An overview of the credit crisis
The crisis that's gripping Wall Street began years ago, when low interest rates spurred unprecedented borrowing and a wave of home buying. Consumers, searching for the best rates, snapped up adjustable-rate mortgages that initially offered lower rates that later rose. Lending standards became more lenient, making it easier for people with bad credit to get loans they previously weren't qualified for and often couldn't afford.
Banks, meanwhile, bundled and sold the loans to investors as mortgage-backed securities. Wall Street profited as a booming housing market boosted home prices.
Interest rates eventually rebounded, leading to dramatic increases to many consumers' mortgage payments. Many borrowers, particularly those with credit scores deemed "subprime," found they could no longer afford their homes. Delinquencies and foreclosures ensued as owners faced eviction.
As borrowers failed to pay, major banks lost billions of dollars and the subprime loan market collapsed. Banks tightened their lending practices, freezing the credit markets and making it harder for businesses to borrow. The housing market suffered as buyers, even those with good credit histories, struggled to arrange financing.
The banks most heavily invested in subprime mortgages, such as Bear Stearns Cos. and Lehman Brothers Holdings Inc., collapsed as their holdings became worthless. Some companies, including Merrill Lynch & Co., were forced to put themselves up for sale. All of the investment banks converted to bank holding companies, which will allow them to take consumer deposits.
Fearing that the ailing finance industry would trigger a global recession, the US government plans to buy ownership stakes in the banks as part of a bailout package that's estimated to cost $700 billion. Stock prices have fallen compared with a year ago as investors brace for a potentially protracted economic downturn.