I read that it stemmed from a housing bubble in the US, but how did it affect countries like Latvia severely, or Estonia in terms of healthcare? Like, how did it become global?
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There are a lot of banks and financial institutions that trade all over the world in many different countries. Many of those companies were selling products to each other such that if something went wrong, everyone was exposed to the financial risk.
Those companies also sold financial products to governments and businesses in those countries all over the world, which meant when one of them got into trouble and those products became worthless, it affected all the other banks who had those products and that affected all of THOSE banks’ customers in countries around the world.
–In the financial world, virtually everybody trades with US banks.
–Normally, mortgages are seen as one of the safest investments you can buy. People tend to pay their mortgages, and even if they don’t, you can repossess the house and then resell it.
–In the 90s, the US Congress passed legislation encouraging banks to give mortgage loans to people who couldn’t afford them. They thought this would help poor people buy houses, and even if they defaulted, it’s not like they had good credit to ruin.
–What ended up happening, is that middle class and above people used this to buy bigger, nicer houses that they couldn’t afford. Houses are seen as great investments, so the bigger the house, the better the investment. But that’s only the case if you can actually make the payments.
–The problem is that ultimately, you need people who can *actually afford* the house they’re living in. And the percentage of houses people couldn’t afford, got out of control. Like super duper out of control.
–Banks continued to sell these mortgages to each other as though they were perfectly good. Selling them as though they were normal mortgages, i..e., super safe investments. But they weren’t. Most of these people were going to default on their loans, and the banks who made them knew (or strongly suspected) it.
–The economy started to slow down, and people started to lose their jobs. Then they couldn’t make their mortgage payments. Then they started to default on their loans. And the banks had sold those loans to other banks all over the world.
This is a really complicated question, and one that tends to get into flame wars pretty quickly based on your political affiliation. So I’m going to limit my answer very narrowly to the question you asked: how did the contagion *spread*? I won’t talk about how it started or what triggered it.
The short answer to how it spread, is that several decades ago, loans in general, and mortgages in particular, used to be held by banks. That is, if Wells Fargo lent you $100k to buy your house, they would hold that loan, and your payments would go directly to them to slowly pay it back. This meant that, if Wells Fargo wrote bad mortgages, they might go under, but it wouldn’t spread to other banks or other parts of the financial system.
In the 80s, this started changing, and in the 90s it got supercharged. Instead of holding loans, banks would package up like a thousand loans into a single Mortgage-Backed Security (MBS), slice it into “tranches” and sell the tranches to other investors. The idea was that the lower tranches would take the first loss on any foreclosures or other non-payments, in exchange for higher interest rates. So if you bought the highest tranches, in exchange for a lower interest rate, the bonds were safer because the lower tranches would take the first losses. So for example, the MBS might be structured that the first 10% of any loss would be taken by the lowest tranche, then the next 10% by the next tranche, etc. until you get to the highest tranche, where, of the 1000 loans in the MBS, 500 would have to foreclose before the highest tranche would take any loss.
Once these loans were packaged as MBS and sliced intro tranches, investors from all over the world could buy these securities. You didn’t even have to be in the mortgage business; Wells Fargo would continue “servicing” the loan (i.e. accepting your mortgage payments, sending you monthly statements, etc.) for a fee, and forward all the payments to the MBS investors. To an investor, they were just like a regular bond.
That’s how investors all over the world, from pension funds in Latvia, to health insurance companies in Estonia, got exposure to America’s housing market that they could never get before.
This all sounds great so far. Why did it all go down? Well, like I said, I won’t talk about what *started* the downfall. But one contributing factor was fraud: banks would stuff these MBS with loans they knew were risky, and ratings agencies like S&P, Moody’s, Fitch, etc. would give them the AAA stamp of approval. And then, when the mortgage market in America collapsed, all these so-called AAA bonds which were supposed to be as solid as a Treasury Bond began taking catastrophic losses. And that’s when investors all around the world got affected.
If you haven’t seen The Big Short, I highly, highly recommend it. It does a fantastic job explaining what happened, and it does it in a funny, engaging story. It’s not boring at all (unless you consider Margot Robbie explaining high finance while naked in a bubble bath boring! 🙂
Because countries are not isolated from each other. The US isn’t isolated. It trades with nations across the globe, and those nations also trade with other nations. It’s a chain reaction effectively.
It’s why for example when the Ukraine war broke out, oil prices in North America skyrocketed. Russia doesn’t sell oil to North America, but it affected them anyway.
In addition to the good previous answers, you might find it helpful to think of its basis as having spread many years prior to 2008, rather than the crisis having spread. The crisis was the wave of dominoes, not the beginning, the setting up of dominoes. The spread happened when the dominoes were set up.
Why it spread? Because one of the foundational impulse-givers of economic activities everywhere are banks by virtue of handing out investment loans. To everyone, because the absolute minimum of people start and operate businesses with their own money. And without businesses, there is no economy. In the buildup of the crisis, these banks started handing out riskier and riskier loans (i.e. they invested in more and more “horseshit” that wasn’t ever gonna work out economically, like people on foodstamps getting 3 mortgages on two houses) that they eventually started to not get back. And everybody was doing it! Now, banks losing all of that money is a problem, because how are they gonna lend new loans? Well, they won’t – and thusly every other person, be it company or private, with an actually economically valuable roadmap won’t be able to realize their actual potential. Beyond that, already active companies in need of regular loans or those who have parked their savings in banks are also gonna be out of luck, i.e. they’ll lose it all and possibly get crushed.
2008 was just a bit special in the sense that everybody invested in everything *internationally* – you had one bank doing the shit trades described above and then sell (transfer) the mortgage contract to another bank, often times overseas and often times by purposely lying about its “quality” (i.e. chances of repayment; i.e. fraud). Which means, another bank would get the lended money from the contract in case of repayment – or would get nothing (and “lose” what they had paid the other bank for getting the contract). That latter bank could be some bigger bank in Latvia or Germany or Spain or Greece or Brazil for what it’s worth. Everybody was in on it.
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Also: Some people talk about “money and savings disappearing” during that time, too, which always confused me a bit. It’s much more accurate and intuitive, to me at least, to describe it as “money spent on dumb shit with next to no value”. It’s like being a millionaire and spending all your fortune on paying people digging holes and filling them with dirt again. Even then, and this is the confusing part, that money never disappears just like that, but it changes owners over a stupid trade. The people digging the holes and filling them up again now have your money. These metaphorical holes being dug and filled during the mortgage crisis were for example, among many other things, houses for people that couldn’t afford them and that nobody else would want either, at least not for any price close to what they cost. A lot of homes were built with more and more investment behind construction, because the investors thought – due to soaring housing prices! – they could sell them later for even more money. But at some point that wasn’t the case (the bubble bursting and prices falling) and a shitload of investors, including directly or indirectly the banks, funnelled an absolute shitton of money into building houses and other stuff for a construction price *far* beyond its (later) actual value. The “lost” or “disappeared” money was, more or less, just a great trade for: construction companies, realtors, … There’s nothing magical about it, it’s “just” a huge kink in the system. The economic system that is supposed to most efficiently, expediently and fairly distribute our social surplus (i.e. everything our labor creates in total) among its members on its own or with very little help did the exact opposite, namely it created a situation where, one way or another, factors of production were combined in one of the most inefficient, inexpedient and unfair ways possible – and that’s what we call a financial crisis in general.
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