So I recently read articles talking about the recession of 2008 and how severe it was, but because I have no knowledge on economics and finance, I can barely understand what happened during the recession. I only know that it has something to do with mortgages. Would anyone care to explain the 2008 recession with some sort of analogy? Like in terms of slices of cake or something easy to understand? Thanks.
In: Economics
Okay. So basically banks wondered how they could make even more money. Economy seemed good. People wanted houses. They went to the banks. They started giving out risky loans they shouldnt have, as part of a larger plan. Yes they were risky but they hwd a fallback.
They began to sell what was basically “loan packages”. Where you would pay the bank a certain amount to take over these loans. This benefited the banks since they removed risk from themselves. They got rid of the risky loans they had been giving. The benefit to the buyer was that they now recieved money from these mortgage loan payments. Yes they were buying risky loans, but they were packaged with good loans so it all averaged out.
Everyone on both sides was making lots of money. Economy still doing great.
“How can we invent even more money for ourselves?” The banks asked.
“More loans!” They summised.
So they began giving out more and more risky loans. They would put more and more of these into the packages, but lie about it. The group of people who were in charge of determining how good these packages were, were being paid off to lie as well. (This is where the fraud came in. Up until this point what they were doing was shitty, risky, and basically just a way to invent more money for themselves, but it was not really fraud until this point. When you hear people ask why no one went to jail, this is what they are talking about. These people straight up commited fraud and it destroyed the economy.)
Businesses, investors, banks, everyone was buying up these packages. They were being called risk free, even as they were being fraudulently labled and created.
Then the market started to slow. Stopped doing so hot. People started not being able to pay back their loans. They started to be foreclosed.
Not such a big deal at first, but when it reached a critical point where enough people could not pay, it caused a chain effect if destruction.
Suddenly, all of these free money making packages that so many places and people had bought up, were doing the opposite. They were costing money. To recoup these, they began foreclosing on people’s homes. People had put all the money they had into their homes. They are always worth money, but at the time they were considered an investment and that too was gone. These packages all collapsed. Tons of “risk free” investments suddenly failed and a lot of people were out a lot of money. People were being foreclosed on with nowhere to go. People panic sold everything and tried to grab all that they could before it disappeared.
This kind of panic quickly steamrolls the market and the economy.
That is the short of it.
You can even see this occuring right now with Corona virus. The market is being hurt not just because people are afraid business will not be good. Many people are taking their money out of things like stocks and bitcoin so that they have money on hand to spend as needed and not risk losing it in the market. Panic is what makes the market drop. The fear of the drop creates the drop, so to speak.
In economics we have ‘demand’ which is how many of a thing people want to buy and ‘supply’ how much of a thing people are willing to sell.
When demand is higher than supply, one of two things happens: Supply increases or prices go up. Often both. The goal of this is to make demand and supply the same amount, and is how economies function best.
For a long time, demand for houses was higher than supply of houses, so house prices kept going up.
Usually, this would mean that people who couldn’t afford to buy houses at the new price would stop demanding houses, so demand would go down and be the same as supply and then prices would stop going up.
But a lot of people, including banks, were making a lot of profit from the prices always going up.
So they started giving mortgages to people who wouldn’t be able to afford them. This made demand go higher, so house prices went up, and when the people who bought the house couldn’t afford to pay back their mortgages, the bank got the house instead, which was now worth more than the mortgage was.
This happened for a long time, but it was always ‘fine’ for the economy because house prices were always going up. The banks never lost money in these situations. What they were doing was effectively gambling, and as long as house prices kept going up, as they had done for decades, they would keep making money.
So in 2008, house prices did in fact not go up, they went down. So all of the houses the banks got from people who couldn’t pay their mortgages were worth less than the mortgages were worth, so the banks lost a lot of money, some of them so much that they had to close. This made people not trust their money was safe in banks, so withdrew it and banks lost even more money.
Homeowners also lost a lot of money, as the value of their homes went down. You’re able to borrow money from the bank up to the value of your home pretty easily, so firstly, this amount went down, and secondly, banks became less willing to lend as they had less money.
Due to all of these people losing money, they stopped spending as much money, because they had less of it. All of the businesses that they stopped spending at lost money, and in turn ended up making redundancies in their staff. The people who lost their jobs and the companies with less income started spending less too, as they had less money, which basically went on and on, with everyone spending less and choosing to save instead which further reduced everyone’s income.
And that’s basically what happened.
Sorry that it’s so long, but hopefully it’s understandable?
started a few years before 2008, way back in 2005. banks offered NINJA loans (No Income? No Job? Approved!) because they thought the stock market would kick ass after Bush admin cut regulations. But the stock market did not kick ass, almost no one could pay the banks back, real estate market collapsed & since most people’s money is tied up in their property value.. well… all their money collapsed.
An analogy would be: everyone at the party told the birthday boy that he gets sick every time he eats too much cake. But every 10-15 years the birthday boy forgets, or doesn’t care, and eats all the cake anyways. Then he gets sick and vomits on everyone, ruining the party for everyone 🙂 only way to fix it is have the parents come in and spend money to fix it until it happens again, because money is ultimately made up
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