UNIVERSITY OF ECONOMICS AND LAW

FACULTY OF FINANCE AND BANKING

THE FINANCIAL CRISIS OF 2008

SUBJECT: FINANCIAL INVESTMENT

Course : 222TC2301
Lecturer : To Thi Thanh Truc
Student : Tran Gia Han
Student ID: K204040181

Thu Duc City, February 11th 2023

 I. Overview
The Global Financial Crisis of 2008 refers to the massive financial crisis the world faced in 2008. The
financial crisis took its toll on individuals and institutions around the globe, with millions of Americans
being deeply impacted. Financial institutions started to sink, many were absorbed by larger entities, and
the US Government was forced to offer bailouts to keep many institutions afloat. The crisis, often referred
to as “The Great Recession,” didn’t happen overnight. There were many factors present leading up to the
crisis, and their effects linger to this day.
II. Progress of the crisis
1. Mortgage backed-securities.
In the 2000s, investors in the U.S and abroad looking for a low-risk high return investment started
throwing their money at the U.S housing market. The thinking was they could get a better return from the
interest rate homeowners paid on mortgages, than they could by investing in things like Treasury Bonds,
which were paying very, very low interest. But big money, global investors didn’t want to just buy up my
mortgage, and Stan’s mortgage. It’s too much hassle to deal with us as individuals. I mean, we are pains.
Instead, they bought investment called mortgage backed securities. Mortgage-backed securities are
created when large financial institutions securitize mortgages. Basically, they buy up thousands of
individual mortgages, bundle them together, and sell shares of that pool to investors. Investors gobbled
these mortgage-backed securities up. again, they paid a higher rate of return than investors could get in
other places, and they looked like really safe bets. For one home prices were going up and up. So, lenders
thought, worse case scenario, the borrower defaults on the mortgage, we can just sell the house for more
money. At the same time, credit ratings agencies were telling investors these mortgage backed securities
were safe investments. They gave a lot of these mortgages backed-securities AAA ratings-the best of the
best. And back when mortgages were only for borrowers with good credit, mortgage debt was a good
investment.
2. Subprime mortgage
Anyway, investors were desperate to buy more and more of these securities. So, lenders did their best to
help create more of them. But to create more of them, they needed more mortgages. So, lenders loosened
their standards and made loans to people with low income and poor credit, You’ll hear these called sub-
prime mortgages. Eventually, some institutions even started using what are called predatory ending
practices to generate more mortgages. They made loans without verifying income and offered absurd,
adjustable-rate mortgages with payments people could afford at first, but quickly ballooned beyond their
means. These new sub-prime lending practices were brand new. That meant credit agencies could still
point to historical data that indicated mortgage debt was a safe bet. But it was not. These investments were
becoming less and less safe all the time. But investors trusted the ratings, and kept pouring in their money.
Trades also started selling an even riskier product, called collateralized debt obligations or CDOs. And
again, some of these investments were given the highest credit ratings from the rating agencies, even
though many of them were made up of these incredibly risky loans. While the investors and traders and
bankers were throwing money into the U.S housing market, the U.S price of home was going up and up
and up. The new tax lending requirements and low interest rates drove housing prices higher, which only
made the mortgages backed securities and CDOs seem like an even better investment. If the borrowers
defaulted, the bank would still have this super valuable house.
 3. The Housing Bubble
Rapid increases, driven by irrational decisions. This was a bubble, and bubble have an annoying tendency
to burst. And this one did. People just couldn’t pay for their incredibly expensive houses or keep up with
their ballooning mortgage payments. Borrowers started defaulting, which put more houses back on the
market for sale. But there were not buyers. So, supply was up, demand was down, and home prices started
collapsing, As prices faell, some borrowers suddenly had a mortgages for any more than their home was
currently worth. Some stopped paying. That led to more defaults, pushing prices down further. As this
was happening, the big financial institutions stopped buying sub-prime mortgages and sub-prime lenders
were getting stuck with bad loans. By 2007, some big lenders had declared bankruptcy. The problems
spread to the big investors, who would pour money into these mortgages backed securities and CDOs.
And they started losing money on their investment. There was another financial instrument that financial
institutions had on their books that exacerbated all these problems-unregulated, over-the-counter
derivatives, including something called credit default swaps, that were basically sold as insurance against
mortgages backed-securities. AIG sold tens of millions of dollars of these insurance policies, without
money to back them up when things went wrong, terribly wrong. These credit default swaps were also
turned into other securities - that essentially allowed traders to bet huge amounts of money on whether the
values of mortgage securities would go up or down. All these bets, these financial instruments, resulted in
an incredibly complicated web of assets, liabilities, and risks. So that when things went bad, they went
bad for the entire financial system.

Therefore, it can be said that”The underlying causes of the Crisis” was perverse incentive. A perverse
incentive is when a policy ends up having a negative effect, opposite of what was intended. Like, mortgages
brokers got bonuses for lending out more money, but that encouraged them to make risky loans, which
hurt profits in the end. That leads to moral hazard. This is when one person takes on more risk, because
someone else bears the burden of that risk. Banks and lenders were willing to lend to sub-prime borrowers
because they planned to sell mortgages to somebody else. Everyone thought they could pass the risk up
the line.

III. Measures and policies to recover the economy of the USA government.
Some major financial players declared bankruptcy, like Lehman Brothers. Others were forced into mergers
or needed to be bailed out by the government. No one knew exactly how bad the balance sheets at some
of these financial institutions really were- these complicated, unregulated assets made it hard to tell. Panic
set in. Trading and the credit markets froze. The stock market crashed. And the U.S economy found itself
in a disastrous recession.
Monetary Policy: The Federal Reserve began to ease interest rates in September 2007, and
by the end of 2008, the federal funds rate had been effectively reduced to zero. However, even before the
Bear-Stearns bankruptcy in March 2008, the Federal Reserve began to expand its operations into non-
traditional areas that came to involve the direct supply of credit to a wide range of financial markets. The
sum of these actions has seen the balance sheet of the Federal Reserve swell from under $900 billion in
August of 2008 to over $2 trillion by March 2009. The government also guaranteed the new debt of
commercial banks as a means of improving the liquidity of the system. These programs have largely
succeeded in restoring liquidity and to some extent they can substitute for private financial intermediaries
who are not active in some markets; but they cannot directly address the problems of financial institutions
that are threatened with insolvency.
Fiscal Policy: The Congress passed an economic stimulus program in late February that calls for a
combination of tax cuts and expenditure increases equal to $787 billion, but many evaluations exclude the
extension of some existing tax measures from the computation of the stimulus and estimate the actual
effect at $720 billion (4.8% of GDP). The bulk of the program takes the form of expenditure increases,
but they are scheduled to be temporary, and the program should have only modest effects on the long-
term budget situation. Both the Obama administration and the CBO project a strong recovery in 2010 and
2011 and a return to trend growth by 2011. The government enacted a program called TARP, the troubled
assets relief program, and which the rest of us call the bank bailout. This initially earmarked $700 billion
to shore up the banks. It ended up spending $250 billion bailing out the banks, and was later expanded to
help auto makers, AIG, and homeowners.
Financial Reconstruction: The basic framework of a program is well known as similar plans have been
executed in both the US and other countries (Waxman 1998). The first step is an accurate assessment of
the losses in individual financial institutions. That is followed by a process of writing off the losses against
equity capital and perhaps moving the non-performing assets to a separate asset management corporation,
which would subsequently sell off these assets over a sustained time-period. Third, the affected financial
institutions must be either closed or recapitalized so that there is no continuing uncertainty about their
financial condition. The experience of several countries would suggest the potential for a fourth
component of this process, which involves restarting the lending process and restoring trust in the financial
system after the banks are recapitalized.
Dodd_Frank
In 2002, Congress passed a financial reform, called the Dodd-Frank law. It took steps to increase
transparency and prevent banks from taking on so much risk. Dodd-Frank set up a consumer protection
bureau to reduce predatory ending. It required that financial derivates be traded in exchanges that all
markets participants can observe. And it put mechanisms in places for large banks to fail in a controlled
predictable manor. But, there’s no consensus on whether this regulation is enough to prevent future crises

IV. Regulatory changes to prevent possible similar crises in the future.

1. The future structure of monetary policy
The earlier emphasis on narrow policy rules, such as inflation targeting, appears to have left policymakers
blind to a wider range of concerns such as asset market bubbles and excessive risk taking. Yet the
broadening of the agenda necessarily implies a more powerful and discretionary role for monetary
authorities, which will heighten concerns about accountability.
2. The originate-to-distribute model and wholesale funding.
Securitization and the development of private-label complex structured credit instruments have
undeniably improved access to credit. However, they might also have increased overall risk-taking, which
could have resulted in a destabilizing shift of risks toward institutions that couldn't manage them
effectively, the reversion of some of these risks to banks that had supposedly offloaded them, and a great
deal more uncertainty regarding how risks were distributed among market participants. Additionally, due
to an excessive reliance on wholesale funding markets, both banks and the off-balance-sheet special-
purpose vehicles created through the securitization process have maturity mismatches without properly
accounting for the risks of such funding running out. Credit rating agencies, in turn, assigned high ratings
to complex structured subprime debt based on limited historical data; in some cases, on flawed models;
and on inadequate due diligence of underlying collateral.
3. Pro-cyclical capital requirements and accounting.
Marked-to-market assets and collateral appreciate during upswings, but loan-loss allowances shrink since
default rates are anticipated to fall in the near term. These increases reported equity value and decreases
default probability estimates, which are normally pessimistic for both borrowers and lenders. However,
because risk metrics frequently neglect risk buildup during upswings, risk-based capital needs can be
reduced in good times. A self-feeding cycle between leverage and asset values results from lenders'
increased use of leverage and credit, which in turn allows lenders to undervalue the risks they are taking.
4. Excessively market-based, backward-looking risk management.
Too much reliance on market prices and on oversimplified, backward-looking models to manage risks,
while neglecting due diligence and analysis of fundamentals, appears to have resulted in grossly
underestimating risks, inducing complacency, and decreasing monitoring. Moreover, when many market
participants use similar models, they may be induced to take similarly oriented market positions, thus
exacerbating systemic risk.
5. A more complex but less differentiated configuration of players
The modern financial system exhibits more muddled differences between various types of participants,
increased consolidation, numerous new types of players, and tighter but more opaque links between them
than it did thirty years ago (Borio, 2007). These changes may have resulted from advances intended at
enhancing the effectiveness of financial intermediation, but they also opened the door for increased
leverage and covert risk transfer among participants. As a result, it became more challenging for the
market and regulators to evaluate risks at any given level, and a lack of variety might have made concerted
actions that might have brought about system instability more likely.
V. Conclusion
When something terrible happens, people naturally look for someone to blame. n the case of the 2008
financial crisis, no one had to look very far because the blame and the pain was spread throughout the U.S
economy. The government failed to regulate and supervise the financial system. To quote the bi-partisan,
the financial inquiry commission report, “ The sentries were not at their posts, in no small part due to the
widely accepted faith in the self- correcting nature of the markets, and the ability of financial institutions
to effectively police themselves” The report placed some of the blame on the years of deregulation in the
financial industry. And the blamed regulators themselves for not doing more. The financial industry fail
because everyone in the system was borrowing too much money and taking too much risk, from the big
financial institutions to individual borrowers. The institutions were taking on huge debt loads to invest in
risky assets. And huge numbers of homeowners were taking on mortgages they couldn't afford. But the
thing to remember about this massive systemic failure, is that it happened in a system made up of humans,
with human failing. Some didn't understand what was happening. Some willfully ignored the problems.
And some were simply unethical, motivated by the massive amounts of money involved.