The Global Financial Crisis of 2008: From Beginning to the Ultimate Doom
As a matter of fact, the global financial crisis, originated in 2008, was the greatest depiction of limitless greed and dishonesty of a few financial giants and their policymakers, primarily based on Wall Street. They’ve manipulated and destabilized the financial system for their own interest and paved the way to the ultimate destruction of the global economic harmony. The consequences were severe — extreme credit crisis, mass default of prestigious financial institutions, rapid economic downturn, massive unemployment and finally, social unrest.
The global financial sector technically sustains on one key catalyst–trust. And there’s another single thing that counters this life-blood of financial endeavors–greed. If greed surpasses the sacred oath of trust, the ultimate result is a crisis. And in some cases, like the global financial crisis of 2008, the crisis can spread like an all-consuming disaster throughout the globe. Here’s the truth — this subprime mortgage fueled financial and later economic crisis is considered as the most disastrous financial outburst in the history of modern financial systems.
As a matter of fact, the global financial crisis, originated in 2008, was the greatest depiction of limitless greed and dishonesty of a few financial giants and their policymakers, primarily based on Wall Street. They’ve manipulated and destabilized the financial system for their own interest and paved the way for the ultimate destruction of the global economic harmony. The consequences were severe-extreme credit crisis, mass default of prestigious financial institutions, rapid economic downturn, massive unemployment and finally, social unrest. Most interestingly, the severity of this crisis crossed the limit of the national border. Originated from the United Stated, practically from Wall Street investment banking giants, the crisis soon crossed the Atlantic and invaded the European financial harmony. It didn’t stop there as the economies of Asian giants like China and India and virtually every other large economies of the world were highly affected. Yes, the small and developing countries were not the big sufferers but that’s only because their economies were not greatly engaged with that of the developed ones.
Now, as the severity of the problem is slightly depicted above, it’s very reasonable to look forward to the lawful accusation, trial and subsequent punishment for the liable ones, say, those Wall Street masterminds. But things get really interesting here as almost everyone responsible got away with it; for nobody was legally prosecuted for his/her deeds and they just bumped off the responsibilities bestowed upon them. Seriously, that’s justice?
Things got worse with all those bailouts of crisis-laden banks. Yes, they were big and they were not intended to fail. But what’s the justification for paying honest taxpayers’ money to save the financial giants that already lost several billion dollars for their immense stupidity and greed? Well, the common sense says — that’s not justified at all. But that was exactly the aftermath of the 2008 global financial crisis — they tricked the system, manipulated it, highly gained through their dishonest activities and in the end got away with absolute nil accountability. Hell! They were not even formally blamed for the issues!
So, let’s have a crystal clear illustration of the overall scenario of the global financial crisis — how it all started and the situation became severe very quickly, how the global economic giants collapsed one by one due to the ripple effect of the crisis and how the responsible people got away with absolute zero punishment.
The Background
The crisis was familiarized to mass people in March 2008 when the 5th largest investment bank in the US, Bear Sterns, collapsed and eventually sold to JP Morgan. However, the root of this crisis laid in the past two decades. The background was prepared during the 80s and 90s when the mortgage-backed securities were introduced and highly familiarized to the marketplace. Investment bankers, investors and homeowners — all found this instrument pretty useful due to its enhanced risk mitigation capabilities and quick return. For better understanding, MBSs are the securitized version of mortgages where the debts of the mortgage holders (who owned the home in exchange for the mortgage) are pooled and then sold to the investors.
Virtually, MBSs were risk-free because the US real-estate price followed a constant upward trend historically. So, here was the plan — create mortgages on homes and sell those to the investment bankers where they convert them to MBSs and sell the securities to the investors. These investors were benefited from the payments of the mortgaged homeowners and the middlemen — investment banks, brokers and lenders received the lucrative instant return in the form of commission.
MBSs were perhaps the greatest invention of modern investment banking. But the situation worsened due to the excessive greed and dishonesty of Wall Street masterminds. How? Well, let’s go forward with the analysis.
How it all started
Due to the sluggish economy following the dot-com bubble and the 9/11 incident, the Federal Reserve decided to reduce the interest rate. And the reduced rate was an incredible 1%! This created immense demand for money in the marketplace as the easy money from the Federal Reserve could be invested in other places with a considerably higher return. Here came MBSs for that was the most lucrative investment vehicle of that time — after all, everybody wanted a quick return and notably, securitized assets never failed them before.
The problem initiated as the number of prime mortgages, meaning the homeowners capable of paying the debt, was not infinite. So, in times, the number of healthy mortgages diminished and those who profited by securitizing those mortgages found it as an obstacle to earning easy money. The banks were still lured by the availability of easy credit and they started to lend it towards subprime borrowers who were not actually capable of repaying that debt. The credit rating agencies completely failed or became intentionally silent (because they were paid off handsomely) about the whole incident. Meantime, people who had no legitimate cash flow to pay for the mortgage obligations became homeowners.
The Weapon of Mass Destruction
The Wall Street masterminds knew that securitizing those subprime mortgages were quite risky. So, they engineered another financial instrument, named CDO (Collateralized Debt Obligation). Here, they pooled the good MBSs with the subprime ones. This new package was securitized and given the name CDO. Well, the investment bankers were smart — they’ve divided this new securitized asset into highly safe (rated AAA), safe (rated BBB) and unsafe (unrated) trenches, offering different returns for each of these. Of course, unsafe CDOs offered the highest return but they were not even rated! While creating CDOs, the banks completely forget two particular things — i. The demand for real-estate was not infinite in the US and ii. Pooling was not going to work here because the real estate markets in different US states were heavily influenced and interconnected by one another.
The Crisis Begins
In the financial sector, failure in risk appraisal is considered the greatest sin. And the failure of doing so intentionally to earn easy money is something like blasphemy. Subprime mortgage and the representing financial instrument — CDO, both were the sins of Wall Street financial engineers who only thought of quick, risky returns. So, when subprime mortgages started to default, there was no turning back. First, the financially incapable homeowners failed to pay the mortgage interest. That directly affected the investors who owned the CDOs. As more and more mortgages defaulted, the banks tried to sell the security — i.e. the home. But there were no customers to buy homes because they already owned one (or more); thanks to easy credit and subprime lending. The result was a drastically reduced demand for real estate products. Following the universal theory of demand-supply, the extremely reduced demand reduced the real value of the homes. So, the healthy or prime mortgage holders, who were still paying their debt ceased to do so.
Deprived of projected cash flows from the homeowners, banks were in deep crisis because they had to repay the easy credit that lured them into this trench. But, the credit market froze, as the lenders became highly cautious about providing new loans now (who would lend to the defaulters?). So, the investment banks failed to repay the short-run obligations that lead them to the verge of bankruptcy.
The First Victims
The first wave had struck the 5th and 4th largest investment banks of US — Bear Sterns and Lehman Brothers respectively. Though Bear Sterns was purchased by JP Morgan, Lehman Brothers were allowed into bankruptcy — triggering the domino effect boosted by the lack of faith. Meanwhile, the UK bank Northern Rock became insolvent for the same reason and later purchased by the UK government. The insurance giant AIG was also extremely troubled due to the credit crunch — it required over $40 billion to back up its Credit Default Swaps (CDSs) and eventually bailed out.
Following the downfall of these financial giants, other market players — both large and small, found themselves on the brink of bankruptcy. The United States of America, despite its financial and economic might, was on the edge of facing the worst financial crisis in history.
The Global Financial Crisis
As we’ve already seen how the financial crisis initiated, let’s have an understanding of how it spread globally –
First of all, the global banking system is highly interlinked and faith is a collective notion. So, when the news of the bankruptcy of a particular bank spreads, other banks become very much cautious about lending, thus tightening the credit availability. So, the banks facing extreme liquidity problems can’t have the necessary funds through soft, short-term loans. This is like a ripple: one bank needs funds to pay another bank and when the first bank fails to pay the obligations, the second bank will be automatically vulnerable to liquidity and default risk. So, the third bank, which owed money from the second bank, would be problematic too. When this scenario becomes international — well, that creates a global financial crisis.
Secondly, lots of foreign banks had massive investment in US collateralized debt. They purchased CDOs which were quite risky and finally defaulted. Like US banks, these foreign banks also faced the same credit crunch problem and eventually bankrupted. So, the financial structures of those countries were also shattered, fueled the ripple effect and affected more and more countries.
Thirdly, the volume of international trade of the US reduced drastically because of the rapid downward pressure on the economy. As the US is the largest economy in the world, a recession in this country will certainly affect its trade partners negatively.
Finally, modern stock markets are highly interlinked too as companies are listed in different countries. So, when the financial crisis hit the stock market, the drastic reduction in stock price worsened the situation. This situation ultimately fueled the crisis and made it tougher to recover.
How They Got Away With It
We’ve reached the final part of our discussion. Certainly, you’re a bit tired now after reading all those cause-effect chronicles. Well, it’s time to be energetic again because here’s the most incredible incident of history: not a single mastermind was punished for causing this great crisis and stealing the money from innocent investors’ pockets! Seems absurd, right?
Let’s take look at the prime weapon of the US government to get rid of the crisis — bailing out the US and foreign banks. For this, the government initiated a program named Troubled Asset Relief Program (TARP). Through this program, the government was intended to purchase the toxic and valueless MBSs, CDOs and other illiquid securities to inject liquidity into the banking system. The initial expenditure limit for the US treasury under the TARP program was $700 billion which was later reduced to $475 billion. However, after severe criticism, TARP stopped buying toxic securities and injected the fund directly into the banking system. Other countries followed this model too.
Now, here’s the scenario. The Wall Street financial masterminds engineered a stupid and highly risky instrument that busted the real-estate boom. That caused the global financial crisis and almost stopped the economic growth for a couple of quarters. Meantime, millions of people lost their job, social anarchy leads the world to a living hell and the financial/economic stability shattered for quite a long time. This crisis was also the trigger of the Eurozone sovereign debt crisis which caused further economic/financial/social disaster to Eurozone countries. So, what was the condition of the responsible ones during this time? Well, they enjoyed very fat bonuses and incentives during the good days and in bad days they were nowhere to be found. The government and the regulators ended their responsibility by bailing out these Wall Street giants; thus further injected the taxpayers’ money in it. Nobody was even prosecuted and a verdict was the dream too far!
Thus, in the end, it was Wall Street that single-handedly brought down both the US and global economy. And for that, nothing but the extensive reward was given to them -in a beautiful bailout package. Do you still have faith in this end line: justice is blind?
Author’s Note: This article was written a couple of years ago. But it still seems very relevant as we can continuously relate this crisis to the chronicles of local and global financial marketplaces. In fact, understanding the Global Financial Crisis is like owning a very special alarm clock, capable of reminding us of the devastating power of unethical and illegal practices in the financial sector.
