9 CHAPTER 1: Origins of the Crisis
Several factors contributed to the run-up in housing prices. One was low interest rates: in
July 2003, the federal funds rate declined to 1.01 percent, its lowest level in 45 years, while
in June 2003, the Freddie Mac 30-year conventional mortgage rate fell to 5.21 percent, the
lowest level in the 32-year history of the Primary Mortgage Market Survey. This prolonged
period of low rates after the 1991–1992 recession made mortgages less expensive, thus
increasing demand, and, with increased demand, house prices began rising. Another factor
in the price run-up was the origination of mortgage products that increased demand by
enabling less-creditworthy borrowers to qualify for mortgages (see the box titled “Types of
Mortgage Products”). Financial institutions, including a number of large thrifts, investment
banks, and commercial banking organizations, acted as originators of subprime and Alt-A
mortgages and also as underwriters and issuers of securitizations backed by these loans.
6
A third factor in driving up prices was the influx of investors into the housing market:
drawn by the expectation of future house price appreciation, investors bought homes for
investment gain, not residence. All of this was consistent with Case and Shiller’s description
of a housing bubble. “The notion of a bubble,” they write, “is really defined in terms of
people’s thinking: their expectations about future price increases, their theories about the
risk of falling prices, and their worries about being priced out of the housing market in the
future if they do not buy.”
7
As interest costs fell and, in response, the demand for mortgages increased, the funding
for mortgages increased significantly, allowing lenders to offer credit to more borrowers.
Behind this increase in funding were (1) a heavy demand of investors worldwide for highly
rated assets with high yields, and (2) the satisfaction of that demand through the mortgage
securitization process, which allowed the financialization of mortgage assets.
8
The heavy worldwide demand for safe assets was brought about by an increase in global
savings. This glut of global savings reflected many factors, including the buildup of foreign
exchange reserves in emerging market economies and the aging populations in industrial
economies (retirees have higher savings).
9
The securitization process that served to satisfy
the worldwide demand involved the packaging of pools of mortgages into securities that
6
Inside Mortgage Finance Publications, The 2010 Mortgage Market Statistical Annual, vol. 2, 2010.
7
Case and Shiller, “Bubble in the Housing Market?,” 301.
8
As explained in the overview section, financialization of housing assets means that “illiquid real estate was
turned into a financial asset that could be traded more easily and therefore made it possible for investors
to participate in new and innovative ways.” Securitization is the process by which assets with generally
predictable cash flows and similar features are packaged into interest-bearing securities with marketable
investment characteristics. Investors buy the right to future cash flow, thus providing increased liquidity back
to the seller, who then has additional monies to lend. Over time, securitized assets have been created using
diverse types of collateral, including home mortgages, commercial mortgages, mobile home loans, leases,
and installment contracts on personal property. The most common securitized product is the mortgage-
backed security (MBS).
9
Ben Bernanke, “The Global Saving Glut and the U.S. Current Account Deficit,” remarks at the Sandridge
Lecture, Virginia Association of Economists, Richmond, VA, March 10, 2005, https://www.federalreserve.
gov/boarddocs/speeches/2005/200503102/.