The
Big Claim
The financial crisis of 2008 was one
of the worst financial crisis’s the United States had ever faced. Comparable to
the great depression, the consequences of the financial crisis were widespread
as it caused millions of homes to be foreclosed on and set record levels of
unemployment in the years following. The collapse of financial markets in the
United States was caused by the predatory lending practices of loan originators
who willfully disregarded risk through lowered lending standards in an effort to
yield higher profits.
The collapse of the housing market
in 2008 would have been an avoidable catastrophe if loan originators had not
remained willfully ignorant to their
fraudulent practices. The subprime mortgage market began to grow
rapidly in the years preceding the crash. Subprime loans are typically packaged
and sold off to people with bad credit and reduced payment capacity whom would
in turn have a greater risk of defaulting on their loans, so how could such a
loan eventually become a multi-trillion dollar market? The answer was simple:
foreclosure.
When
borrowers were unable to refinance their loans from adjustable to fixed rates
they defaulted on their loans. Investment banks and other loan originators
would take control of the homes of the borrowers through foreclosure and hope
to resell the properties at a profit. This became the goal of the subprime
mortgage loan. The subprime mortgage industry did not grow because of demand
from the borrower’s side but rather through an increase in supply on the
lender’s side. As other financial institutions began to see the potential of
such a market they eagerly joined in an effort to reap profit for themselves.
An
increase in the number of firms participating in subprime lending creating
increased competition within the market. With the increased competition, loan
originators needed new ways to sell their subprime loans which lead to a sharp
increase in predatory lending practices. Subprime loans were being packaged
into loans with “teaser” periods and adjustable rates where borrowers would
only pay the interest on the loans for the first two years. After the first two
years monthly payments would double or even triple and borrowers would be
unable to keep up with payments leading to widespread defaults. With the
subprime mortgage market growing rapidly between 2005 and 2007 a ticking time
bomb was set in place. Once the teaser periods ended, waves of loan defaults
hit the market starting in the third and fourth quarters of 2008 as borrowers
failed to make payments on their loans that now had higher interest rates and
higher monthly payments leading to the collapse of the housing market.
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| A detailed diagram listing the causes behind the financial crash of 2008 |
The greed of loan originators became its own
end. As they sought increased profits through intentionally targeting the
uneducated and poorer part of America, they ignored the risks involved in
lending and had to pay the consequences. The big plan to profit off the
foreclosure of homes in a time when housing prices were at an all-time high backfired.
Thousands of small firms filed for bankruptcy across the nation as the shadow
banking system they operated on collapsed.
The
shadow
banking system was where most of the funding for subprime
loans came from. Under the shadow banking system these firms did not take
direct deposits and were therefore subject to less regulation so larger banking
institutions that were subject to greater regulation would fund the shadow
banking market in an effort to profit off the subprime mortgage market. Non-bank
financial institutions on the shadow banking market, those operating on
off-balance sheets to hide their fraudulent practices from regulators, began
“repo-runs” on their repurchasing agreements in efforts to regain their short
term borrowed collateral. These repo runs became widespread across the shadow
banking system, which made up 25-30% of the entire financial system, leading to
the failure of many financial institutions. Ultimately the G-20, a group of finance ministers and central bank governors from 20 major economies, summed up the crisis best by stating that “market participants sought higher yields without
an adequate appreciation of the risks and failed to execute proper due
diligence”. When financial institutions rank profit ahead of risk disaster in
eminent.
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| The "Domino Effect" caused by bankrupting financial institutions. |
The effects of the financial crash
and collapse of the housing market were disastrous. According to The
Aftermath of the Financial Crises
written
by Carmen Reinhart and Kenneth Rogoff, the crash not only affected the United
States but global markets as well. Between June 2007 and November of 2008
Americans lost nearly a quarter of their net worth. The IMF (International
Monetary Fund) estimated that US and European banks lost over 2.5 trillion in
toxic loans between 2007 and 2010. Stock market prices fell 57% from their peak
in October of 2008. In every quarter
following the 2008 crash hundreds of thousands of jobs were lost and thousands
of homes were being foreclosed on. Unemployment levels skyrocketed to over 10% in
late 2009 as 8.5 million Americans remained out of work, nearly 6% of the
entire workforce. Real GDP growth in the United States was negative starting in
the third quarter of 2008 and did not return to growth until the first quarter
of 2010.
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| A diagram listing the effects of the collapse of the housing market. |
With the evidence stacked against
them, major corporate leaders such as Howie Hubler were being flamed and held
accountable for their roles in the financial crisis. They sought to defend
themselves and their actions by claiming that creative destruction was at work.
They argued that capitalistic economic development would arise out of the
destruction of the previous economic system, one of the key arguments behind
the defense of creative destruction. To make such a statement after their own
practices lead to the destruction of the previous economic system makes it very
difficult to understand their argument of creative destruction, as Robert Skidelsky
writes in his NewStatemen
article about the role creative destruction played in the
crisis of 2008.
New
economic growth and development maybe come from the destruction of a previous
system but if that previous system was rigged to encourage fraudulent trading
only to be intentionally driven into the ground for profit… how can we be so
sure that the same will not be repeated in a new system? Sure, there may have
been ineffective use of regulatory power by regulators and ineffective crisis
management capability by the Federal Reserve when it did not stem the tide of
toxic mortgages… but these are the exact changes that can and will be made in
the new economic system. There will always been risk involved in trading but if
it is acknowledged crisis can be avoided. Altering the system is not as hard as
altering the people that run the system. Regulatory legislation can be passed
to ensure that all trading done is safe and fair but if the system continues to
be manipulated like it had been by the financial institutions then nothing will
ultimately change.
As
the dust settled in the years following the financial crash of 2008 fingers
were being pointed and many questions were being left unanswered. It became
clear that the collapse of financial institutions and the housing market was an
avoidable catastrophe. The fate of the economic systems in place were
unfortunately in the hands of yield seeking Wall Street leaders who willfully
disregarded the risks of their actions and chose profit over prosperity.
A video of senator Levin ripping into Goldman Sach's CEO Lloyd Blankfein for his company's practices of selling securities and then buying insurance on those securities knowing that they will fail.
