The Financial Crisis which occurred between the time period of 2008–2009 was a mammoth economic crisis encompassing worldwide. It was an enormous setback to the global financial system and had a series of aftermath. The crisis is contemplated as the grimmest financial crisis since the Great Depression of the 1930 s by many eminent economists around the world.
The fracture of the economic system-induced monetary damage on millions of Americans and gradually escalated to other economies. The reasons and causes behind the catastrophe are not solely driven by one factor, but it is a conflux of several prominent factors. Let’s look at it step by step what caused the financial crisis of 2008!
Table of Contents
What caused the 2008-09 Economic Crisis?
— Sub Prime Mortage
Subprime Mortgage commenced in the year 2007 with a crunch in the Subprime Mortgage Market in the United States. Subprime Mortgages and the Subprime Meltdown are usually termed as the felons for the onslaught of The Great Recession.
A subprime mortgage is generally remitted to borrowers with low credit ratings because the lender perceives the borrower with high-risk appetite regarding defaulting on the loan. Lending organizations often put a burden of high-interest rates on subprime mortgages compared to prime mortgages due to the exposure to steep risk. Such mortgages didn’t require any down payment or, any proof of income.
Later, when the housing market took a crashing downturn, the borrowers found themselves in a precarious situation with their home values lesser than the value of their mortgage. Many of the borrowers lapsed because the associated interest rates were variable in nature according to the clause. Initially, the lending institutions provided loans with low-interest rates but they swelled over time and as a result, the borrowers were underwater. Due to ballooning up of interest rates upon the principle, it was difficult for the borrowers to pay down the principal amount. Many lending institutions were flexible in the provision of these loans due to high capital liquidity and a golden opportunity to make a lump sum profit.
Immense greed also led them to pool in the mortgages and sell off to the investors. The heightened increase of population who could all of a sudden purchase mortgages resulted in a situation of a housing shortage which led to a rise in housing prices. The soaring demand for the housing market made way for easy sanction of loans. When a large chunk of people started defaulting on their mortgages, the loan sharks lost all their lent money and so did many financial institutions that had invested extensively in the pack of mortgages. The subprime mortgage deadlock continued to exist and eventually transformed into a global recessionary situation as its repercussions beamed thoroughly in the financial markets and economies around the globe.
— Lehman Brothers
The highly talked about Financial crash of 2008 had elongated lineage but it wasn’t palpable until September 2008 when its flak became quite noticeable to the world. The news of the bankruptcy of Lehman Brothers is heavily claimed to be the torchbearer of the great economic crisis.
The filing of the bankruptcy was one of the grand incidents in the pages of history. Lehman was the fourth-largest. an investment bank in the USA with $639 billion in assets, $619 billion in debt and consisted of 25,000 employees all over the world. The investment bank is considered to be the largest victim of the Subprime Mortgage generated Financial Crisis that mopped away all the financial markets in the year 2008. The deflation of Lehman’s was an extremely crucial event that tremendously added fuel to the fire and eroded an approximate amount of $10 trillion in market capitalization from global markets.
However, in spite of its stamina to emerge victorious from previous disasters, the downfall of the U.S. Housing Market completely brought Lehman to a rock bottom. Lehman’s hovering amount of leverage and its extensive portfolio full of mortgage securities pushed it to extreme vulnerability under declining market conditions. Finally, on 15th September 2008 Lehman Brothers, filed for bankruptcy. The further announcement of “No Bailouts” intensified the panic-stricken scenarios. Lehman’s paralysis agitated global financial markets for days, weeks, months and years.
— Politics and Other Factors
Since the era of the 1980s, bankers and politicians have constructed a peevish partnership. Politicians had dramatically bribed banks into generating absurd loans to un-creditworthy borrowers on the pretext of the confirmation of bank mergers according to the Community Reinvestment Act. Politicians effectively advertised the expansion of the American idea of homeownership without calculating the possible risks and negative consequences.
Bankers were paid ludicrous amounts of money to securitize pernicious subprime mortgages. On the other hand, Rating Agencies swept in profits by labeling virulent securities as worthy of investment ie. “A” grade. The firms that followed the herd and gave into the riskiest hazardous types of subprime mortgages, securities, and derivatives were the first to backslide when the house of cards stumbled one after the other. CITIGROUP is the most prominent example of falling under this category!
AFTERMATH: 2008-09 Economic Crisis
— Crisis on Banking Sector
The financial crisis viciously slaughtered the banking sector where a large number of banks had to be bailed out by governments while others were mandated into unions with stronger heads. Institutions like Merrill Lynch, American International Group, Halifax Bank of Scotland, Royal Bank of Scotland, Fortis, Bradford & Bingley, Hypo Real Estate, and Alliance & Leicester were apprehended to pursue the road to bankruptcy but the announcement of a US Federal Bailout worth $85 Billion rescued them from absolute collapse. In spite of the “Bailouts” by the US Federal government, it became much more harrowing to take loans from the bank.
— Effect on the Equity Market
The 2008 crisis was a worldwide anomaly as it severely disturbed almost all the economies with a heightened degree of invasion. When the gigantic investment banks and eminent insurance companies were under immense pressure, they started selling equities to get some liquid cash for debt payments. The selling pressure induced a relentless crash in the equity markets around the globe. Since almost all Capital markets consist of foreign institutional investors, the impact was noticeable everywhere. The Asian markets in China, Hong Kong, Japan, and India were promptly affected and became parched after the U.S. Sub-Prime Crisis. Whenever there is a crucial correction in the markets in the USA it triggers all other markets as well because the rate of return in stocks is extremely correlated globally.
— Investor’s Catastrophe
The Bank Stocks went through a bloodbath where their respective dividends were ripped off and consequently led to the loss of wealth amongst investors. The majority of the population had much of their money parked in bank stocks because they were generating such high dividends.
— Declination in Consumer Wealth
The financial crisis caroused a critical role in the downfall of grass-root businesses and declination in consumer wealth. It also completely contributed to the European Sovereign-Debt Crisis which later manifested into a full-swing international issue and cornered the world’s banking system towards a deflation. Economies paced down during this phase as there was a decrease in international trade and the tightening of credits.
— Fall in Income & Opportunities
The Great Recession immediately fueled cutbacks in many reputed and non-reputed companies and there was a considerable fall in income. Great Recession restricted the opportunities for career enhancement and income raises. Financial flexibility was tremendously tampered by the Great Recession to a vast extent.
— Calamity in Economic Policies
The engineering of economic policies also altered thoroughly. Central Banks & Governments took on additional functions in regulating the financial system to managing monetary policy and also deployed new apparatuses like “Quantitative Easing” and ‘Austerity’. Quantitative Easing synthetically escalated the values of many fiscal assets, benefitting the existing wealthy section of the society. On the contrary, “Austerity Programmes” declined the aids and support available for the people belonging to the lowest rung of the income distribution. Austerity Programmes also led to the creation of high unemployment and curtailed public services.
Amidst the financial crisis, due to unfair structural reform, “Rich became richer” and “Poor became poorer.”
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