Coker 1
Peyton Coker
Dr. Durrat
Econ 312–001
9 May 2017
How Greed Drove Us into the Great Recession
Since its inception, the American economy has faced
numerous crises. From several panics during the infancy of the
country, to the most catastrophic depression the world has
ever seen in the Great Depression, our capitalistic nation has
had its downfalls. Our most recent downfall occurred in 2008,
and later went on to be known as the Great Recession due to
the havoc it wreaked on our country as well as the world. The
Great Recession was caused by the massive increase in the
market for mortgage–backed securities, the explosion of
subprime mortgages, as well as the raise in the Federal Funds
Rate. This left our economy in shambles, and had serious
ramifications for American financial institutions.
Mortgage–backed securities set the American economy up
for failure. These securities, as their name suggests, are
composed of many mortgages that are alike in several aspects.
Mortgages that have the similar risk of default, amount owed,
monthly payments, and interest rates would be packaged by the
companies that owned them, typically hedge funds, and then
Coker 2
sold on the secondary market. The government held many
mortgage–backed securities through their sponsored enterprises
Fannie Mae and Freddie Mac. This is because these securities
turned out to be valuable assets to all parties involved in
the process, creditors and investors alike. Because the
mortgages had been passed down from banks, to hedge funds, and
then to investors, each firm would take a percentage of the
payments made by the citizens who took out the mortgages. In
doing this, banks and hedge funds would receive profits with
no risk since they did not own the mortgages. So, the risk
fell on the investors. However, they did not balk at the
assumption of this risk because insurance was made available
to them in the form of credit default swaps. The main company
that insured investors with credit default swaps was American
International Group, or AIG. These credit default swaps
guaranteed the payback of the mortgages in each security.
This, in turn, allowed investors to take on more investments
and even investments that entailed more risk. The combination
of all these factors led to a drastic increase in demand for
mortgage–backed securities.
As the demand for these securities continued to rise,
banks were left scrambling as they attempted to match the
demand with the supply. Banks sold all of the normal,
Coker 3
conventional mortgages that the market demanded, so they were
forced to get creative. This inevitably led to the growth of
subprime mortgages. Subprime mortgages are created when banks
give loans to people who have a poor credit history, or no
credit history at all, and are looking to purchase homes.
Because of the lack of sufficient credit, subprime mortgages
carry a much greater risk of default on the loans. To offset
this risk, banks would charge these customers with steeper
interest rates, more expensive down payments, or closing costs
that were above the norm. Eventually, homeowners were unable
to make their payments on their subprime mortgages.
