What Caused the Financial Crisis of 2008?
If you want to witness a very interesting game of political football, just search online and look for conservative and liberal websites discussing the genesis of the financial crisis of 2008. The answers are quite entertaining, not so much for the gems of truth that they contain, but in the way they position their arguments. It is really quite revealing how these arguments are made. You can quickly tell whether you are looking at a liberal democrat website or a conservative Republican website. Both sides have their side as the cause of the great crash of 2008.
On the one hand, you have liberals pointing to private greed – we are of course talking about investment banks, big banks, mortgage banks just cranking out these debts knowing that people are in no position to pay for that, but they're still cranking it out because they know that the government backs them and, they are selling this debt in the security's market. There are all these sucker investors in the world over. Many of them are governments with pension funds, institutional investors that have bought this debt by the billions.
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According to liberals, banks like JP Morgan, Gold Mann Sachs and others are just literally laughing all the way to the bank at the other end of the equation.
When you look at the conservative perspective on the other hand, the big demon, of course, as always in conservative circles is government policy. They look at government programs like Fannie Mae that subsidize bad debt to people who can ill-afford it. According to this thinking, the mortgaged crisis really heated up when the US government essentially subsidized bubble to form, and this bubble instead of being contained because it only had an impact on the people who didn't have a high enough income, to be able to afford their homes truly and it spread to the rest of the mortgage of the economy.
Well, the reality is that there are gems of truth on both sides. When you slice away all the moral drama and the finger-pointing, there are key lessons to learn. Here are some underlying facts that contributed to the financial crisis of 2008. The reality is there is no one major reason; they all combine together to create a perfect storm – this is the most sensible and most realistic answer if you fall for the highly politicized answers offered by the left and the right, then you really aren't going anywhere because a lot of that analysis focuses too much on finger-pointing and really goes around in circles.
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Out of control consumer debt
One key reason for the financial crisis leading up to 2008 was the fact that American consumers were just borrowing and borrowing and borrowing. We're not just talking about borrowing to buy the home that they're living in but borrowing against that home – I'm talking about mortgage refinancing.
Mortgage refinance rates were just crazy and the sad part was instead of using that money to add value to their homes – like adding a room addition, adding a pool, or basically building up the asset. They use it to buy a new car, buy new clothes – in a very real sense, Americans were using their homes as giant credit cards. You can see that this is not going to end well, right?
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Overly aggressive sub-prime mortgage deals
I remember in 2004 leading up to 2007 turning on the radio and we are listening to these very ridiculous radio commercials. The announcer would say, "No job – no problem, No assets – no problem, No money – no problem – you can buy a house." That's it, that was the ad, and sadly, this no asset, no job loans were very big.
The very reason was there was these unscrupulous lenders just cranking out loans to people they know cannot pay the loan and then selling the loan to banks, would then sell it to the general investor community.
Investors didn't have a clue, because remember, prior to that 2008 crash, the safest places you can invest is in mortgages, why? Homes back up mortgages; it is backed up by something of value. It's not like a stock that can crater overnight. We're talking about somebody's home.
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So for the longest time, if you have some extra money and you really want a solid gold slam dunk investment, you can put in mortgage guarantees. You can either be the second mortgage owner or you can be the first mortgage owner, it didn't matter. If that person defaulted you, get the house.
So, it's not a surprise that investors really ate this up, but the problem is, there was this middle layer of really shady lenders that would run all these ads that are very cheesy, insulting to the intelligence that's really demeaning but really effective. Basically, you didn't need to have a job in America to buy a home.
The underlying thinking on the consumers is that he or she only needs to buy the home before it appreciates, let's say 3 to 6 months and then sell it. This flipper mentality actually made a lot of money, the problem is, you have to leave the market at the right time. If you get burned, you lose everything and that is precisely what happened in 2008.
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The underlying economy didn't expand fast enough
Maybe a lot of this group of credit screwing around and credit inflation would have continued and maybe hit a "soft landing" if the underlying economy was in great shape, unfortunately, it wasn't.
The US is no longer a massive manufacturing powerhouse. The US owes the rest of the world a lot of money – it's the number 1 debtor country. Based on these facts, it's no surprise that it was very susceptible to the shock of 2008. This was a perfect storm because of the factors discussed above, and the US isn't in a terrifically great physical-economic shape that the crash happened. Put all these factors together and throw in a little sprinkle to that highly politicized reason and you get the great crash of 2008.
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