THE FINANCIAL CRISIS

2008
• The 2008 Financial Crisis explained, this piece becomes ever more
important in today’s time (that is, 2020) when the world is all over
again going through a crisis. Although there is a stark difference in
the reasons of the causes of both – the recession of today and that
of 2008. We must understand the effects are similar. That is,
people will lose their jobs, consumption will drop, economies and
small businesses will collapse.
• Given these times, the government needs to act swiftly. Although,
we’re somewhere in June currently and the unlock is in place,
things are radically changing around the globe and will continue to
do so in the coming year.
•
• Also called the US housing recession, the 2008 financial crisis has
been one of the worse economic situations the world had ever
seen(Great depression still tops the list), and all this before 2020
happened. Whenever there has been a downfall in the US, all the
other countries’ economies has have suffered along equally or
more.
REASONS

• Because almost everything around the world is traded in terms of

dollars be it Oil or any other commodity. This means the dollar
indirectly controls everything that goes around the World. So, if
the value of the dollar goes up or down even by a little
bit, currencies around the world suffer.
• The entire fall is a little tricky to understand unless you have
knowledge of some terms of finance, like collateral, loans, etc.
But let us attempt to simplify this by the way of an example. Shall
we?
•
• Let us say there is a family who wants to buy a house in the US.
They go to a broker, who offers them a house on a loan. All the
formalities and paperwork is carried out by the broker. On
agreement of both the parties, the broker then approaches a
commercial bank for the loan amount.
• Here, the bank asks for a security/mortgage against the loan,
which will be provided by the purchasing family. Just like when
you borrow some money from a friend in exchange for something.
Anyway, now, the commercial bank is in the possession of
mortgage papers of the family. This bank can sell these mortgage
securities to third parties such as Investment banks. It is similar to
saying: hey, these papers have a value of say $20 when you return
this to us we will pay you $20 + $1 amount – for now, give us the
money, will you? Here the bank is the party giving the paper and
these investment banks are giving them money in return. They will
give the papers when they get their money and interest back.
• Now, here’s what an investment bank is: It is a financial institution that
offers very high returns among their services. All the prime layer parties
such as companies and high-income group people invest in such
institutions. In the name of securities, what is given to these people by
investment banks are CDOs (Collateral Debt Obligation- explained in the
following notes). These CDOs were back then insured by the government
and credit rating agencies were telling investors that these mortgage-
backed securities were safe investments giving these securities AAA
ratings. Thus people were willingly investing in huge amounts.
•
• Now, since these CDOs are made up of mortgage papers of various
loan takers, investment banks started demanding for more such
security bonds from commercial banks. Commercial banks asked
the brokers to find more families who needed loans. And thus
began the sub-prime lending (refer following notes). They started
predatory lending practices without verifying paying capability of
the families.
• You see the above cycle of 4 parties? this became a famous cycle!
People started giving loans and credit agencies labelled these
papers to be good (AA bonds). This basically means that these
parties who took loans are capable of paying them back. Now the
problem was, they were not capable of paying anything back – and
as it turned out all the ratings were a lie!
• And thus, the bubble busted when these sub-prime families
stopped paying their loans. Since families were unable to repay,
commercial banks started seizing their houses. Eventually, a lot of
houses came under the control of banks and became available in
the market, which led to the lowering of value of these houses.
This all led to the US housing crisis as all the loan takers became
NPAs (Non-performing assets) for the banks.
Effects:

• Investment banks like Lehman brothers became bankrupt and

other institutions like Fannie Mae and Freddie Mac were taken
under government control
• All the countries who invested in investment banks became
bankrupt, out of which one was Iceland
• Global Economy faced an enormous slowdown and created a panic
in the financial market
• World trade fell by 40% in 2008