![]() If the borrower failed to repay on schedule, the home's increase in value would facilitate a refinancing or, in the event of foreclosure, would cover the loan and accrued interest and penalties. Therefore, any potential repayment problems would be substantially mitigated, if not eliminated, by higher market prices for the underlying collateral. The rationale for such risky lending was that house prices were appreciating rapidly and had not fallen nationally in the United States since the 1930s. This allowed borrowers to get larger mortgages, but created greater future payments for households when the teaser rate expired or principal repayments began. To make matters worse, many of these mortgages were issued with initially low "teaser" interest rates or with other terms, such as interest-only or negative amortization payment options, to make them seem more affordable to borrowers. Instead, many subprime mortgages were "ninja" loans-standing for no income, no job, and no assets. ![]() Too often, however, standards were steadily loosened in recent subprime and "Alt-A" (whose risks are between prime and subprime) lending. But prudence dictates that in making subprime loans, lenders must control the risks by more closely evaluating the borrower, setting higher standards for collateral, and charging rates commensurate with the greater risks. There is nothing inherently wrong or reckless about lending to borrowers with lower incomes and lower credit scores. We examine the origins of the subprime crisis and the various places, some of them surprising, where the effects of the crisis have been found-such as markets in which banks make loans to one another, short-term commercial paper, and even municipal bonds. Just as diseases are passed on by close human contact, pests, and contaminated food, so this financial crisis has been transmitted through connected markets and institutions while leaving others largely untouched. Like an epidemic in which an invisible virus infects many people and communities, the financial crisis spread when losses to intermediaries in one nontransparent market raised concerns about liquidity and solvency elsewhere. What is not so clear, though, is how these losses could spread to other parts of the global financial system. But damage was propagated at each stage of the complicated process in which a risky home loan was originated, then became an asset-backed security that then formed part of a collateralized debt obligation (CDO) that was rated and sold to investors. They started with poor underwriting practices, which became legion. The causes of the crisis in subprime mortgages have become clear. ![]() mortgage market could have been contained, but together they caused a crisis that spread across the globe
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