Initial Years

• Subprime lending became possible after legislation in the 1980s removed earlier restrictions on charging high interest rates. As the interest rates began to rise, demand for prime rate credit began to decline. To compensate, bankers started to extend loans to subprime borrowers at higher interest rates. The business website Goliath reports that according to Inside B & C Lending, between 1994 and 1997, subprime lending grew from $35 billion to $125 billion. During this period, the number of lenders also tripled from 70 in 1994 to 210 in 1997. During these initial years, most of the subprime lending was carried out by newly founded companies, while traditional banks continued to deal in prime lending.
  
  

Securitization

• As the subprime lending business grew, lenders started to raise money in the public markets. Securitization was used as a means to raise this money. Securitization essentially involves grouping together thousands of mortgages of varying risk levels and then cutting them in parts to be sold in financial markets. These Residential Mortgage Backed Securities (RMBS) were given high credit ratings by credit agencies. Theoretically, securitization reduces risk through diversification. However, as the securities became more and more complex, it became impossible to properly gauge their risks.
  
  

Indiscriminate Growth

• The late 1990s and early 2000s saw a boom in the housing market as homeownership rates increased. As the demand increased, house prices also went up. This was accompanied with an increase in the supplying of mortgage credit. During this time, lenders began issuing credit without carrying out a thorough background check on borrowers. People could get credit even if they did not have any documentation to prove their income and asset status. As a result, the quality of subprime mortgages fell even further as loans were issued to people who could not possibly repay it. As the markets grew, traditional mortgage lenders also entered the subprime market.
  
  

Bursting of the Bubble

• By the end of 2005, the inevitable happened as more and more people began defaulting on their mortgage payments. As the delinquency rates began to rise, it led to mortgage foreclosure filings across the nation. This led to the bursting of the housing market bubble. The securities that were used to fund the mortgages suddenly lost their value and credit became scarce. Many banks that had invested heavily in these RMBS found that there were no buyers for these securities. This led to the financial meltdown termed the Great Recession starting in late 2008.