Professional Documents
Culture Documents
Sec: 02
Identical Thinkers
Financial Crisis of
2008
Submitted To,
Mr. Anwar Zahid
Lecturer
Department of Finance
School of Business
Submitted By, Independent University, Bangladesh (IUB)
Letter of Transmittal
Department of Finance,
Dear Sir,
We are very pleased to submit this report on ‘financial crisis of 2008’, which has been prepared
for the requirement of the course of FIN-401. We have tried our level best to complete this report
properly and to write an efficient assignment within all the constraints and the report contains a
comprehensive study on financial aspects.
We appreciate that the approach really contributes in giving our course learning a lasting shape
on us. We have a great hope that the report will meet your expectation and aid you in getting a
clearer idea about whole mechanism of financial crisis of 2008. We have tried our level best to
follow the guidelines of yours. We are very much glad that you have given us the opportunity to
prepare this report for you and hope that this report will meet the standards of your judgment.
Sincerely yours,
Students, sec-2
FIN-401.
Financial Crisis of 2008
Table of Contents
Executive Summary ...................................................................................................................................... 2
Acknowledgement ........................................................................................................................................ 3
Financial Crisis ............................................................................................................................................. 4
World’s Most-Devastating Financial Crises ............................................................................................. 4
Reason Behind 2008 Global Financial Crisis ............................................................................................... 6
Securitization: ........................................................................................................................................... 6
The Growth of Subprime Mortgage: ......................................................................................................... 7
The Fed Raises Rates on Subprime Borrowers:........................................................................................ 7
Deregulation:............................................................................................................................................. 7
Deregulations & regulatory failures:- ........................................................................................................... 8
Low Interest Rate ...................................................................................................................................... 8
Fail to Control Housing Market by Fed .................................................................................................... 8
Innovation of New Financial Instrument .................................................................................................. 8
Poor Rating by Rating Agencies ............................................................................................................... 8
Predatory Lenders ..................................................................................................................................... 8
The Impact (Cost) of 2008 Economic Collapse for deregulation ................................................................. 9
Key players of Golbal Financial Crisis ....................................................................................................... 10
Lehman Brothers......................................................................................................................................... 12
Last day of Lehman Brothers .................................................................................................................. 12
Credit Rating ............................................................................................................................................... 13
Credit Rating Scale of The Agencies ...................................................................................................... 14
No Income No Job No Assets Loan (NINJA)............................................................................................. 15
Subprime mortgage ..................................................................................................................................... 15
How ‘NINJA’ & Subprime Mortgage Involved in Financial Crisis? ......................................................... 16
Collateralized Debt Obligation (CODs) ...................................................................................................... 16
How CDO Caused Financial Crisis? ....................................................................................................... 17
Credit Default Swaps (CDS) ................................................................................................................... 17
Short Selling................................................................................................................................................ 18
Conclusion ................................................................................................................................................... 20
References ................................................................................................................................................... 21
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Financial Crisis of 2008
Executive Summary
The 2008 financial crisis was the worst economic disaster since the Great Depression of 1929. It
occurred despite aggressive efforts by the Federal Reserve and Department to prevent the
U.S. banking system from collapsing. It led to the Great Recession. That's when housing prices
fell 31.8 percent, more than during the Depression. Two years after the recession
ended, unemployment was still above 9 percent.
That's not counting discouraged workers who had given up looking for work.
The causes of the 2008 Financial Crisis have been analyzed by scholars and many have come to
different conclusions as to which cause is at the core of the crisis. The purpose of this senior
thesis is to analyze the causes of the crisis and empirically explain deregulation as the main cause
of the crisis. This study will use data on bank failures from 1965-2013 gathered from the Federal
Deposit Insurance Corporation to analyze how different regulatory and deregulatory banking
laws affected the number of bank deletions that occurred over time using regression analysis.
Other variables will be used to represent the other causes that are mentioned by scholars.
Our hypothesis is that the deregulation laws will have a significant and positive affect on the
number of bank deletions over time. Laws should therefore be aimed at regulating banks to
ensure the stability of the financial system.
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Financial Crisis of 2008
Acknowledgement
The success of this financial report depends on the contribution of a number of people, especially
those who take the time to share their thoughtful guidance and suggestion to improve this
financial report. First of all we would like to pay our gratitude to almighty Allah, who has given
us patience to complete this financial report. Because working on this issue for a month and then
preparing a report regarding our experience is quite tedious job.
We would like to thank Independent University, Bangladesh (IUB) for planning such a course
that gave us the chance to gather practical knowledge about what we learnt in few weeks. The
knowledge we gathered throughout the course would help us to develop our future career.
Then we would like to express our gratefulness to our honorable faculty of Business School Mr.
Anwar Zahid in Independent University (IUB) who supported us sharing his knowledge
according on this “How a period of de-regulation of financial markets contributed to the financial
crisis of 2008”.
Lastly, we must be thankful to our friends for their endless inspiration not to be hopeless and
keep working harder.
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Financial Crisis of 2008
Financial Crisis
A financial crisis is a situation in which the value of financial institutions or assets drops rapidly.
A financial crisis is often associated with a panic or a run on the banks, in which investors sell
off assets or withdraw money from savings accounts with the expectation that the value of those
assets will drop if they remain at a financial institution.
A financial crisis can occur as a result of institutions or assets being overvalued, and it can be
exacerbated by irrational investor behavior. A rapid string of selloffs can further result in lower
asset prices or more savings withdrawals. If left unchecked, the crisis can cause the economy to
go into a recession or depression.
This crisis originated in London and quickly spread to the rest of Europe. In the mid-1760s the
British Empire had accumulated an enormous amount of wealth through its colonial possessions
and trade. This created an aura of over optimism and a period of rapid credit expansion by many
British banks. The hype came to an abrupt end on June 8, 1772.
This was the worst financial and economic disaster of the 20th century. Many believe that the
Great Depression was triggered by the Wall Street crash of 1929 and later exacerbated by the
poor policy decisions of the U.S. government. The Depression lasted almost 10 years and
resulted in massive loss of income, record unemployment rates, and output loss, especially in
industrialized nations. In the United States the unemployment rate hit almost 25 percent at the
peak of the crisis in 1933.
This crisis began when OPEC (Organization of the Petroleum Exporting Countries) member
countries—primarily consisting of Arab nations—decided to retaliate against the United States in
response to its sending arms supplies to Israel during the Fourth Arab–Israeli War. OPEC
countries declared an oil embargo, abruptly halting oil exports to the United States and its allies.
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Financial Crisis of 2008
Despite the shock of the savings and loans crisis, two more crises took place before the 1989
Act. The most memorable was the 1987 stock market crash. On what became known as Black
Monday, global stock markets crashed, including in the US, where the Dow Jones index lost 508
points or 23% of its value. The causes are still debated. Much blame has been placed on the
growth of programmed trading, where computers were executing a high number of trades in
rapid fashion. Many were programmed to sell as prices dropped, creating something of a self-
inflicted crash.
This crisis originated in Thailand in 1997 and quickly spread to the rest of East Asia and its
trading partners. Speculative capital flows from developed countries to the East Asian economies
of Thailand, Indonesia, Malaysia, Singapore, Hong Kong, and South Korea (known then as the
“Asian tigers”) had triggered an era of optimism that resulted in an overextension of credit and
too much debt accumulation in those economies.
This sparked the Great Recession, the most-severe financial crisis since the Great Depression,
and it wreaked havoc in financial markets around the world. Triggered by the collapse of the
housing bubble in the U.S., the crisis resulted in the collapse of Lehman Brothers (one of the
biggest investment banks in the world), brought many key financial institutions and businesses to
the brink of collapse, and required government bailouts of unprecedented proportions. It took
almost a decade for things to return to normal, wiping away millions of jobs and billions of
dollars of income along the way. Let’s talked about this financial crisis in more detail
The 2008 financial crisis was the worst economic disaster since the Great Depression of 1929.
The root cause has been traced to no one single event or reason. Rather, it was the result of a
sequence of events, each with its own triggering mechanism that led to near collapse of the
banking system. It has been argued that the seeds of the crisis were sown as far back as the 1970s
with Community Development Act, which forced banks to loosen their credit requirements for
lower-income minorities, creating a market for subprime mortgages.
The amount of subprime mortgage debt, which was guaranteed by Freddie Mac and Fannie Mae,
continued to expand into the early 2000s, about the time the Federal Reserve Board began to cut
interest rates drastically to fend off a recession. The combination of loose credit requirements
and cheap money spurred a housing boom, which drove speculation, which in turn drove up
housing prices.
In the meantime, the investment banks, looking for easy profits in the wake of the dotcom bust
and 2001 recession, created collateralized debt obligations (CDOs) out of mortgages purchased
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Financial Crisis of 2008
on the secondary market. Because subprime mortgages were bundled with prime mortgages,
there was no way for investors to understand the risks associated with the product. Around the
time when the market for CDOs was heating up, the housing bubble that had been building up
for several years was beginning to burst. As housing prices fell, subprime borrowers began to
default on loans that were worth more than their homes, accelerating the decline in prices.
When investors realized the CDOs were becoming worthless due to the toxic debt they
represented, they tried to unload them, but there was no market for them. This caused a cascade
of subprime lender failures, which created a liquidity contagion that worked its way to the upper
tiers of the banking system. Two major investment banks, Lehman Brothers and Bear Stearns,
collapsed under the weight of their exposure to the subprime debt, and more than 450 banks
failed over the next five years. Several of the major banks were on the brink of failure had it not
been for a taxpayer-funded bailout. (Bondarenko, n.d.)
The financial crisis was primarily caused by deregulation in the financial industry. That
permitted banks to engage in hedge fund trading with derivatives. Banks then demanded more
mortgages to support the profitable sale of these derivatives. They created interest-only loans that
became affordable to subprime borrowers.
In 2004, the Federal Reserve raised the fed funds rate just as the interest rates on these new
mortgages reset.
Housing prices started falling as supply outpaced demand. That trapped homeowners who
couldn't afford the payments, but couldn't sell their house. When the values of the derivatives
crumbled, banks stopped lending to each other. That created the financial crisis that led to the
Great Recession. There are some other reasons too let us have a look on those
Securitization:
Commercial Bank and others sold mortgage-backed securities, and other derivatives. Since the
bank sold mortgages, it can make new loans with the money it received. The investment bank
then bundles mortgage with a lot of other similar mortgages which calls ‘CDO’. The investors
took all the risk of default. But they didn't worry about the risk because they had insurance,
called credit default swaps (we’ll discuss in later). As the demand for these derivatives grew, so
did the banks' demand for more and more mortgages to back the securities. To meet this demand,
banks and mortgage brokers offered home loans to just about anyone. This is called NINJA loan.
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Financial Crisis of 2008
Deregulation:
In 1999, the Gramm-Leach-Bliley Act repealed the Glass-Steagall Act of 1933. The repeal
allowed banks to use deposits to invest in derivatives. The following year, the Commodity
Futures Modernization Act exempted credit default swaps and other derivatives from regulations.
Texas Senator Phil Gramm, Chairman of the Senate Committee on Banking, Housing and Urban
Affairs. “Enron Energy Company” was a major contributor to Senator Gramm’s campaigns.
Federal Reserve Chairman Alan Greenspan and former Treasury Secretary Larry Summers also
lobbied for the bill’s passage. This leads a new product of subprime loan. (Amadeo, What
Caused the 2008 Global Financial Crisis?, 2017)
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Financial Crisis of 2008
Low Interest Rate: Failure to Manage the U.S. Trade Deficit. The housing bubble (as well as
the surge in leveraged buyouts of publicly traded companies “private equity”) was fueled by
cheap credit — low interest rates. One reason for the cheap credit was an influx of capital into
the United States from China. China’s capital surplus was the mirror image of the U.S. trade
deficit — U.S. corporations were sending lots of dollars to China in exchange for the cheap stuff
sold to U.S. consumers.
Fail to Control Housing Market by Fed: Failure to Intervene to Pop the Housing
Bubble. Along with an influx of capital, Federal Reserve policy kept interest rates very low.
There were good reasons for the Fed Policy, but that did not mean the Fed was helpless to
prevent the housing bubble. As economists Dean Baker and Mark Weisbrot of the Center for
Economic and Policy Research insisted at the time, Federal Reserve Chair Alan Greenspan
simply by identifying the bubble — and adjusting public perception of the future of the housing
market — could have prevented or at least contained the bubble.
Poor Rating by Rating Agencies: Private Regulatory Failure. It was the job of ratings
agencies (like Standard and Poor’s, and Moody’s) to assess the CDOs and give investors
guidance on how risky they were. They failed totally, likely in part because they wanted to
maintain good relations with the investment banks issuing the CDOs.
Predatory Lenders: No Controls over Predatory Lenders. The toxic stew of financial
deregulation and the housing bubble created the circumstances in which aggressive lenders were
nearly certain to abuse vulnerable borrowers. The terms of your loan don’t matter, they
effectively purred to borrowers, so long as the value of your house is going up. Lenders duped
borrowers into conditions they could not possibly satisfy, making the current rash of foreclosures
on subprime loans inevitable. Effective regulation of lending practices could have prevented the
abusive loans, but none was to be found. (Weissman, 2011)
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Financial Crisis of 2008
The cost of the financial crisis to the world economy has so far remained under examined,
Probably because of the difficulty in making such an assessment. The crisis was precipitated
By an unsustainable bubble that artificially inflated economic figure, so what should be?
Used as a benchmark for measuring the effects of the crisis on economy. U.S. households lost on
average nearly $5,800 in income due to reduced economic growth during the acute stage of the
financial crisis from September 2008 through the end of 2009. Costs to the federal government
due to its interventions to mitigate the financial crisis amounted to $2,050, on average, for each
U.S. household. Also, the combined peak loss from declining stock and home values totaled
nearly $100,000, on average per U.S. household, during the July 2008 to March 2009 period.
This analysis highlights the importance of reducing the onset and severity of future financial
crises, and the value of market reforms to achieve this goal.
Income – The financial crisis cost the U.S. an estimated $648 billion due to slower economic
growth, as measured by the difference between the Congressional Budget Office (CBO)
economic forecast made in September 2008 and the actual performance of the economy from
September 2008 through the end of 2009. That equates to an average of approximately $5,800 in
lost income for each U.S. household.
Government Response – Federal government spending to mitigate the financial crisis through
the Troubled Asset Relief Program (TARP) will result in a net cost to taxpayers of $73 billion
according to the CBO. This is approximately $2,050 per U.S. household on average.
Home Values – The U.S. lost $3.4 trillion in real estate wealth from July 2008 to March 2009
according to the Federal Reserve. This is roughly $30,300 per U.S. household. Further, 500,000
additional foreclosures began during the acute phase of the financial crisis than were expected,
based on the September 2008 CBO forecast.
Stock Values – The U.S. lost $7.4 trillion in stock wealth from July 2008 to March 2009,
according to the Federal Reserve. This is roughly $66,200 on average per U.S. household.
Jobs – 5.5 million more American jobs were lost due to slower economic growth during the
financial crisis than what was predicted by the September 2008 CBO forecast. (The Impact of the
September 2008 Economic Collapse, 2010)
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Financial Crisis of 2008
Richard Fuld
Fuld’s nickname was the “Gorilla” on Wall Street because of his competitiveness,
joining Lehman Brothers in 1969 and rising through the ranks to become CEO and
chairman. Fuld became CEO in 1994 until the firm filed for bankruptcy in 2008, at
which point he was hauled in front of Congress to explain his role in the financial
meltdown of the economy. Fuld has since kept a low profile, opening an advisory
firm Matrix Advisory in Midtown Manhattan and has been consulting quietly,
according to news reports and SEC filings.
Angelo Mozilo
The founder and former CEO of Countrywide Financial Corporation became the
face of the subprime mortgage crisis, famous for seeking lenient regulation by
providing special terms to elected “friends of Angelo.” Countrywide was bought by
Bank of America early in 2008 as problems mounted in its lending operations. He
ultimately settled securities fraud cases with the Federal government by agreeing to
pay a fine of $67.5 million.
Henry Paulson
Treasury Secretary Hank Paulson was the architect of the TARP program which bailed out
Wall Street’s biggest banks. He is considered by some the most important person at the height
of the financial crisis, memorable for his quick, aggressive response as the economy was on
the brink of collapse. Others see him as a Wall Street player engineering the salvation of his
peers with federal bailout funds. Paulson, with Federal Reserve Chairman Ben Bernanke and
then New York Fed President Tim Geithner, convinced then President George W. Bush and
Congress to approve TARP, in the days after the Lehman collapse, though not before some of
Wall Street’s most volatile trading days ever.
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Ken Lewis
The former Bank of America chairman and CEO is noted for the
disastrous purchases of Countrywide and Merrill Lynch, which lead to
massive losses for the bank and multi-billion dollar bailouts by the
government. Lewis retired at the end of 2009 and was replaced by
current CEO Brian Moynihan. Bank of America agreed lasted year to
pay $2.4 billion to settle claims stemming from the Merrill Lynch
acquisition.
Tim Geithner
Geithner played a key role in the financial crisis as New York Fed
President and was involved in critical decisions involving bailing out
banks, allowing the collapse of Lehman Brothers and the sale of Bear
Stearns. Geithner went onto become Treasury Secretary under President
Obama, serving almost five years in the post, before leaving to become
head of the Council of Foreign Relations in New York.
Jamie Dimon
The CEO of J.P. Morgan Chase & Co. was considered to be running the
most stable firm during the financial crisis and at the urging of the
government, bought Bear Stearns in a fire sale as the firm was failing in
early 2008. Dimon has been highly critical of regulations brought by the
government subsequent to the crisis to crack down on risk on Wall
Street and has been quoted saying his firm had a “fortress balance
sheet.” More recently J.P. Morgan US:JPM suffered more than $6
billion in trading losses from complex derivatives, after initial reports
were dismissed by Dimon as a “tempest in a teapot.”
Erin Callan
Callan was considered one of the most powerful women on Wall Street
when she was appointed CFO of Lehman in September 2007 after
rising up the ranks. She was stripped of the CFO title just six months
later after the firm reported massive second-quarter losses the following
year and had to raise more $6 billion in capital. Three months later the
firm filed bankruptcy. Callan briefly joined Credit Suisse as a
managing director but left by the end of December 2009.
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Lehman Brothers, Inc. operates as an investment bank that serves institutional, corporate,
government, and high-net-worth individual clients. Its business includes capital rising for clients
through securities underwriting and direct placements; corporate finance and strategic advisory
services; private equity investments; securities sales and trading; research; and the trading of
foreign exchange and derivative products, and certain commodities. The company operates in
three divisions: Investment Banking, Capital Markets, and Client Services. The Investment
Banking division provides advice to corporate, institutional, and government clients throughout
the world on mergers, acquisitions, and other financial matters. (VanderMolen, n.d.)
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From the beginning of 2001 the housing demand of US economy started to increase, house price
was going really high therefore people started to take house loan as we discussed earlier, bank in
return were getting good interest and high priced collateral security as mortgages. These
mortgages were letter sold in stock market in terms of bond by lenders in orders to gain more
money. Lehman Brothers was also one of them. They were continuously selling the mortgage
loan to investors and they were also making huge profit until February 2007. But then starts the
real problem. As time goes interest of the house goes up, and people who are NINJA loan taker
unable to pay their interest and premium. House price started to fall down. People were now not
interested to buy more house. As price goes down people a stop to pay loan. So, there is huge
supply of house but less demand. Price starts to fall down more rapidly. Lehman brothers were
left with huge amount of CDOs and losses. But Lehman Brothers cheats with their investors.
Lehman Brothers sold their CDOs for $50 Billion to “Cayman Island Bank” as they will be
bought back for short term cash. Bus instead of showing those cash as loan, they show it as sales.
By this they reduce their CDOs. But when bank like “JP Morgan” and other investor started to
ask for their money back they went for bankruptcy.
Credit Rating
An estimate of the ability of a person or organization to fulfill their financial commitments,
based on previous dealings.
What are the Credit Rating Agencies and how do they work?
There are credit rating agencies who give rating of people (borrowers) who will able to pay up
the loans or not. Based on that they give AAA grade to D grade of the bonds. The upper the
grade is the lower the interest rate is. There are Big Three credit-rating agencies which are
Moody’s Corporation
Standard & Poor’s. (known as S&P Global)
Fitch Ratings
Moody’s corporation
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S&P Global
Standard & Poor's Financial Services LLC (S&P) is an American financial services company.
It is a division of S&P Global that publishes financial research and analysis on stocks, bonds and
commodities. S&P is considered one of the Big Three credit-rating agencies.
Fitch ratings
Fitch Group is a global leader in financial information services with operations in more than 30
countries. Fitch Group is comprised of: Fitch Ratings, a global leader in credit ratings and
research. Fitch Solutions, a leading provider of credit market data, analytical tools and risk
services. An independent provider of country risk and industry analysis specializing in emerging
and frontier markets.
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A NINJA loan is a slang term for a loan extended to a borrower with "no income, no job and no
assets". Whereas most lenders require the borrower to show a stable stream of income or
sufficient collateral, a NINJA loan ignores the verification process. A NINJA loan is considered
to be a type of subprime lending, often found in the mortgage market. While the specifics of any
NINJA loan can change, most offer the lender a low initial rate, which is then increased after a
few periods of payment. The borrower is hoping for the value of their property to appreciate
significantly, allowing them to repay the loan with the newly found equity. However, when the
property doesn't appreciate, many borrowers cannot make the repayment. This makes the NINJA
loan a very risky proposition for lenders. (NINJA Loan, n.d.)
Subprime mortgage:
A subprime mortgage is a type of mortgage that is
normally issued by a lending institution to borrowers with
low credit ratings. As a result of the borrower's lower
credit rating, a conventional mortgage is not offered
because the lender views the borrower as having a larger-
than-average risk of defaulting on the loan. Lending
institutions often charge interest on subprime mortgages
at a rate that is higher than a conventional mortgage in
order to compensate them for carrying more risk.
Therefore, borrowers with credit ratings below 600, for example, will often be stuck with
subprime mortgages and higher interest rates to go along with those mortgages. Additionally,
making late bill payments or declaring personal bankruptcy could very well land borrowers in a
situation in which they can only qualify for a subprime mortgage. Thus, it is often useful for
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people with low credit scores to wait for a period of time and build up their scores before
applying for mortgages, to ensure they are eligible for a conventional mortgage.
Citibank, Bank of America, along with Countrywide Financial, was making junk
mortgages. One day, Wall Street couldn’t find any more qualified people to sell mortgages to.
To solve this problem Wall Street started selling mortgages to people who did not qualify for one
before. The mortgage salesmen lowered their credit score and down payment requirements. They
also introduced a new type of mortgage called an “Adjustable Rate Mortgage” (ARM) that
would entice home buyers by offering a lower rate in the beginning and raising it later. “NINJA”
loans, or loans for people with No Income, No Job, and No Assets. All of these changes reduced
the quality of the mortgages and increased the market for “subprime mortgages” or more
colloquially “mortgages for unqualified people”. The strange fact is that mortgage salesmen were
actually incentivized to sell more subprime mortgages because they were riskier and, for that
reason, carried a higher interest rate. (Subprime Mortgage, n.d.)
The funds they received gave financial institutions more cash to make new loans. It moved the
loan's risk of default from the bank to the investors. CDOs gave banks new and more profitable
products to sell. That boosted share prices and managers bonuses. That happened with ‘Lehman
Brothers’ CEO Richard S. Fuld, Jr.
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CDO provided more liquidity in the economy for home loans. The spread of CDOs is one reason
why the U.S. economy was robust until 2007. The invention of CDOs also helped create new
jobs. Unlike a mortgage on a house, a CDO is not a product that you can touch or see to find out
its value.
Unfortunately, the extra liquidity created an asset bubble in housing, credit cards, and auto debt.
Housing prices skyrocketed beyond their actual value. People bought homes so they could sell
them. The banks that sold the CDOs didn't worry about people defaulting on their debt. They had
sold the loans to other investors, who now owned them. That made them less disciplined in
adhering to strict lending standards. Banks made loans to borrowers who weren't credit-worthy.
That ensured disaster. What made things even worse was that CDOs became too complicated.
The buyers didn't know the value of what they were buying.
CDOs make it possible to recycle risky debt into AAA-rated bonds that are considered safe for
retirement investing and for meeting reserve capital requirements. This helped to encourage the
issuance of subprime, and sometimes subpar, mortgages to borrowers who were unlikely to make
good on their payments. This opaqueness and the complexity of CDOs created a market panic in
2007. Banks realized they couldn't price the product or the assets they were still holding.
Overnight, the market for CDOs disappeared. Banks refused to lend each other money because
they didn't want more CDOs on their balance sheet in return. It was like a financial game of
musical chairs when the music stopped. This panic caused the 2007 Banking Crisis. When
housing prices started to drop in 2006, the mortgages of homes bought in 2005 were soon
upside-down. That created the subprime mortgage crisis. The Federal Reserve assured investors
it was confined to housing. In fact, some welcomed it and said that housing had been in a bubble
and needed to cool down. What they didn't realize was how derivatives multiplied the effect of
any bubble and any subsequent downturn. Not only banks were left holding the bag, they were
also holding the pension funds, mutual funds and corporations. It was until the Fed and the
Treasury started buying these CDOs that a semblance of functioning returned to the financial
markets.
A credit default swap is a particular type of swap designed to transfer the credit
exposure of fixed income products between two or more parties. In a credit default swap, the
buyer of the swap makes payments to the swap’s seller up until the maturity date of a contract. In
return, the seller agrees that, in the event that the debt issuer defaults or experiences
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another credit event, the seller will pay the buyer the security’s premium as well as
all interest payments that would have been paid between that time and the security’s maturity
date.
Many CDSs were sold as insurance to cover those exotic financial instruments that created and
spread the subprime housing crisis. As those mortgage-backed securities and collateralized debt
obligations became nearly worthless, suddenly that seemingly low-risk event-an actual bond
default-was happening daily. The banks and some investment banks selling CDSs were no longer
taking in free cash; they had to pay out big money. (Credit Default Swap - CDS, n.d.)
Short Selling
Short selling is the sale of a security that is not owned by the seller, or that the seller has
borrowed. Short selling is motivated by the belief that a security's price will decline, enabling it
to be bought back at a lower price to make a profit. Short selling may be prompted by
speculation, or by the desire to hedge the downside risk of a long position in the same security or
a related one. Since the risk of loss on a short sale is theoretically infinite, short selling should
only be used by experienced traders who are familiar with its risks.
During the booming of housing market and mortgage backed securities some investors find that
there will be a collapsed of financial market for those bad credits. So, the bet against the housing
market. This is call shorting. If the housing market really collapsed they will be earn cash for it.
Banks like Goldman Sachs, Deutsche Bank and even Bank of America short sell of their bonds.
(Short Selling, n.d.)
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Bankers were not the only people to blame. Central bankers and other regulators bear
responsibility too, for mishandling the crisis, for failing to keep economic imbalances in check
and for failing to exercise proper oversight of financial institutions. The regulators’ most
dramatic error was to let Lehman Brothers go bankrupt. This spread panic in markets. But the
regulators made mistakes long before the Lehman bankruptcy, most notably by tolerating global
current-account imbalances and the housing bubbles that they helped to inflate. Central banks
could have done more to address all this. The Fed made no attempt to stem the housing bubble.
Now who is possibly responsible for this crisis? It’s not only bankers whom we can claim for
perhaps also the Credit Rating Agencies, Greedy Short seller, and lastly the regulator of this
whole system the Federal Reserve Bank other regulators bear responsibility too, for mishandling
the crisis, for failing to keep economic imbalances in check and for failing to exercise proper
oversight of financial institutions. The regulators’ most dramatic error was to let Lehman
Brothers go bankrupt. This spread the panic in markets and turned the whole economy.
Suddenly, nobody trusted anybody, so nobody would lend. Non-financial companies, unable to
rely on being able to borrow to pay suppliers or workers, froze spending in order to hoard cash,
causing a seizure in the real economy. But the regulators made mistakes long before the Lehman
bankruptcy, most notably by tolerating global current-account imbalances and the housing
bubbles that they helped to inflate. Central banks could have done more to address all this. The
Fed made no attempt to stem the housing bubble. Then blame goes for commercial bank. They
give NINJA loan and made subprime mortgages. Also, there was no intervention from Fed. Now
here comes the background crook which is the credit rating agency. They give those bad credit
mortgages AAA rating just for little money and afraid for competitor. By believe in those rating
investors invest. Some made CDS and some Short Sell. There was no one to regulate. Everyone
was responsible for collapse in 2008 global financial crisis.
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Financial Crisis of 2008
Conclusion
The breakdown of financial crisis 2008 taught us that once it’s shattered can’t be restored
quickly. In this globalization world liquidity crisis spreads very fast. The whole world has
affected for 2008 financial crisis. The political leaders and central bank had tried their best to
minimize the affect but it was too late as the crisis spread all over the world. Due to this
devastating financial crisis the poor people got poorer and the rich got richer. Besides the
increasing rate of unemployment and the decreasing growth of the economy fluctuated the whole
economic indicators. Now the main concern is how to prevent or what are the possible key
measures can be taken so that this devastating crisis might not come again. To prevent this main
regulator of all banks the Federal Reserve should monitor over the banks so that banks cannot go
for extreme investment in subprime loans. There should be a balanced ratio given by the Fed on
how much the banks will need to hold for hedging future risk and how much they can give loans
to people. Besides there are some key measures they can also take such as ensuring a proper
Monetary policy to control the economic condition, Liquidity support providing by enforcement
by Federal Reserve so that the banks get engage collateralized lending programs, FDIC (Federal
Deposit Insurance Corporation) expanded guarantees, capital injections (surplus sing) by
government if the economy becomes really unstable, testing on and checking the conditions of
large banks. If these measures can be followed and the Fed monitors over the banks properly
only then this crisis can be prevented from repetition.
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Financial Crisis of 2008
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https://www.thebalance.com/what-caused-2008-global-financial-crisis-3306176
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