Pop Goes the Stock Market Bubble

The fall of the housing bubble caused many mortgages to default, particularly the riskier subprime mortgages given to people who often could not afford them in the longer term. Some of these subprime mortgages probably would have gone into default even if the housing price bubble was still afloat, because they were risky loans. But once the housing bubble started to fall, and lots of people had mortgages greater than the value of their homes, mortgage defaults began to rise dramatically. This caused unexpectedly large losses in the massive mortgage-backed securities market, felt both by the investors who bought mortgage-backed securities and the investment banks that held mortgage-backed securities. Because the mortgage-backed securities market was so big, these losses roiled the entire credit market.

The credit markets began to freeze up partly driven by fear of not knowing which financial institutions were holding what losses (the financial institutions themselves didn’t even know, so it was hard for anyone else to know). More importantly, credit froze because investors who thought they were buying highly secure AAA bonds lost confidence. If AAA bonds could go bad, what was next?

The collapse in credit market confidence and in the value of banks helped start the popping of the stock market bubble. Had the stock market not been in a bubble, it would not have fallen so far so quickly. Not only were stock prices in a bubble, but about two-thirds ...

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