In the intricate web of the financial world, perception wields a significant influence over the stock market's health. A robust market is marked by a strong dollar, a narrow trade deficit, and elevated company valuations, fostering a cycle of investment. Conversely, when pessimism looms, a domino effect of economic misfortune often ensues. The pivotal year of 2007 witnessed a downturn in the American stock market, largely attributable to the subprime mortgage fallout.
Unraveling the Subprime Mortgage Saga
At the epicenter of this crisis were subprime mortgages, extending home loans to high credit risk borrowers. These loans, enticingly packaged with low initial interest rates and no down payments, masked an underlying risk. Frequently, borrowers found themselves committed to amounts beyond their financial means, especially considering that many of these subprime mortgages operated as adjustable rate mortgages (ARMs). The reset of interest rates, typically occurring after two years, resulted in higher monthly mortgage payments, often rendering homeowners financially strained.
This predicament triggered a surge in home foreclosures in the United States, soaring by a staggering 75% from 2006 to 2007 [source: CNN Money]. The ramifications, however, transcended the housing sector, creating a ripple effect across various financial domains.
The Evolution of Mortgage Trading
Historically, banks adhered to stringent regulations, issuing mortgages and retaining them until the loans were fully repaid over 15 or 30 years. However, in the mid-1990s, regulatory relaxations aimed at expanding homeownership inadvertently facilitated the easy buying and selling of mortgages. Subprime mortgages became commodities in the hands of stockbrokers, bundled into portfolios, and sold as securities [source: Federal Reserve Bank].
This shift resembled a metastasizing cancer, spreading risk across the financial spectrum. As interest rates reset and home loan payments surged, coupled with external factors such as massive layoffs in the auto industry and real estate speculators defaulting on ARMs, a significant number of homeowners chose to abandon their properties, leaving the associated loans behind [source: Federal Reserve Bank].
The Global Contagion
The fallout extended beyond individual homeowners. Major mortgage lenders, having disbursed funds for these homes, witnessed a sudden evaporation of revenue. Countrywide, the largest U.S. home loan lender, reported a staggering $1.5 billion loss in revenue during the latter half of 2007 [source: AP]. This downturn marked a stark contrast to the more than $2.5 billion in profits reported in 2006, prior to the subprime crisis [source: Fortune].
The contagion wasn't confined to consumer banks; non-consumer banks and institutions deeply entrenched in the subprime market faced the repercussions. Global ramifications ensued as investors worldwide, having purchased subprime mortgages as securities, found themselves entangled in the mire of worthless assets. The entire global economy bore the brunt of the American subprime fallout.
The Precarious State and Government Intervention
In the wake of impending economic catastrophe, significant investment banks and major lenders teetered on the brink of collapse, prompting fears of a stock market crash. Enter the U.S. government, stepping in to salvage the sinking ship of the American economy.
Can a government truly control a stock market crash? The answer unfolds in the subsequent exploration of government intervention and its effectiveness in mitigating the aftershocks of the 2007 stock market crisis.
For an in-depth understanding of how governments grapple with the challenges of controlling a stock market crash, delve into our comprehensive analysis: .
