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The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. On the one hand many people are concerned that those responsible for the financial problems are the ones being bailed out, while on the other hand, a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The problem could have been avoided, if ideologues supporting the current economics models weren’t so vocal, influential and inconsiderate of others’ viewpoints and concerns. This article provides an overview of the crisis with links for further, more detailed, coverage at the end. The financial crisis and wealthy countriesA crisis signaling the decline of US’s superpower status? A collapse of the US sub-prime mortgage market and the reversal of the housing boom in other industrialized economies have had a ripple effect around the world.
Furthermore, other weaknesses in the global financial system have surfaced. Some financial products and instruments have become so complex and twisted, that as things start to unravel, trust in the whole system started to fail. John Bird, John Fortune, Subprime Crisis, February 14, 2008While there are many technical explanations of how the sub-prime mortgage crisis came about, the mainstream British comedians, John Bird and John Fortune, describe the mind set of the investment banking community in this satirical interview, explaining it in a way that sometimes only comedians can. Bremner, Bird, and Fortune, Silly Money: Where did all the money go?
The betting of practically anything helped create enormous sums of money out of almost nothing. The Crisis of Credit Visualized, Jonathan Jarvis If you are unable to see the video, or, for further details, the next two sections go into this further. For banks, millions can be made in money-earning loans, but they are tied up for decades. So they were turned into securities. Starting in Wall Street, others followed quickly. With soaring profits, all wanted in, even if it went beyond their area of expertise.
Banks borrowed even more money to lend out so they could create more securitization. Some investment banks like Lehman Brothers got into mortgages, buying them in order to securitize them and then sell them on. Some banks loaned even more to have an excuse to securitize those loans. Some banks evens started to buy securities from others. While things were good, no-one wanted bad news. High street banks got into a form of investment banking, buying, selling and trading risk. Investment banks, not content with buying, selling and trading risk, got into home loans, mortgages, etc without the right controls and management.
Many banks were taking on huge risks increasing their exposure to problems. Perhaps it was ironic, as Evan Davies observed, that a financial instrument to reduce risk and help lend more—securities—would backfire so much. When people did eventually start to see problems, confidence fell quickly. Lending slowed, in some cases ceased for a while and even now, there is a crisis of confidence. Some investment banks were sitting on the riskiest loans that other investors did not want.
Assets were plummeting in value so lenders wanted to take their money back. The problem was so large, banks even with large capital reserves ran out, so they had to turn to governments for bail out. New capital was injected into banks to, in effect, allow them to lose more money without going bust. That still wasn’t enough and confidence was not restored. Some think it may take years for confidence to return. Shrinking banks suck money out of the economy as they try to build their capital and are nervous about loaning.
Meanwhile businesses and individuals that rely on credit find it harder to get. As Evan Davies described it, banks had somehow taken what seemed to be a magic bullet of securitization and fired it on themselves. There have been a number of attempts to mitigate risk, or insure against problems. While these are legitimate things to do, the instruments that allowed this to happen helped cause the current problems, too.
In essence, what had happened was that banks, hedge funds and others had become over-confident as they all thought they had figured out how to take on risk and make money more effectively. As they initially made more money taking more risks, they reinforced their own view that they had it figured out. They thought they had spread all their risks effectively and yet when it really went wrong, it all went wrong. In a follow-up documentary, Davis interviewed Naseem Taleb, once an options trader himself, who argued that many hedge fund managers and bankers fool themselves into thinking they are safe and on high ground.