The Origins of the Mortgage Crisis in the USA


The World financial crisis of 2007-2010 is considered to be the strongest collapse since the Great Depression. It started in the US and gradually grasped the national economies throughout the World. The following factors are considered to be the reasons for the World crisis:

  • US monetary policy;
  • Huge disbalance in the World economy;
  • The mortgage crisis of 2007.

After the peak of the crisis seems to be behind, the public has shown a strong interest in those responsible for the economic collapse of 2007 caused by the mortgage boom. Last time, a wave of investigation has reached the supposed “initiators”. Throwing light on the crisis mechanism and those who are to blame for the collapse is extremely important in terms of further decision-making at all levels of the national economy, as well as forming a notion about the condition of the national regulation. This work is aimed at considering the main reasons for the mortgage crisis of 2007 and defining the responsibility for it.

Monetary policy is a set of procedures implemented by a government, central bank, or monetary authority focused on the regulation of money supply, currency rate, and rates of interest. The function of the monetary policy is to provide growth and stability to the national economy. However, the balance between growth and stability in financial regulation has always been “a point of contention” (Greenspan, 2010).

The mortgage crisis is connected to the notion of a high-risk loan, which implies granting loans to subprime borrowers at excessive interest rates and fees (Rose, 2010). Today it becomes clear that the danger of high-risk loans was rather underrated. A market economy is based on a principle which implies that demand defines the volume of supply. The XX century has brought the following paradox: huge supply can give rise to the demand. Theoretically, this will repeat many times and make the economy flourishing. However, economic growth requires a perpetual consumption boom, which becomes the reason for the banks to grant numerous loans of huge volumes.

In the case of the US mortgage crisis, this situation took place for a long time, until the banks have decreased the standards and began to work with the subprime borrowers. Thus, the mortgage market has become a weak link: at first sight, it seems to be protected quite well, having a guarantee in the real estate mortgage; however, when a bank tries to sell it, the market proves to be saturated with numerous similar propositions. As a result, this affects not only the bank but also a building company, its suppliers, etc.

The mortgage crisis in the USA was provoked by the mortgage boom, based on the subprime loans

The mortgage giants Fannie Mae and Freddie Mac are often considered responsible for triggering the crisis. These key players in the mortgage market were able to influence the market, creating a great demand for high-risk loans. These loans were packaged into securities and resold (Wagner, 2010). The same actions are incriminated to Washington Mutual, which sold such bonds on Wall Street. WaMu is considered to stimulate its loan officers to increase the number of subprime mortgage loans closed (Gordon, 2010). Such pillars of the US economy as Citibank, J.P. Morgan, Morgan Stanley, and AIG have taken part in this derivative trade.

The investigation has shown, that WaMu practiced illegal operations, including fabricating loan documents (Gordon, 2010). The activation of packaging subprime mortgage loans into securities was caused by the deterioration of underwriting standards. In effect, between 2002 and 2006 the volume of subprime mortgage pools has increased significantly and reached 20% of those in all US (Greenspan, 2010). This “joint effort” of Fannie and Freddie, and the Wall Street players on saturating the market with the toxic mortgage securities has led to the near-catastrophic situation.

However, it would be rather hasty to put the whole blame on the mortgage market giants. When the rules of the game have holes, a player always uses them to win. The companies mentioned above are rather powerful, but first of all, they are economic agents, which need to get profit and compete with the contenders in the market struggle, which makes the management, like it or not, commit frauds. The companies can be blamed for overlooking the possibility of collapse; however, firstly, they could hardly estimate the whole scale of the tendency boiling up; besides, this fraud has made a net, where the whole top of the market giants has fallen in.

To imagine the scale of these “cobwebs”, it is sufficient to observe the testimony of Richard Bowen, the former mortgage executive from Citigroup Inc. (Testimony of Richard Bowen), and the numerous “warning issues” mentioned in it. Particularly, the contradictions in the field of the mortgage have a history of several years: in his testimony, Richard Bowen has claimed that yet in 2006 he found out that over 60 percent of the mortgages that passed through Citifinancial Mortgage do not correspond to the Citigroup’s underwriting standards (Wagner, 2010). Bowen marks, that the necessary measures were not taken.

It becomes clear, that the market players are not able to keep the balance on their own. The regulators cannot rely on the companies’ “consciousness” and risk management procedures: instead, they should provide a clear guideline for maintaining the market balance.

The FRS has not managed to fulfill its responsibilities of maintaining safety and stability included in its mission.

“Regulators can readily identify underpriced risk and the existence of bubbles, but most importantly they cannot, except by happenstance, effectively time the onset of crisis”, says Greenspan in his report (Greenspan, 2010). Having faced serious accusations in causing the crisis, he has expressed his view upon the role and possibilities of the regulators. “The major failure of both private risk management and official regulation was to significantly misjudge the size of tail risks that were exposed in the aftermath of Lehman default”, says Greenspan in his work (Greenspan, 2010).

Thus, he considers the regulation and the risk management to be equally responsible for the crisis, if not the risk management is to be blamed more. At the same time, he blames foreign regulators, as well as the US rating agencies, financial companies, and even traditional monetary theory. By his statements, Greenspan, known for his liberal style of regulation, also claims that the FRS should stay aside from the active regulation in the future.

At the same time, the economist does not agree to the invalidity of his policy which implied maintaining low-interest rates. Opposing to general indignation at reducing the FRS short-term rate from 6.5% to 1% in 2003, Greenspan argues that those were the long-term 30-year mortgage rates which were reduced by injecting huge volumes of developing markets’ liquid assets into the global financial system (Greenspan, 2010). However, the connection between the interest rate and the situation on the mortgage market is obvious: the low rate has to lead to the demand increase, the mortgage boom, and the huge volume of loans. Besides, if Greenspan had known about the reduced long-term rates, it would be logical for him to have assumed, that his policy of reducing the short-term rates would hardly relieve the situation, if not vice versa.

It is necessary to mention, that the matter of time has played a significant role in the crisis. Gradually the economic think tank has come up with an idea that late decisions and inaction have contributed to the crisis not less than the destructive processes themselves. One by one, numerous remarks about delays in decision-making began to appear in the mass media. The former California state treasurer Phil Angelides mentioned, that the staff of the FRS gave an advance recommendation about “broad prohibitions on deceptive lending”, which was not considered properly by Greenspan (Wagner, 2010).

The frightening tendency has been noticed yet in 2004; moreover, Greenspan has mentioned in his monograph, that yet in 2002 he expressed his concerns about the fact that the boom on the mortgage market can not be perpetual.

After this, however, Greenspan admits his blame only in terms of “overlooking”, although since that time the FRS still has not taken any measure besides fulfilling usual responsibilities on monetary regulation. Greenspan can be blamed not only for the monetary policy itself but although for doing nothing but implementing the monetary policy. Angelides was indignant that Greenspan did nothing “to contain abusive, deceptive subprime lending” (Wagner, 2010). He also remarked that the measures taken by the FRS covered only 1 percent of the subprime lending volume.

An eternal question of balance between free market and regulation, liberalism, and intervention arises again when considering Greenspan’s policy. He has always kept his liberal point of view, practicing minimal interference in the market. The events of 2007 have shown, that the Fed’s responsibilities should not have stayed within the limits of using tools of monetary policy to control the US mortgage market. To solve the conundrum of the Fed’s responsibilities, it is sufficient to look at the formula of its mission (Mission of the Federal Reserve System), which includes the following points:

  • executing the national monetary policy considering the money supply and crediting fields;
  • providing control upon the banking institutions to provide the safety of the whole financial system;
  • managing with the systemic risk that may take place in the national financial markets.

It is obvious, that Greenspan limited Fed’s responsibility only by the first statement, although the second and the third points are right about preventing the crisis. The reason for this limitation looks ambiguous: besides liberal policy in the regulation, Greenspan has also shown his groundless unconcern, predicting that the diverse range of financial instruments has strengthened the whole financial system and now can dilute the risks. In other words, Greenspan not only considered hindering the bubble burst to be an issue outside the Fed’s competence; he did not believe in the bubble burst itself.

The regulation of the market of derivatives has proved to be not able to provide the transparency necessary for avoiding destructive effects. The huge volume of underlying financial instruments has contributed to the appearance of the crisis (Dodd’s Banking Bill). To overcome this situation, it is necessary to make trade more transparent and move it to the exchanges and clearinghouses.


Greenspan outlines the after-crisis measure necessary to take: to toughen requirements on banks in terms of capital volume and liquidity (Greenspan, 2010). However, the most evident answer is concerned with the Fed and its functions: the organization must accept the realities and face the global changes in the financial system. This reality consists at the minimum of the derivatives’ excessive growth, insufficient transparency of the financial market, and the domination of risk-taking behavior of investment banking upon the conservative culture of that commercial. Nowadays it has become obvious, that the market needs the Fed’s regulation, and it should not be limited only by the monetary policy. It is talked not about the radical reform, but about executing its responsibilities of maintaining safety and stability which are included in its mission.

List of References

Bowen, R. (2010). Testimony of Richard M. Bowen, III. Web.

Dodd’s Banking Bill Doesn’t Do Enough, Many Experts Say. Yahoo.Finance. Web.

Greenspan, A. (2010). The Crisis. Brookings.Edu. Web.

Gordon, M. (2010). Top ex-WaMu executives come before Congress. YahooNews. Web.

Gordon, M. (2010). Ex-WaMu Execs Defend Bank’s Actions Before Failure. YahooFinance. Web.

Mission of the Federal Reserve System. Board of Governors of the Federal Reserve System. Web.

Rose, P. S., & S.C. Hudgins. (2010). Bank Management and Financial Services. 8th ed. Boston: McGraw-Hill/Irwing.

Wagner, D. (2010). Ex-Citi exec says he warned Rubin on mortgage risk. Yahoo.Finance. Web.

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