Final answer:
The connection between high mortgage rates and the collapse of the housing market contributed to the financial crisis of 2007, resulting in widespread foreclosures, devaluation of mortgage-backed securities, and a global credit freeze which led to the Great Recession.
Step-by-step explanation:
High mortgage rates can lead to a downturn in the housing market as fewer people are able to afford loans to buy houses. This situation was a contributing factor to the financial crisis of 2007. Initially, the housing boom was fueled by low interest rates and high demand, leading to rising home prices. Banks and financial institutions provided mortgages to a greater number of people, including those with poor credit history. These mortgages were then packaged into mortgage-backed securities (MBS), spreading the risk across the financial system.
When home prices started to fall, homeowners found themselves owing more on their mortgage than their homes were worth, leading to defaults and foreclosures. This negatively impacted the banks and investors who owned the MBS, as the value of these securities plummeted. This led to significant losses for these institutions and a subsequent credit freeze, where banks became reluctant to lend money.
The housing bubble and bust affected not just the United States but also other countries such as Iceland, Ireland, the United Kingdom, Spain, Portugal, and Greece. This global impact further exacerbated the financial crisis, resulting in what we now refer to as the Great Recession. The crisis demonstrated the interconnectedness of global financial markets and the systemic risks posed by complex financial products like mortgage-backed securities.