Starting this past summer, the press swirled with talk of subprime mortgages, a housing bubble and a credit crunch. These days, The Wall Street Journal consistently reports on a much less esoteric economic phenomenon: a recession. How do these terms fit together, what do they mean, and, most importantly, how did the economy end up where it is today?
The story starts years ago, during the economic boom of the 1990s. With the decade's technology-fueled stock market growth, the average homeowner's wealth increased, and with more money, that average homeowner wanted to become an above-average homeowner. Demand for housing soared, inflating home prices nearly 130 percent between 1997 and 2006. Though there was a brief recession following the terrorist attacks in 2001, former Presidents Clinton and George W. Bush urged the public to spend their way out. People borrowed heavily against the value of their homes using mortgages and home equity lines regardless of their disposable income, and financial institutions were willing to lend. Usually, lenders will only give up to 80 percent of the value of the home. "At the peak," explained University Bank Management Prof. Richard DeMong, who is also a pre-eminent subprime researcher, "lenders were lending 100 percent of home value."
The high-priced properties served as collateral that the mortgage lenders could repossess if people started to default on, or not pay, their loans. As University Asst. Commerce Prof. Matthew Clayton put it, "banks got a little bit aggressive -- they were happy to lend money whenever they could, regardless of if the borrower would pay back." So, banks made loans to people who had a high chance of defaulting: subprime loans. Banks offered teaser rates
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