What Caused the 2008 Mortgage Crisis?

The 2008 mortgage crisis was primarily the result of a significant decline in home prices that took place after the collapse of the United States housing bubble between 2005 and 2006. Prior to this collapse, the United States government helped create the housing bubble due to the government's efforts to promote home ownership to low income individuals. This effort spurred the growth of subprime lending.

Lenders were incentivized to grant loans to more individuals, because high capital liquidity and low interest rates gave lenders the opportunity to profit from loan grants. In an attempt to grant more loans, lenders pooled together subprime mortgages and sold them to investors. The proceeds from these sales allowed lenders to grant further loans. More significantly, the viability of subprime loans to provide profit increased the number of consumers who could afford mortgages. On the other hand, because of relatively lax initial terms and the long-term trend of rising housing prices, borrowers had high incentive to take on risky property mortgages.

Demand for housing had outpaced the supply of housing, which led to housing shortages and subsequently raised housing prices, contributing to the sense that mortgages were a safe investment. However, an increase in interest rates by the U.S. Federal Reserve led to a drop in housing prices across many states. A domino effect of defaults and foreclosure soon ensued because borrowers were not able to refinance their loans. Many homeowners went "underwater" at this time. This led to foreclosures on delinquent mortgages and the devaluation of housing-related securities, those bundled subprime mortgages sold by lenders.