The financial crisis of 2008 is one of the most important events in the history of the contemporary economy.
Perhaps when we talk about serious economic crises, two events come to mind: The crisis or crash of 29, also known as The Great Depression, and the financial crisis of 2008, which is known as The Great Recession.
The father of political economy, Karl Marx, had already communicated for some time that capitalism was marked by crisis, likewise, the economist Joseph Alois Schumpeter indicated that in market economies there were processes of creative destruction, in which what The old was destroyed to make way for the new, for what would be more productive. Perhaps these two ideas, Marx’s and Schumpeter’s, will help us understand why the history of capitalism has been plagued by crises, depression and recession processes that drag the economy down.
The 2008 financial crisis was not an event that happened overnight or only in deregulated markets in the absence of strong state intervention.
Here we will see what the background to these crises was, how it developed and what their consequences were.
Background to the 2008 financial crisis
The American dream
The crisis did not originate in unbridled and savage capitalism as has traditionally been believed, although the role and failure of the market cannot be ignored. In 2002, George W. Bush launches a housing program with the idea that all Americans can have their own home.
The memories of the terrorist attacks of September 11, 2001, and the dot-com financial bubble were still fresh in the memory of Americans, yet that did not prevent an unprecedented stimulus to the economy that would mark the beginning of one of the worst economic downturns in history.
On June 15, 2002, he made public his intention to launch a program so that 40,000 poor families, mainly Afro-Americans and of Hispanic origin, would have access to housing as part of the American dream. Bush’s plan would initially have $2.4 billion in incentives.
Likewise, after the attacks of September 11, Alan Greenspan, president of the Federal Reserve, seeks to stimulate the national economy through an expansionary monetary policy and lowers interest rates to 1% per year. Money became so cheap that more than 8,000 banks and mortgage brokers launched an aggressive credit program for low-income families.
Financial instruments that caused the crisis
After the Bush and Greenspan stimuli, the credit bureaus and the big banks offered cheap credit to people without assets without work or income (which in English is known as the NINJA: No Income, No Job, No Assets). Two credit bureaus became particularly well known for providing loans to this type of customer: Fannie Mae and Freddie Mac, the two credit bureaus controlled almost half of the mortgage credit in the United States. The famous bank Lehman Brothers also issued this type of debt, initially at very low-interest rates.
Investment banks and hedge funds began to buy the debt that commercial banks had provided to the NINJAS Families (Without income, assets or work) through debt packages called Collateralized Debt Obligations or CDOs (for its acronym in English). The CDO’s were debt packages that investors could buy from banks and in which debts of all types of clients were grouped, both high risk and low risk. Many of these CDOs, being mixed with high-value debt, were classified as AAA investments, but in reality, they were toxic assets that contained debt obligations of poor families that very likely would not pay their obligations.
Mortgages: a safe asset
For years it was considered that housing was a safe asset since all families aspired to have a house, in the same way, investors considered that in the world’s leading economy this asset could only have one direction in the market: promotion. In other words, no one ever believed that housing would go down in price or that its financial instruments would fall.
Due to this trust, the mortgage assets, the CDOs that banks and investment funds traded in the markets did nothing but rising in price. The trend was so strong that thousands of investors believed that this was a type of asset and bought billions of dollars in subprime debt, or high-risk mortgages, granted to families without the ability to pay.
The real estate bubble
As prices rose, the financial assets associated with high-risk mortgage loans became increasingly popular. The banks issued as much credit as possible and hundreds of thousands of families took them with the aspiration of having a home or having a second, third or even fourth home. However, the loans began to raise their interest rates, since they had initial incentives that disappeared in the third year of payment. To the extent that loans began to charge families interest, and since many of the families that acquired them could not really pay these credit obligations, non-payment of debts became frequent.
When families were trapped with unpayable debts, they handed over their homes to the banks, who were left with the red balance of the credit default. When the prices of mortgages cannot go up anymore and with a sector, the construction sector, which had delivered more houses than Americans could afford, soon the prices of the CDOs, of the shares of the banks that had acquired these loans, and housing began to plummet. This is known as the bursting of the housing bubble.
Also read: How to start a real estate business
Key events of the 2008 financial crisis
In early August 2007, Bear Stearns Investment Bank closes one of its investment funds associated with subprime mortgages, anticipating that a crisis is likely to begin.
On October 1, 2007, the Swiss bank UBS announces losses of 482 million dollars, as it is exposed to the storm of massive US mortgage debt.
On January 21, 2008, a stock market crisis occurs, when the share prices of the main global investment banks begin to fall. The crisis did not last long, but it was the harbinger of a deep recession to come.
On September 15, 2008, the US Bank Lehman Brothers, one of the largest issuers of mortgage debt and which had embarked on toxic financial products, declared bankruptcy. With liabilities of more than $600 billion, the Lehman Brothers bankruptcy is one of the largest in US history. One day before its bankruptcy, risk rating agencies, including Fitch Ratings, estimated that Lehman Brothers was a solid entity and maintain their AAA rating on it.
On September 18, 2008, after the bankruptcy of Lehman and Merrill Lynch (the latter a large investment bank that ended up being bought by Bank of America), the US government recognized the financial crisis and launched a financial rescue plan for banking entities affected by the crisis. This caused a record rise in the stock markets.
Between October 10 and 25, 2008, banks and stock market traders warn that stimulus plans are not enough. Stock markets crash globally, marking the start of The Great Recession and the definitive end of the euphoria over bad debt bonds that many investors thought were safe.
Consequences of the 2008 financial crisis
Bank shares are plummeting and investors who had relied on the security of mortgages no longer see investment options in the real economy. Due to the above, the actions of the stock markets collapse worldwide, which causes a liquidity crisis that translates into a recession in the real economy.
As a consequence, millions of people lose their jobs, and the economies of developed and emerging countries enter a recession, seeing production and demand fall. Countries like Spain, Greece and Italy have to request financial bailouts from the International Monetary Fund and the European Central Bank so that their economies regain the dynamism lost after the crisis.
One of the most important consequences of the 2008 financial crisis in the global economy is the return of the role of the State as an important agent in the economy. In the United States, President Obama, with the help of Ben Bernanke (the then-president of the Federal Reserve ), launched a rescue plan for the big banks that ended up being paid for by the taxpayers, which unleashed a wave of citizen indignation that capitalized on the Occupy Wall Street movement. The state intervention marks a return to Keynesian economic principles and the end of the liberal Hayekian era in the US economy.
At the same time, economists, analysts, politicians, investors and bankers were forced to recognize the need to regulate the financial sector, avoiding the fever over high-risk speculative products. However, the steps that have been taken in this direction are rather timid and it is expected that the world may experience a new global recession as a result of the great power that the financial sector still possesses. Today it is claimed that we are living in a carbon bubble since the assets tied to fossil fuels lack the value that the market assigns to them.