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The 2008 Financial Crisis - Causes and Effects
by Patrick on September 29, 2008 The 2008 financial crisis is affecting millions of Americans and is oneof the hottest topics in the Presidential campaigns. In the last fewmonths we have seen several major financial institutions beabsorbed by other financial institutions,receive governmentbailouts, or outrightcrash. So what caused the financial crisis of 2008? This is actually theperfect storm which has been brewing for years now and finallyreached its breaking point. Let’s look at it step by step.
Market instability
 The recent market instability was caused by many factors, chief among them a dramatic change in the ability to create new lines of credit, which dried up the flow of money and slowed new economicgrowth and the buying and selling of assets. This hurt individuals,businesses, and financial institutions hard, and many financialinstitutions were left holding mortgage backed assets that haddropped precipitously in value and weren’t bringing in the amount of money needed to pay for the loans. This dried up their reserve cashand restricted their credit and ability to make new loans. There were other factors as well, including the cheap credit whichmade it too easy for people to buy houses or make otherinvestments based on pure speculation. Cheap credit created moremoney in the system and people wanted to spend that money.Unfortunately, people wanted to buy the same thing, whichincreased demand and caused inflation. Private equity firmsleveraged billions of dollars of debt to purchase companies andcreated hundreds of billions of dollars in wealth by simply shufflingpaper, but not creating anything of value. In more recent monthsspeculation on oil prices and higher unemployment furtherincreased inflation.
How did it get so bad?
Greed.
The American economy is built on credit. Credit is a greattool when used wisely. For instance, credit can be used to start orexpand a business, which can create jobs. It can also be used topurchase large ticket items such as houses or cars. Again, more jobsare created and people’s needs are satisfied. But in the last decade,credit went unchecked in our country, and it got out of control.Mortgage brokers, acting only as middle men, determined who gotloans, then passed on the responsibility for those loans on to others
 
in the form of mortgage backed assets (after taking a fee forthemselves originating the loan). Exotic and risky mortgagesbecame commonplace and the brokers who approved these loansabsolved themselves of responsibility by packaging these badmortgages with other mortgages and reselling them as“investments.” Thousands of people took out loans larger than they could afford inthe hopes that they could either flip the house for profit or refinancelater at a lower rate and with more equity in their home - which theywould then leverage to purchase another “investment” house.A lot of people got rich quickly and people wanted more. Beforelong, all you needed to buy a house was a pulse and your word thatyou could afford the mortgage. Brokers had no reason
not 
to sellyou a home. They made a cut on the sale, then packaged themortgage with a group of other mortgages and erased all personalresponsibility of the loan. But many of these mortgage backedassets were ticking time bombs. And they just went off.
The housing market declined
 The housing slump set off a chain reaction in our economy.Individuals and investors could no longer flip their homes for a quickprofit, adjustable rates mortgages adjusted skyward and mortgagesno longer became affordable for many homeowners, and thousandsof mortgages defaulted, leaving investors and financial institutionsholding the bag. This caused massive losses in mortgage backed securities and manybanks and investment firms began bleeding money. This also causeda glut of homes on the market which depressed housing prices andslowed the growth of new home building, putting thousands of homebuilders and laborers out of business. Depressed housing pricescaused further complications as it made many homes worth muchless than the mortgage value and some owners chose to simplywalk away instead of pay their mortgage.
The credit well dried up
 These massive losses caused many banks to tighten their lendingrequirements, but it was already too late for many of them… thedamage had already been done. Several banks and financialinstitutions merged with other institutions or were simply boughtout. Others were lucky enough to receive a government bailout andare still functioning. The worst of the lot or the unlucky onescrashed.
 
The Economic Bailout is designed to increase the flow of credit
Many financial institutions that are saddled with risky mortgagebacked securities can no longer afford to extend new credit.Unfortunately, making loans is how banks stay in business. If theircurrent loans are not bringing in a positive cash flow and theycannot loan new money to individuals and businesses, that financialinstitution is not long for this world - as we have recently seen withthe fall of Washington Mutualand other financial institutions. The idea behind the economic bailout is to buy these risky mortgagebacked securities from financial institutions, giving these banks theopportunity to lend more money to individuals and businesses,hopefully spurring on the economy.
What? Credit got us into this mess! Why give more?!?
Ironic isn’t it? Yes, it is true that credit got us into this mess, but it isalso true that our economy is incredibly unstable right now, andbeing that it is built on credit, it needs an influx of cash or it couldcome crashing down. This is something no one wants to see as itwould ripple through our economy and into the world markets in amatter of hours, potentially causing a worldwide meltdown.As I previously mentioned, credit in and of itself is not a bad thing.Credit promotes growth and jobs. Poor use of credit, however, canbe catastrophic, which is what we are on the verge of seeing now.So long as the bailout comes with changes to lending regulationsand more oversight of the industry, along with other safeguards toprotect taxpayer dollars and prevent thieves from not only getting of the hook, but profiting again, there is potential to stabilize themarket, which is what everyone wants. Whether or not it works is tobe seen, but as it has already been voted on and passed, we shouldall hope it does.
 
Reforming financial regulation, supervision, and oversight: What todo and who should do it
24 February 2009
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This column sketches proposed reforms for regulation, supervision, and oversight of international financial markets. At both the national and international levels, there will be plenty of work to do for the IMF, the FSF, international standard-setting bodies, and national regulators and supervisors.
In the midst of the most serious financial and economic crisis since the Great Depression, it isclear that major regulatory failure (in the long run-up to the crisis) was one of the keycontributing factors. The two central questions are:
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