Remember the Financial Crisis?

Occupy protests outside St Paul’s Cathedral, London

Being at the tender age of 26, I tend to assume that everyone is acutely aware of the financial crisis of 2008 and it’s legacy on everything from interest rates to unemployment. However it turns out I’m getting old, and there are now 18 year olds beginning their undergraduate degrees who barely have any recollection the events, not to mention swathes of politicians and financiers who seem to have conveniently forgotten what the credit crash and subsequent austerity measures meant for millions of ordinary people.

So to everyone out there who wishes to be reminded of the chaos, or learn it a fresh, I hope you enjoy the following recollections …

Wall Street vs. Main Street: The Subprime Mortgage Crisis

Chief Economics Commentator of the Financial Times Martin Wolf, a man who by his own admission surprised himself by the extent of radical monetary policy reforms he now believes must be implemented, stated in his 2014 lecture at the London School of Economics that the global financial crisis was ‘the biggest disaster that pretty well nobody in economics and nobody in policy expected.’ Whilst it is evident that a lack of regulation was in-part to blame for the 2008 crash, it is not true to say that such a situation was unforeseen and indeed warned against.

Back in the 1980s when the western world was ablaze with financial deregulation, Hyman Minsky, an economist regarded by his peers as somewhat of a radical, was pushing his ‘financial-instability hypothesis’ in which he recognised the dangers of boom and bust credit cycles under his model of displacement, boom, euphoria, profit taking, and panic.

Meanwhile, President George W. Bush, referred to by the culture jamming activist duo The Yes Men as ‘a corporation’s wet dream,’ said in October 2002 ‘We want everybody in America to own their own home.’ The President, having challenged lenders to create 5.5 million new home-owners by the end of the decade set Minsky’s ‘displacement’ in motion, whereby investors got overly excited about the U.S. property market. After the bursting of the dot-com bubble and the economic woes caused by the September 11th attacks, former Chairman of the Fed Alan Greenspan, reduced short-term interest rates to help stimulate the flow of credit into the U.S. economy and as rates of borrowing hit a historic low, a speculative real-estate ‘boom’ developed. Credit was extended to prime and subprime borrowers alike, and a tsunami of people now able to enter the housing market meant prices rose faster than ever. ‘Euphoria’ and ‘profit-taking’ ensued as unbeknown to borrowers their risky mortgages were sold to investment banks, bundled together with other similar loans, repackaged, sliced up into tranches, and sold to investors as collateralised debt obligations (CDOs). The reassembled CDOs were constructed in such a way that they were deemed worthy of coveted triple-A investment ratings (the safest there is) from dominant agencies such as Moody’s and Standard & Poor’s, as banks claimed they had a dependable stream of income from the many thousands of supposedly uncorrelated borrowers.

Provided interest rates stayed low, employment was high and the price of property continued its rising trend, this model worked beautifully. Local subprime lenders had no worries, as it was not their capital at risk but that of the investment banks they sold the loans to in return for profitable commissions. The banks proceeded in turning the loans into CDOs, and sold them to investors around the world desperate for a few extra percentiles on their returns in a climate of low interest rates. As demand for these financial products grew, and with revenues soaring, so too did bank leveraging, with banks owing and lending much more than their underlying capital bases. Naturally, such lucrative circumstances cannot be relied upon for sustainable gains.

The ‘panic’ point of Minsky’s theory occurred when the ratio of subprime to prime loans in the system became unbalanced and high-risk subprime mortgages saw interest rates increase after the expiration of their one or two year teaser periods. The interconnected web of global finance was then revealed as mounting defaults from subprime borrowers created a spasm in the credit system, large swathes of home owners stopped making payments, and the market was flooded with property. Too many houses and no buyers results in falling prices and in this case, the scale was such that they plummeted.

What followed was the biggest crash since the Great Depression. With no money coming in from mortgage repayments, and banks unable to liquidate due to such high leveraging practices, hedge funds, insurances companies, mutual funds and investment banks, fell like dominos. The rest of us were left wondering how someone defaulting on their mortgage in Alabama could cause a spasm in the credit system so monumental, that it meant neoliberal austerity measures across the globe.

This article was originally published on dollarjill.com. Dollar Jill was born out of my experiences of growing up with the legacy of the financial crisis, the high cost of living in London, and a desire to gain financial independence and autonomy. The blog shares tools for financial literacy and offers insights about economics, personal finance and investing.

Investor. Stock market sleuth. Irrationally exuberant life enthusiast. Sharing the tools for financial empowerment.

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