What is the Subprime Mortgage Crisis?

The Subprime Mortgage Crisis, fully known as the Subprime Housing Loan Crisis, was a financial crisis triggered by a sharp increase in mortgage defaults and foreclosures in the United States. Beginning in 2007, it swept across the U.S. and spread globally, severely impacting both the American and world economies. The root cause of this crisis was a common housing loan product—subprime mortgages—loans provided by U.S. lenders to borrowers with poor credit, unstable income, and weak repayment capacity.

Seeking higher profits, lenders securitized these subprime loans, repackaging them into Asset-Backed Securities (ABS) and selling them to investment banks to raise funds for continued mortgage lending and interest margin profits. Subsequently, investment banks further repackaged these subprime bonds into Collateralized Debt Obligations (CDOs), transforming them into higher-rated bonds sold to hedge funds, insurance companies, banks, and other financial institutions. Ultimately, these financial products were distributed to investors worldwide.

Risk was silently amplified through each wave of transmission. This chain of capital and bonds, with its positive and negative flows, resembled a line of dominoes—from homebuyers with poor credit and unstable income, to subprime mortgage companies, investment banks, hedge funds, insurers, and banks... All of Wall Street joined in this reckless game, awaiting catastrophic consequences.

Why Did the Subprime Crisis Occur?

The timeline traces back to 2001. Following the dot-com bubble burst and the 9/11 attacks, the U.S. economy fell into recession. To stimulate the sluggish market, the government implemented loose monetary policies, and the Federal Reserve responded swiftly with consecutive interest rate cuts. By January 2003, rates had dropped to a 30-year low of 1%, remaining there until mid-2004. In this ultra-low interest rate environment, borrowing became exceptionally easy, creating an illusion of prosperity in the U.S. housing market as home prices soared.

Correspondingly, various mortgage businesses flourished. However, while low rates sustained economic growth, they also led to twin fiscal and trade deficits, a weakening dollar, rising inflationary pressures, and asset bubbles from excessive liquidity. Compelled to act, the Fed reversed course, tightening monetary policy through aggressive rate hikes that reduced market liquidity.

From June 2004 to June 2006, the Fed raised rates 17 times, increasing the federal funds rate from 1% to 5.25%. Ultimately, rising rates burst the U.S. housing bubble. Borrowers began defaulting, home prices fell, assets became illiquid, banks sold foreclosed properties at losses, and widespread bank failures followed. Wall Street institutions collapsed like dominoes, with the top five U.S. investment banks severely impacted, further destabilizing the entire market.