Economic history · The 2008 Financial Crisis
Six steps, about nine minutes, and a question at each. You need no economics and no preparation, only a willingness to guess before you are told.
This is where the crisis begins, and it begins with a bet few of the people making it had ever stated.
Six steps on the assumption underneath American lending, on how far prices actually fell, on where they broke first, and on whose money was funding all of it.
What this module covers
Written for every level. Tap any underlined word for what it means, and open the boxes below for the economics behind each decision. If you already know the theory, skip both and the history reads straight through.
Step 1 of 6
House prices in America had not fallen across the whole country since the 1930s.
A lender who believes that can lend against the house instead of against the person. The house is sold if the payments stop, and a house that cannot fall in value everywhere at once always covers the loan.
The Federal Deposit Insurance Corporation, the American body that stands behind money held in banks, wrote afterwards that the United States had not experienced large nationwide declines in house prices since the Great Depression.
So the safety of a loan made in 2005 did not turn on what the person earned. It turned on a price never falling everywhere at once.
The Case-Shiller index follows what the same houses go for from one sale to the next. It is set at 100 index points for January 2000, and in July 2006 it stood at 184.6 index points.
Only the houses that change hands have a price at all. An index takes those sales and follows the same house from one sale to the next, so what it measures is the change in what a given house fetches rather than the mix of houses that happened to sell. It is set at 100 in a chosen month, and every later number is that month multiplied. 184.6 index points means a house was worth 84.6 per cent more than in the month the scale starts.
So the average American house had gained about eighty-five per cent in six and a half years, and the loans of those years were written against that.
The index reached its lowest point in February 2012, at 134.0 index points, and no month in between was lower.
How far did American house prices fall from that peak in July 2006 to the bottom in February 2012?
For scale. The Federal Deposit Insurance Corporation puts the same fall at more than 30 per cent, and says that in some areas of the country prices fell more than 50 per cent.
The Financial Crisis Inquiry Commission was set up by Congress to find out what had happened. It found that people fell badly behind on their mortgages most often in the parts of America that had had the biggest booms.
A loan made at the top of a local boom has the least room under it. When the price turns, that household is the first to owe more than the house is worth, and has nothing to sell its way out with.
People in those four states fell badly behind at twice the rate of the rest of the country.
So the loss was not spread thinly across America. It sat where prices had risen fastest, which meant the loans failed together rather than one at a time.
The defaults did not arrive evenly across America. Where did they come first and fastest?
Go back to 2006, when a fifth of all new American mortgage lending was : made to somebody the lender counts as more likely not to pay.
It carries a higher rate of interest to match, which is where the profit in it sits, and it is written against the house rather than against what the household earns.
The Federal Deposit Insurance Corporation counts subprime at 20 per cent of all American mortgage production in 2006.
The FDIC counts subprime at 20 per cent of American mortgage lending in 2006. The Financial Crisis Inquiry Commission counted the same year off the same trade figures. Higher or lower?
A tie counts as correct either way.
For scale. In 2007, the year after, the FDIC's count falls to 8 per cent.
The Federal Reserve's account of these mortgages is that they were got out of rather than paid off.
When these households could not make the payments, the Federal Reserve says, they either sold their homes at a gain and paid the mortgage off, or borrowed more against the higher price.
Both of those need the price to be higher than it was when the loan was made. The Federal Reserve puts the other side of it plainly: once house prices peaked, and selling a home became much weaker ways of settling the debt.
So the price falling and the households failing did not happen to arrive together in 2007. The second is what the first does to a loan built this way.
A subprime mortgage was not built to be paid off out of what the household earned. What was it built to do?
Money moved into America from the rest of the world in these years, and moved out again.
That is what standing in the middle of something means. The money arrives, and it leaves again for somewhere else.
The Bank's Financial Stability Report of October 2008 says the United States took in money from the rest of the world and sent those funds out to other countries.
The money behind American mortgage lending in these years came mostly from where?
Module 1 of 7 in The 2008 Financial Crisis
The assumption
no large nationwide fall in American house prices since the Great DepressionWhat prices did
184.6 index points in July 2006, 134.0 in February 2012, a fall of 27.4 per centAnd on the FDIC's count
more than 30 per cent, and more than 50 per cent in some areasWhere people fell behind
twice the rate of the rest of the country in California, Arizona, Nevada and Florida, as a share of American mortgage lending in 2006
20 per cent on the FDIC's count, 23.5 per cent on the Inquiry Commission's, and 8 per cent the year afterWhere the money came from
the rest of the world, taken in by America and passed onYou met two terms in this module
,
The loans were safe only while prices rose. Prices stopped rising in July 2006, and the money had come from abroad.
[1] The assumption the lending rested on, how far prices fell, and how much of the lending was subprime: Federal Deposit Insurance Corporation, Crisis and Response: An FDIC History, 2008-2013, chapter 1. Read twice, identical both times. "After all, the United States had not experienced large nationwide declines in house prices since the Great Depression." "house prices at the national level declined more than 30 percent from their peak" and "in some areas of the country, they fell more than 50 percent". "As subprime loan originations plummeted from 20 percent of total mortgage production in 2006 to 8 percent in 2007". THE CHAPTER NAMES NO STATES: it says only "concentrated in certain states" and "some areas of the country", which is why the sand states are cited to the Inquiry Commission instead.
[2] What American house prices actually did, month by month: S&P CoreLogic Case-Shiller U.S. National Home Price Index, S&P Dow Jones Indices, served by the Federal Reserve Bank of St. Louis. Read twice off the series data, identical both times. The index is set at 100 for January 2000, not seasonally adjusted. JULY 2006 = 184.607, the highest value of 2006. FEBRUARY 2012 = 133.987, the lowest value anywhere between 2007 and 2013. 27.4 PER CENT IS DERIVED AND NOT QUOTED: 1 - 133.987/184.607 = 0.2742, and the division is the build's own. The two index values are what the source publishes and both print, so a reader can check the arithmetic. The FDIC puts the same fall at more than 30 per cent; see fdic1. Neither is corrected here.
[3] Where people fell behind first: Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, chapter 11. Read twice, identical both times: "Serious delinquency was highest in areas of the country that had experienced the biggest housing booms", and in the "sand states" - California, Arizona, Nevada and Florida - serious delinquency ran at "double the rate in other areas". THE PERCENTAGES IN THIS CHAPTER DO NOT RENDER and came back as placeholders on both reads, which is the FCIC PDF glyph fault recorded earlier in the 2008 build. No figure from this chapter prints. HOLE 7: no institution publishes a measure of the concentration itself, and the step does not invent one.
[4] The other count of how much of the lending was subprime: Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, chapter 5, Subprime Lending. Read twice, identical both times, and the numerals were checked explicitly on the second read because other FCIC PDFs return digits as unreadable glyphs. Both legible here: "In 2006, $600 billion of subprime loans were originated, most of which were securitized. That year, subprime lending accounted for 23.5% of all mortgage originations." The FDIC counts the same year at 20 per cent. Both draw on Inside Mortgage Finance and neither is corrected.
[5] What the loans were built to do: Federal Reserve History, Subprime Mortgage Crisis, 22 November 2013. Read twice, identical both times. "When high-risk mortgage borrowers could not make loan payments, they either sold their homes at a gain and paid off their mortgages, or borrowed more against higher market prices." And: "When house prices peaked, mortgage refinancing and selling homes became less viable means of settling mortgage debt and mortgage loss rates began rising for lenders and investors."
[6] Where the money came from: Bank of England, Financial Stability Report No. 24, October 2008. Read twice, identical both times: "In particular, the United States acted as an intermediary, attracting capital inflows from the rest of the world and exporting these funds to other countries." The neighbouring sentence, "Much of this funding was ultimately sourced overseas", is about UK banks and does not print. THIS SUPPORTS THE INTERMEDIATION HALF OF SPINE LINK 6 AND NOT THE OTHER HALF: nothing read this session states that the money came from countries running persistent surpluses hunting for safe dollar assets, so the step does not say it. The same report carries a customer funding gap figure that module 3 owns and states first, and that figure is not repeated here.
Country data from the World Bank (CC BY 4.0) and the UNDP Human Development Report (CC BY 3.0 IGO)
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