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Economists saw the failures of subprime lenders as bad omens for the housing market as
a whole.
A Center for Responsible Lending (CRL) study in 2007 found that one in five subprime
loans issued during 2005-2006 would fail, leaving two million homeowners at risk for
foreclosure. The CRL study placed much of the responsibility on the marketing of risky
“creative” mortgage products such as adjustable-rate mortgages to consumers with bad or
no credit or bad financial histories.
Industry Analysts Warn Subprime Collapse Not Isolated Event
By March 2007, the U.S., subprime mortgage industry had collapsed. More than 25
subprime lenders had declared bankruptcy, announced significant losses or put
themselves up for sale. The stock of the nation’s largest subprime lender, New Century
Financial, plunged 84 percent amid Justice Dept. investigations before filing for Chapter
11 bankruptcy on April 2, 2007, with liabilities exceeding $100 million.
The manager of the world’s largest bond fund, PIMCO, stated in June 2007, that the
subprime mortgage crisis was not an isolated event and would eventually take a toll on
the economy. The meltdown’s greatest impact, he said, would be on the impaired prices
of homes.
By mid-2007, financial analysts were predicting that the subprime mortgage market
meltdown would result in earnings reductions for large Wall Street investment banks
trading in mortgage-backed securities, especially Bear Stearns, Lehman Brothers,
Goldman Sachs, Merrill Lynch and Morgan Stanley.
Lou Ranieri of Salomon Brothers, inventor of the mortgage-backed securities market in
the 1970s, warned of the future impact of mortgage defaults, saying “This is the leading
edge of the storm . . . If you think this is bad, imagine what it’s going to be like in the
middle of the crisis.”
In Ranieri’s opinion, more than $100 billion in home loans were likely to default once the
problems in the subprime industry appeared in the prime mortgage markets.
Impact on Stock Markets, Other Industries
On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing above
14,000 for the first time. By Aug. 15, 2007, the Dow had dropped below 13,000, and the
S&P had crossed into negative territory year-to-date. Similar drops occurred in virtually
every market in the world. Large daily drops became common, with, for example, the
Korea Composite Stock Price Index dropping about 7 percent in one day. 2007’s largest
daily drop by the Standard & Poor’s 500 in the United States was in February 2007, and
was a direct result of the subprime crisis.