The Causes and Effects of the Financial Crisis 2008

credit prices visualized what the credit

crisis

is it's a global

financial

fiasco involving terms you've probably heard like subprime mortgages collateralized debt obligations frozen credit markets and credit default swaps who has affected everyone how it happened this is how the credit

crisis

brings two groups of people together owners and investors the owners represent their mortgages and the investors represent their money these mortgages represent houses and this money represents large institutions such as pension funds insurance companies sovereign funds mutual funds, etc. These groups are brought together through the

financial

system a group of banks and brokers commonly known as Wall Street, although it may not seem like it, these banks on Wall Street are closely connected to these houses on Main Street that understand how we started from the beginning years ago, Investors are sitting on their pile of money looking for a good investment.

To convert it into more money, they traditionally go to the US Federal Reserve, where they buy Treasury bills believed to be the safest investment, but in the wake of the dot-com crisis on 9/11, the Fed chairman Fed Alan Greenspan cuts interest rates to just 1% to keep the economy strong 1% is a very low return on investment, so investors say no thanks. On the other hand, this means that Wall Street banks can borrow from the Federal Reserve for just 1%, adding to that the overall surpluses of Japan, China and the Middle East. and there is a lot of cheap credit, this makes borrowing money easy for banks and drives them crazy with leverage. then he sells it to someone else for $11,000 for a profit of $1,000, a good deal, but using leverage, someone with $10,000 would borrow 990 thousand dollars more, giving him 1 million dollars in hand, then he goes and buys 100 boxes with his million dollars and sells them. to another person for 1 million dollars 100,000, then he gives him back his 990 thousand plus 10,000 plus interest and after his initial 10,000 he is left with a profit of 90,000 dollars versus the other guy's 1,000 leverage turns good deals into big deals this is one of the main ways banks make money so Wall Street takes out its ton of credit, makes big deals and gets filthy rich and then goes backwards.

Investors see this and want a piece of the action and this gives Wall Street an idea that they can connect investors with homeowners through mortgages. how it works a family wants a house so they save for the down payment and contact a mortgage broker the mortgage brokers connect the family with a lender who gives them a mortgage the broker makes a good commission the family buys a house and they become owners This is great for them because house prices have been going up pretty much everything works out one day the lender gets a call from an investment banker who wants to buy the mortgage the lender sells it to them for a very good rate the investment banker then he borrows millions of dollars and buys thousands more mortgages and puts them in a nice little box, which means that each month he receives payments from the owners of all the mortgages in the box and then six of his banker wizards in it to do their financial magic, which is basically they cut it up into three portions, safe, good and risky, they repackage the portions into the box and call it a collateralized debt obligation or CDO.

A CDO works like three cascading trays, as the money hits the top tray, fills up first, and then spills out into the middle and whatever. is left at the bottom, the money comes from homeowners paying their mortgages, if some homeowners don't pay and default on their mortgages, less money comes in and the bottom tray may not fill, this

causes

the bottom tray be riskier and the top tray safer to compensate for the higher risk the bottom tray receives a higher rate of return while the top tray receives a lower return but still good to make the top part even safer the banks will insure it For a small fee called a credit default swap the banks do all this work so that the credit rating agencies consider the upper portion as a safe investment with a triple A rating, the highest and safest rating there is, the acceptable portion is triple B , is still pretty good and they don't bother rating the risky portion because of the Triple A rating.

The investment banker can sell the safe portion to investors who only want safe investments. He sells the acceptable portion to other bankers and the risky portions to hedge funds and other risk takers. The investment banker makes millions and then pays off his loans. finally investors have found a good bang for their buck much better than 1% treasury bills they are so happy they want more C God so the investment banker calls the lender for more mortgages the lender calls the broker for more homeowners of homes but the broker can't find someone who qualifies for a mortgage already has one, but they have an idea when homeowners default on their mortgage, the lender keeps the house and houses always increase in value since they are covered if the If homeowners default, lenders can start adding risk to new mortgages that require no down payments with no proof of income without any documents and that's exactly what they did, instead of lending to responsible homeowners called master mortgages, they started getting some that They were much less responsible, these are subprime mortgages, this is the tipping point, so they just As always, the mortgage broker connects the family with a lender and a mortgage generates their commission.

The family buys a big house. The lender sells the mortgage to the investment banker, who converts it into a CDO and sells portions to investors and others. This really works. good for everyone, that makes them rich, no one was worried because as soon as they sold the mortgage to the next, it was their problem if the homeowners defaulted, they didn't care, they were selling their risk to the next and making millions is like playing hot potato With a ticking time bomb, it is not surprising that homeowners do not pay their mortgage, which is currently owned by the banker, this means he forecloses and one of his monthly payments becomes a house, no big deal, the put up for sale. but more and more of your monthly payments are converted into houses, there are now so many houses for sale on the market that it creates more supply than demand and home prices are no longer increasing, in fact, they are plummeting, creating a problem interesting for owners who still pay. their mortgages as all the houses in their neighborhood go up for sale, the value of their house drops and they begin to wonder why they are paying their $300,000 mortgage when the house is now only worth $90,000 and they decide it doesn't make sense for them to continue paying even if they can afford it and they move away from their homes default rates sweep the country and prices plummet now the investment banker basically has a box full of worthless houses in his hand he calls his friend the investor to sell his CDO but the investor is not stupid and says no thanks, he knows that the flow of money is not even a bargain anymore, the banker tries to sell to everyone, but no one wants to buy his bomb, he is going crazy because he borrowed millions, sometimes billions of dollars, to buy this bomb and you can't return it, whatever you do, you can't get rid of it, but you're not the only one, investors have already bought thousands of these bombs, the lender calls to try to sell his mortgage, but the banker won.

I don't buy it and the broker is out of a job, the entire financial system freezes and things get dark, everyone starts going bankrupt, but that's not all, the investor calls the homeowner and tells him He says his investments are worthless and you can start to see how. the crisis flows in a cycle welcome to the credit crisis