this was the housing market, and that did not hold up as
we all know from the credit crunch 2007. Extending risky loans to people who had
proven track records of defaulting, and who often did not have the income to sustain
the loans to begin with, is the root to much of the economic unrest spinning around
the world today.
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