why and how the 2008 economic crisis happen?
In: Economics
A lot of people will try to pin the crash on one thing but it was a multi-layer
– Back then there somewhat loose regulation on lending, people can easily lie about their income and lenders can give loans to people that shouldn’t qualify. Banks get money from the interest on the loan and if the buyer defaults they get the house which has been increasing in value.
– There were investment banks that saw this and decided they want in so they bought a pool of mortgages from lenders so they get to collect on the interest on the mortgage payments and get the house if the buyer defaults. This seemed lucrative to retail investors (say someone like you and I) so the Investment Bank sells Mortgage-Backed Securities to them. The lender gets their money back (with some interest) and can re-lend the money again. So long as they can buy mortgages off lenders they can keep making money.
– There were insurance companies seeing this and saw the potential to make more money, they can sell Credit Default Swaps which they payout when buyers can’t make payments. This seemed lucrative and other investors want in, so they would sell multiple insurance policies on a single mortgage. So long as people made their payments they can keep making money.
Now banks can lend money to anybody and pass the risk off to investors who pass the risk off to insurance. If there’s little risk, why not sell mortgages to everyone whether they can pay it off or not?
– Now there are sub-prime mortgages. These are targeted to people with bad credit and low income. They seem low at first but can increase the interest to ridiculous amounts making the payments unaffordable, unfortunately since the buyer isn’t the most finance savvy person that doesn’t read the contracts, they buy it anyway.
– Investment Banks still want MORE mortgages and keep the gravy train going so they also buy these subprime mortgages. This made those mortgage-backed securities into ticking time bombs. They rolled these subprime mortgages into those securities, lie to investors about the risk, sell “riskier” securities, and new investments.
All this made a red hot real estate market and thus made the “bubble”hinged on people making their mortgage payments on time. You have lender that doesn’t care who they lend to, investment banks that doesn’t care about how risky those loans are and insurance companies that are backing these, all pretending not to see if people make their mortgage payments on time.
Then a recession happens and people start to miss their payments. People start to lose their homes.
Then those mortgage-backed securities become real estate. Investment Banks now have more homes than it could possibly handle.
Then there is a MASSIVE wave of foreclosed houses flooding the real estate market meaning there are way more houses than buyers. This plummeted house prices.
Now the domino effect begins.
Those investments default, they stopped buying mortgages from banks. Insurance companies now have impossible amounts payouts. Banks, investment companies and insurance companies start shutting down.
Now the government has to step in to save two of the largest insurance companies.
This causes a massive shockwave in investing and effects citizens and companies who invested in the USA, the global economic engine stalls. This took YEARS to recover and new regulation and lending practice took place.
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