Subprime Mortgage Crisis Flashcards

Who was the U.S. Treasury Secretary at the time this crisis unfolded?

Answer: Henry Paulson

Henry Paulson served as the U.S. Secretary of the Treasury under President George W. Bush from 2006 to 2009. He was a central figure in the government's response to the 2008 financial crisis, overseeing major interventions like the Troubled Asset Relief Program (TARP). His tenure directly coincided with the unfolding and peak of the crisis.

How does leverage operate?

Answer: The more money an investor borrows, the higher the returns will be for the investment.

Leverage in finance involves using borrowed capital to increase the potential return of an investment. By borrowing money, an investor can control a larger asset position than their own capital would allow. While it amplifies potential gains, it also significantly magnifies potential losses, making it a high-risk, high-reward strategy.

What happens to the value of properties owned by those who continue to make timely mortgage payments to the bank despite the fact that many of their neighbors have defaulted?

Answer: Their home goes down in value because of all the houses for sale

When many homes in a neighborhood go into foreclosure and are put up for sale, it creates an oversupply in the housing market. This increased supply, coupled with potentially distressed sales, drives down the overall property values in the area. Even homeowners who are current on their mortgages will see the market value of their homes decrease due to these broader market dynamics.

Which of the following didn't contribute to the economic crisis?

Answer: Increasing interest rates

The 2008 economic crisis was largely fueled by a period of *low* interest rates, which encouraged excessive borrowing and risky lending practices, particularly in the housing market. Increasing interest rates typically *cool down* an overheated economy and make borrowing more expensive, which would have counteracted some of the factors leading to the crisis, rather than contributing to it.

What kind of financing traditionally lends to those who would not be able to qualify for a mortgage?

Answer: Sub-prime

Sub-prime lending refers to loans offered to borrowers with lower credit ratings or higher risk profiles who do not qualify for conventional, 'prime' mortgages. These loans typically come with higher interest rates and less favorable terms to compensate lenders for the increased risk. This type of lending was a significant factor in the 2008 financial crisis.

What kind of financial inducement prompted so many foreclosures?

Answer: The home is worth less than the amount of the mortgage.

Many foreclosures during the crisis were prompted by 'underwater' mortgages, where the outstanding loan amount exceeded the current market value of the home. When property values plummeted, homeowners found themselves owing more than their house was worth, removing the financial incentive to continue making payments, especially if they faced other financial difficulties. This situation is known as negative equity.

Which of the subsequent claims is untrue?

Answer: On subprime adjustable rate mortgages, lenders are 20% less likely to have started the foreclosure process than on standard mortgages.

Subprime adjustable-rate mortgages (ARMs) are inherently riskier than standard mortgages due to being offered to borrowers with lower credit scores and having interest rates that can increase significantly. These factors make borrowers *more* prone to default and foreclosure, not less. Therefore, the claim that lenders are 20% less likely to start foreclosure on subprime ARMs is factually untrue.