Subprime mortgages: the snowball effect Intermediate macroeconomicsSubprime mortgages were a new, profitable market idea, promoted by the government, implemented by credit institutions, in order to provide all the American dream. During the booming economy, this dream became reality – untested and uncontrolled – as low interest rates fueled investors' desire to make dreams come true! Eventually, the vicissitudes of the economy turned downward and the snowball effect began as financial sectors and investors rushed to grab the falling knife. As history is made today and hindsight is 20/20, we can reflect on the ideologies and policies that led to the worst economic downturn since the Great Depression. At the birth of the subprime mortgage market, investors and lenders had found a way to allow more families to live the American dream while they could profit from it. The economy was booming, the unemployment rate was low, and the demand for housing was high due to low interest rates. The idea was that lenders were willing to accept more risk by financing homes with less equity than those that were not creditworthy. The incentive for the lender was a higher interest rate for the consumer, who expected a higher foreclosure rate. Due to the high demand for housing, assets have also appreciated, decreasing the implicit risk. Add origination fees and suddenly the whole proposition became very profitable. In theory, the market assumed an annual foreclosure rate of 8% with an average loss due to foreclosure of 30%. Out of a $1.2 trillion market pool, projected foreclosures would cost only an implied 2.4% loss on gross revenues. If subprime homeowners are…paper leaders…and with thorough oversight, our economy should bounce back with another painful lesson learned. References Petroff, Eric. “Who is to blame for the subprime mortgage crisis?” 2007. Investopedia. October 5, 2008. http://investopedia.com/printable.asp?a=/articles/07/subprime-blame.aspAmerman, Daniel. “The subprime mortgage crisis has just begun.” March 20, 2008. University of Financial Sense. October 5, 2008. http://www.financialsense.com/fsu/editorials/amerman/2008/0320.htmlBajaj, Vikas and Story, Louise. “Mortgage crisis spreads beyond subprime lending.” February 12, 2008. The New York Times. October 5, 2008. http://www.nytimes.com/2008/02/12/business/12credit.html?_r=1&pagewanted=printBarnes, Ryan. “The fuel that fueled the subprime mortgage meltdown.” 2007. Investopedia. October 5, 2008. http://investopedia.com/printable.asp?a=/articles/07/subprime-overview.asp