The Great Recession / Global Financial Crisis (2007–2008)
The Housing Bubble
Summary
What Caused The Financial Crisis of 2008?
The 2007-2008 financial crisis severely jolted the global financial system, pushing the world's banking to the brink.
Indicators of the crisis began emerging in August 2007, with events like the bankruptcy of American Home Mortgage and issues at BNP Paribas.
Causes of the crisis are multifaceted; while some blame banks and financial entities, others point at over-borrowing by individuals.
The dot-com crash in the early 2000s and the aftermath of the 9/11 attacks led to significant interest rate cuts by Alan Greenspan’s Federal Reserve.
Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac played roles in expanding credit, backed by government assurances.
Government interventions, like the Community Reinvestment Act (CRA), pushed banks to lower lending standards for political and social reasons.
Austrian business cycle theory suggests artificial interest rate reductions lead to misconceptions about resource availability, causing bad investments.
The resulting low interest rate environment spurred a housing bubble and increased leveraged buyouts.
Many investors, wary of stocks and bonds, sought higher returns in Complex Debt Obligations (CDOs) and other derivatives, often without fully understanding them.
Lending criteria relaxed over time, facilitating riskier loans, particularly in the housing market.
Credit rating agencies, paid by security issuers, may have had conflicts of interest, which contributed to the crisis.
Credit derivatives, particularly CDOs, played a significant role in the crisis. CDOs allowed banks to package and sell risky loans.
Misaligned interests between loan originators and investors exacerbated the crisis; originators did not bear the risks of their loans.
The Federal Reserve's concerns around Credit Default Swaps (CDS) and potential bank failures contributed to interventions like the Bear Stearns bailout.
The crisis reshaped the global financial landscape, underscoring the need for more informed and cautious investment and lending practices.
The Collapse of Lehman Brothers - A Simple Overview
Lehman Brothers filed for the largest bankruptcy in U.S. history with assets valued at $691 billion.
Their bankruptcy in September 2008 led to a 500-point fall in the Dow Jones.
Lehman Brothers was the fourth largest investment bank, serving larger companies and facilitating financial transactions such as IPOs, debt financing, and mergers.
Lehman Brothers was heavily involved in real estate, making it vulnerable to the 2000s housing market crash.
They held mortgage-backed securities, originated mortgages themselves, and invested in real estate directly.
The firm's high leverage ratio made them unstable when the real estate market crashed.
Despite having assets exceeding liabilities, they had only $7 billion in available cash when they filed for bankruptcy.
They were heavily impacted by the mortgage crisis due to their investments in subprime mortgages and the declining value of real estate.
No government bailout or acquisition by another bank saved them from bankruptcy.
The collapse of Lehman Brothers is seen as a significant trigger of the 2008 financial crisis.
Their 158-year legacy is overshadowed by their role in the recession.
The AIG Scandals - A Simple Overview
American International Group (AIG) was the world's largest insurance company in the early 2000s with a market valuation nearing $250 billion.
They provided a range of insurance products, including life, property, casualty, and annuities.
Despite their size, AIG has faced significant scandals and financial challenges.
2008 was a notably bad year for AIG, with its stock price plummeting.
AIG has had a history of accounting fraud, unethical business practices, and risky financial activities.
Hank Greenberg led the company's massive growth in the late 20th century through numerous acquisitions.
In 2005, AIG was charged with accounting fraud for manipulating financial reports to deceive investors.
AIG paid a $1.6 billion settlement in 2006 due to various fraudulent activities.
During the 2007-2008 housing crisis, AIG played a significant role by insuring mortgage-backed securities. When many homeowners defaulted on their loans, AIG faced potential bankruptcy.
Deemed "too big to fail," the US government bailed out AIG, taking over 79.9% equity for an initial $85 billion investment.
The government eventually profited from the bailout, selling its stake in AIG for a net gain of about $22 billion.
Today, AIG continues to operate but has undergone significant changes and still grapples with a damaged reputation.
Further Analysis
Inside Job + Panic: The Untold Story of the 2008 Financial Crisis
Meltdown - The Global Financial Crisis - Part 1 + Part 2 + Part 3 + Part 4