Benjamin Soung

Derek Komar

2008 crisis recap

The main causes leading to the 2008 credit crash was
deregulation floating exchange rates, and privatization of
state enterprises. The introduction of the neoliberal SSA in
the 1970s introduced fundamental flaws in the financial
structure of the global economy.
OPEC caused the price of gas to quadruple leading to a
global recession in the 1970s. During this period, Congress
creates Freddie Mac. The federal government implicitly
guarantees this institution, along with Fannie Mae.
Lower tariff barriers improved telecommunication and
allowed cheap air transport. This encouraged globalization
and the distribution of CDOs and CDSs.
Globalization reached in all time high, and global trading
zones were established, primarily in Asia. These zones were
also called global production zones.
The dollar was unpegged from the gold standard. This made
the global currency float against other currencies around the
world.
The first subprime bubble occurs in 1990. Around this period,
JP Morgan invents credit default swaps. There was a lack of
financial literacy that leads to the housing bubble and credit
bubble. Financial institutions assumed that individuals were
able to make informed and rational decisions regarding
investments.

The Dot Com bubble begins to form in 1995 and bursts in

2001. This leads to investors turning towards subprime MBSs
for investment. In the late 1990s, Glass-Steagall is repealed
and the Gramm-Leach-Biley Act is passed. This lead to the
deregulation of the banking, insurance, securities, and the
financial services industry. This also allowed financial
institutions to grow.
The Dot Com crash prompted the Federal Reserve to lower
the fed funds rate in an attempt to pump the economy.
However, this allowed more individuals to purchase
subprime mortgages.
People continued to spend due to higher cost of living
despite the stagnating wages. This lead to big credit bubbles
and poor standards from credit rating agencies, that were
also perversely incentivized to give artificially high ratings to
questionable and highly leveraged securities. There was a
lack of due diligence from the underwriters as well as
government ignorance to the shadow banking system. This
was made worse due to the fact that the shadow banking
system was federally insured.
In 2003, Alan Greenspan the chairman of the Fed, lowers
the fed interest rate to 1%. This fuels financial institutions to
continue issuing large amounts of debt, and invest in MBSs
they believed that the housing prices would keep rising. The
music is still playing, and there is no reason to stop.
Fall of 2005, the booming housing market comes to a halt.
AIG gets scared and stops selling CDSs.
In 2006, many financial institutions begin to reduce their
purchasing of MBSs, although Goldman Sachs continued
selling CDOs to its clients. Housing prices start to fall.

The housing prices continue to fall in 2007. Smaller financial

institutions begin to file for Chapter 7 and 11. This marks the
beginning of the collapse of the subprime industry.
The Fed injects 41 billion into the money supply for banks to
borrow at a low rate. It was not enough.
In 2008, the CDSs fail as CDO tranches fail, and ratings
agencies begin to downgrade the financial securities. 2008
was met with the collapse of all major lenders and investors.
No financial institution was spared. The Feds take over
Fannie and Freddie, basically nationalizing them. Lehman
collapses, Merrill Lynch is sold to BOA, and Washington
Mutual is liquidated and destroyed, the remnants bought by
JP Morgan Chase.
A 700 billion bailout is created to purchase the failing assets.
Small financial institutions swallowed by the bigger ones.
The surviving institutions grow bigger.
Moral hazard played a large role, especially in the case of
Fannie and Freddie. As long as banks know that they will be
bailed out, they will continue to act in the same types of
risky behavior. As long as the basic financial structures allow
for deregulation over time, the financial institutions will
continue making the same mistakes. During a credit crisis
much like the one in 2008, panic will bring liquidity
preference. It is unavoidable. People will want to store their
cash beneath their beds. They will make bank runs. They
will force the stock market to drop 22 percent in one day. It is
not rational thinking, which unfortunately is assumed in the
financial architecture that facilitated the deregulation of the
US financial institutions.