Name: Phạm Trần Cẩm Vi

Student ID: K204040222

Lecturer: Tô Thị Thanh Trúc
Subject: Financial Investment

Financial Crisis of 2008

The financial crisis of 2007-2008 was years in the making. By the summer of 2007,
financial markets around the world were showing signs that the reckoning was overdue for a
years-long binge on cheap credit. Two Bear Stearns hedge funds had collapsed: BNP Paribas
was warning investors that they might not be able to withdraw money from three of its funds,
and the British bank Northern Rock was about to seek emergency funding from the Bank of
England.
Yet despite the warning signs, few investors suspected that the worst crisis in nearly
eight decades was about to engulf the global financial system, bringing Wall Street's giants to
their knees and triggering the Great Recession.It was an epic financial and economic collapse
that cost many ordinary people their jobs, their life savings, their homes, or all three.
Although the exact causes of the financial crisis are a matter of dispute among
economists, there is general agreement regarding the factors that played a role (experts
disagree about their relative importance): First, the Federal Reserve (Fed), the central bank of
the United States, having anticipated a mild recession that began in 2001, reduced the federal
funds rate (the interest rate that banks charge each other for overnight loans of federal
funds—i.e., balances held at a Federal Reserve bank) 11 times between May 2000 and
December 2001, from 6.5 percent to 1.75 percent. That significant decrease enabled banks to
extend consumer credit at a lower prime rate (the interest rate that banks charge to their
“prime,” or low-risk, customers, generally three percentage points above the federal funds
rate) and encouraged them to lend even to “subprime,” or high-risk, customers, though at
higher interest rates (see subprime lending). Consumers took advantage of the cheap credit to
purchase durable goods such as appliances, automobiles, and especially houses. The result
was the creation in the late 1990s of a “housing bubble” (a rapid increase in home prices to
levels well beyond their fundamental, or intrinsic, value, driven by excessive speculation).
Second, owing to changes in banking laws beginning in the 1980s, banks were able to offer to
subprime customers mortgage loans that were structured with balloon payments (unusually
large payments that are due at or near the end of a loan period) or adjustable interest rates
(rates that remain fixed at relatively low levels for an initial period and float, generally with
the federal funds rate, thereafter). As long as home prices continued to increase, subprime
borrowers could protect themselves against high mortgage payments by refinancing,
borrowing against the increased value of their homes, or selling their homes at a profit and
paying off their mortgages. In the case of default, banks could repossess the property and sell
it for more than the amount of the original loan. Subprime lending thus represented a
lucrative investment for many banks. Accordingly, many banks aggressively marketed
subprime loans to customers with poor credit or few assets, knowing that those borrowers
could not afford to repay the loans and often misleading them about the risks involved. As a
result, the share of subprime mortgages among all home loans increased from about 2.5
percent to nearly 15 percent per year from the late 1990s to 2004. Third, contributing to the
growth of subprime lending was the widespread practice of securitization, whereby banks
bundled together hundreds or even thousands of subprime mortgages and other, less-risky
forms of consumer debt and sold them (or pieces of them) in capital markets as securities
(bonds) to other banks and investors, including hedge funds and pension funds. Bonds
consisting primarily of mortgages became known as mortgage-backed securities, or MBSs,
which entitled their purchasers to a share of the interest and principal payments on the
underlying loans. Selling subprime mortgages as MBSs was considered a good way for banks
to increase their liquidity and reduce their exposure to risky loans, while purchasing MBSs
was viewed as a good way for banks and investors to diversify their portfolios and earn
money. Fourth, in 1999 the Depression-era Glass-Steagall Act (1933) was partially repealed,
allowing banks, securities firms, and insurance companies to enter each other’s markets and
to merge, resulting in the formation of banks that were “too big to fail” . In addition, in 2004
the Securities and Exchange Commission (SEC) weakened the net-capital requirement (the
ratio of capital, or assets, to debt, or liabilities, that banks are required to maintain as a
safeguard against insolvency), which encouraged banks to invest even more money into
MBSs. Fifth, and finally, the long period of global economic stability and growth that
immediately preceded the crisis, beginning in the mid- to late 1980s and since known as the
“Great Moderation,” had convinced many U.S. banking executives, government officials, and
economists that extreme economic volatility was a thing of the past. That confident
attitude—together with an ideological climate emphasizing deregulation and the ability of
financial firms to police themselves—led almost all of them to ignore or discount clear signs
of an impending crisis and, in the case of bankers, to continue reckless lending, borrowing,
and securitization practices.
Progress of the crisis lasted two years. It became apparent by August 2007 that the
financial markets could not solve the subprime crisis and that the problems were
reverberating well beyond the U.S. borders. The interbank market that keeps money moving
around the globe froze completely, largely due to fear of the unknown. Northern Rock had to
approach the Bank of England for emergency funding due to a liquidity problem. In October
2007, Swiss bank UBS became the first major bank to announce losses—$3.4 billion—from
sub-prime-related investments. In the coming months, the Federal Reserve and other central
banks would take coordinated action to provide billions of dollars in loans to the global credit
markets, which were grinding to a halt as asset prices fell. Meanwhile, financial institutions
struggled to assess the value of the trillions of dollars worth of now-toxic mortgage-backed
securities that were sitting on their books. By the winter of 2008, the U.S. economy was in a
full-blown recession and, as financial institutions' liquidity struggles continued, stock markets
around the world were tumbling the most since the September 11 terrorist attacks. In January
2008, the Fed cut its benchmark rate by three-quarters of a percentage point—its biggest cut
in a quarter-century, as it sought to slow the economic slide. The bad news continued to pour
in from all sides. In February, the British government was forced to nationalize Northern
Rock. In March, global investment bank Bear Stearns, a pillar of Wall Street that dated to
1923, collapsed and was acquired by JPMorgan Chase for pennies on the dollar. By the
summer of 2008, the carnage was spreading across the financial sector. IndyMac Bank
became one of the largest banks ever to fail in the U.S and the country's two biggest home
lenders, Fannie Mae and Freddie Mac, had been seized by the U.S. government. Yet the
collapse of the venerable Wall Street bank Lehman Brothers in September marked the largest
bankruptcy in U.S. history and for many became a symbol of the devastation caused by the
global financial crisis. That same month, financial markets were in free fall, with the major
U.S. indexes suffering some of their worst losses on record. The Fed, the Treasury
Department, the White House, and Congress struggled to put forward a comprehensive plan
to stop the bleeding and restore confidence in the economy.
The Wall Street bailout package was approved in the first week of October 2008. The
package included many measures, such as a huge government purchase of "toxic assets," an
enormous investment in bank stock shares, and financial lifelines to Fannie Mae and Freddie
Mac. The amount spent by the government through the Troubled Asset Relief Program
(TARP). It got back $442.6 billion after assets bought in the crisis were resold at a profit. The
public indignation was widespread. It appeared that bankers were being rewarded for
recklessly tanking the economy. But it got the economy moving again. It also should be noted
that the investments in the banks were fully recouped by the government, with interest. The
passage of the bailout package stabilized the stock markets, which hit bottom in March 2009
and then embarked on the longest bull market in its history. Still, the economic damage and
human suffering were immense. Unemployment reached 10%. About 3.8 million Americans
lost their homes to foreclosures. The most ambitious and controversial attempt to prevent
such an event from happening again was the passage of the Dodd-Frank Wall Street Reform
and Consumer Protection Act in 2010. On the financial side, the act restricted some of the
riskier activities of the biggest banks, increased government oversight of their activities, and
forced them to maintain larger cash reserves. On the consumer side, it attempted to reduce
predatory lending. By 2018, some portions of the act had been rolled back by the Trump
Administration, although an attempt at a more wholesale dismantling of the new regulations
failed in the U.S. Senate. Those regulations are intended to prevent a crisis similar to the
2007-2008 event from happening again. Which doesn't mean that there won't be another
financial crisis in the future. Bubbles have occurred periodically at least since the 1630s
Dutch Tulip Bubble.
Congress passed the Dodd-Frank Wall Street Reform Act to prevent banks from
taking on too much risk. It also allows the Fed to reduce bank size for those that become too
big to fail. Meanwhile, banks keep getting bigger and are pushing to minimize or get rid of
even this regulation. The financial crisis of 2008 proved that banks could not regulate
themselves. Without government oversight like Dodd-Frank, they could create another global
crisis. Securitization, or the bundling and reselling of loans, has spread to more than just
housing. To prevent further destabilization, stronger regulations of these derivatives should
be considered.
 Bubbles occur all the time in the financial world. The price of a stock or any other
commodity can become inflated beyond its intrinsic value. Usually, the damage is limited to
losses for a few over-enthusiastic buyers. The financial crisis of 2007-2008 was a different
kind of bubble. Like only a few others in history, it grew big enough that, when it burst, it
damaged entire economies and hurt millions of people, including many who were not
speculating in mortgage-backed securities. The 2007-2008 financial crisis was a global event,
not one restricted to the U.S. Ireland's vibrant economy fell off a cliff. Greece defaulted on its
international debts. Portugal and Spain suffered from extreme levels of unemployment. Every
nation's experience was different and complex.