The recession looks like a history chapter now

The recession of 2008 was an ongoing process. It started happening not at a particular date or time. It was a gradual process. There is no blame game here but the major responsibility goes towards the Housing sector during that period of time. Without the bank bailouts in the end this could have evolved into a 1930's style global environmental and financial meltdown with worldwide disasters.

What Happened?

Someone looking to buy the house in the USA during the early 2000's would often borrow thousands of dollars from a bank and in return would sign a paper. This paper is called a mortgage. Simple. This mortgage is to be paid back in Principal plus interest by the person taking the loan to fully own the house they are borrowing the money for. Now, if they stop paying it’s called defaulting. The bank or whoever holds the mortgage legally then gains ownership of the house. And the housing market was going up and up by the day so it’s a safe bet right? WRONG.

“We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.” — Ben Berenanke, July 2005

The Problem

Investors looking to make a quick buck without the problem of high risk and to enable quick returns set eyes on the US housing market mortgage system that was backed by a great historical record of mortgages and the AAA ratings by financial agencies. Investors were looking to make money on the interest rates of the mortgage. This was higher yielding than investing in U.S. Treasury bonds which provided lower returns.

Mortgage backed securities were created by securitizing the mortgages in groups by financial institutions. They were rated, arranged in terms of risk evaluation, yield and profiling of mortgages. Big investors bought a lot of these to make money on the interest rates and kept asking for more because they all believed that this was safe. When demand to buy these mortgage backed securities increased. Many loan granting agencies followed predatory practices to get more people on mortgages. This is how subprimes were born. Subprime mortgages were a new thing. They allowed people who did not have a proper job or financial backing or poor credit score to get a mortgage even though it was highly likely they could fail to pay up. Nobody cared because again these had AAA ratings and had always been safe in the past. Then came CDOs or Collateral Debt Obligations. Again, highest ratings from the agencies and most of these CDOs were based on incredibly risky loans.

The Bubble

A lot of people couldn’t pay for their houses. A lot of houses came back on the market but demand was low so the prices begin to decline. Now, the people who were still paying were paying much more interest than the current value of their house so they also defaulted. By 2007, investors stopped making money. Then there were the over the counter derivatives like Credit default swaps, which were insurances against these loans which completely crumpled institutions like AIG and were shown in the movie The Big Short (great movie you should watch it by the way) These financial instruments failed the entire system. The likes of Lehman brothers and Bear Sterns collapsed.

Panic Everywhere

NYSE crashed, the US Economy slowed down. The government sprung into action. TARP (Troubled assets relief program) was put together to bailout these institutions to get them back on track. They were paid of by the taxpayers dollars. 700 billion dollars! This cascade crumpling was put under control.

Banks balance sheets were swooped up by the government accountants to publicly declare which banks were sound and which were not.

Congress also passed a big stimulus package in January 2009, pumping 800 billion into the economy for new spending and tax slashing. The DODD-Fank law was put into place to prevent future hazards and to allow these banks a structure to fall into if they fail.

I shall leave you with this quote from Alan Greenspan -

“If they are too big to fail, they are too big”

Thank you, I have yet to put the references here which I shall do as soon as possible.

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