Illinois Attorney General Lisa Madigan’s recent lawsuit against S&P is the latest example of fallout from the subprime mortgage crisis. The mortgage crisis, one of the leading indicators of the U.S. financial crisis that began in 2007, was characterized by a marked increase in foreclosures and mortgage delinquencies. Subprime mortgages refer to mortgages that are risky and are considered to be of a lower quality than mortgages that are relatively secure. The increasing number of delinquencies led to a decline in mortgage-backed securities.
There are several reasons why this crisis occurred including:
An Increase in High-risk Loans
Lender behavior changed dramatically in advance of the housing crisis. In 1996, subprime mortgages only amounted to roughly 9% or total originations. Fast-forward 10 years to 2006 and 20% of all mortgages could be classified as subprime. In an effort to bolster mortgage-backed securities (which could then be sold to investors), lenders doled out loans to high risk borrowers—including undocumented immigrants.
Securitization refers to the practice of selling consolidated debts as bonds to investors. The amount of mortgage-backed securities almost tripled between 1997 and 2007. Many of these debt pools were sold by private banks and were not guaranteed against default. The Financial Crisis Inquiry Commission reported in January of 2011 that major credit rating agencies were complicit in the subprime mortgage crisis since subprime mortgages could not have been marketed or sold without their approval. According to the report:
“This crisis could not have happened without the rating agencies. Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms.”
There are several investigations in progress as to whether or not banks hoodwinked credit rating agencies to inflate the rating of various mortgage-backed securities. According to the New York Times, “the United States attorney’s office and more are examining how banks created, rated, sold and traded mortgage securities that turned out to be some of the worst investments ever devised.”
These are merely a few of the speculated causes of the subprime mortgage crisis. Subprime mortgages can be a multifaceted and complex issue to understand. In cases that involve mortgage-backed securities, it can often be helpful to retain an expert witness with financial credentials.