subprime mortgage crisis, the
AbstractDuring the subprime mortgage crisis of 2007–2008, previously profitable loans to subprime borrowers turned sour and investments thought to be as safe as government debt sustained severe and unexpected losses. The crisis reconfigured the US financial services industry and helped spark the worst economic crisis since the 1930s. While the consequences of subprime losses for Wall Street are well understood, the reason that the crisis occurred is not. The fundamental outstanding question is why so many people made decisions that turned out to be so unprofitable. Millions of borrowers took out loans they could not repay. Thousands of lenders lent them money. And investors advanced billions of dollars, either to fund the firms involved in subprime lending, or to purchase the mortgage-backed securities that these firms created. This article outlines and evaluates two potential explanations for the subprime crisis. One is based on ‘insider/outsider' frictions in the subprime lending industry. The other interprets the crisis as the consequence of a classic asset bubble, which in this case occurred in the US housing market. The article concludes by discussing the implications of these explanations for policies designed to prevent financial crises in the future.
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This chapter was published in: Steven N. Durlauf & Lawrence E. Blume (ed.) , , pages , 2011, 2nd quarter update.
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