Explain how each of the following relates to the financial crisis of 2007-2008:

 Declines in real-estate values.

 Subprime mortgage loans.

 Mortgage-backed securities.

Prior to the 2007 and 2008 financial crisis the banking institutions issued a large number of loans to borrowers that were relatively more risky in the sense that these borrowers were more likely to default on their loans. This was referred to as the subprime market. This resulted in a rapid increase in home prices (along with housing market speculation) that was unsustainable (sometimes referred to as bubble). This problems was also exacerbated by the issuance of mortgage backed securities, which bundled riskier mortgages together, and sold them to investors. In theory, this reduced the risk exposure that banks faced after issuing these loans. This apparent reduction in risk was an accounting illusion since the banks also made loans to the groups purchasing the mortgage backed securities.

When housing prices started to decline and individuals started to default on their mortgages this reduced or completely eliminated the value of these mortgage backed securities. This caused the financial investors who held these securities. Thus, there was a major credit crunch as banks wrote off the bad loans