The 2008 financial crisis is known to be the worst economic disaster since the Great Depression of 1929. It is a world wide financial ‘fiasco’ involving terms everyone is familiar too, like subprime mortgages, collateralised debt obligations, frozen credit markets and credit default swaps. Most homeowners were affected due to this.
The financial crisis is bringing two groups of people together - homeowners and investors. With homeowners representing their mortgages which would be houses; and investors represent their money which would be huge institutions like pension funds. These two groups are brought together by the financial system - banks etc. Years backs, investors wanted to invest in something that will make them more money. This was usually done by going to the US Federal Reserve, where they buy treasury bills - safest kind of investment (AAA rating). After ‘9/11’, federal reserve chairman Alan Greenspan lowers interest rates to only 1% in order to keep the economy strong. This was bad news to investors as their returns were not very high resulting in not much profit. However this means banks can borrow money for only 1%, this causes an abundance of cheap credit, which the bank took advantage of. Banks can easily make money with this - charging borrowers more interest. Investors seeing how banks make huge profits want to do the same, and this is where it begun.
Firstly the banks started by connecting homeowners to investors, through mortgages. To put into perspective this cycle, we begin with a family wanting a house. They set a down payment and contact the mortgage broker which then connects the family to a lender who gives them a mortgage. The broker receives a commission and the family become homeowner - which is pretty advantageous as housing prices are increasing. After this the lender sells the mortgage to an investment banker, making profit. The investments banker buys many mortgages, so this means they receive monthly payments from homeowners, making huge profits. After doing some ‘financial magic’ they turn it into a collateralised debt obligation (CDO). One way to imagine a CDO is a as box into which monthly payments from multiple mortgages. It is divided into three tray, each representing different risk levels. The ‘bottom tray’ being labelled as risky and middle being ‘okay’ and top being ‘safe’. This is labelled so because the money fills from the ‘top tray’ which means that it will fill more likely than the ‘bottom tray’ - like a cascade. To compensate for the higher risk the bottom tray will get a higher return than the top and middle trays. To make the top tray even safer the banks may insure it, a credit default swap.
So the investment banker sells the ‘safe’ tray to investors who only want save investments. And sells the ‘okay’ tray to other bankers. Lastly the ‘risky’ tray to hedge funds and other risk takers. Then investment banker makes millions from doing this and pay any loans off they might have borrowed to buy the mortgages. This makes the investors satisfied as they have good returns, higher than the 1% on treasury bills. Greed takes over and the investors want more CDO slices. But here is the problem - everyone who's qualified for a mortgage already has one. They resolve this problem by giving out mortgages to people ‘less responsible’ which are called subprime mortgages. These mortgages required no down payment and no proof of income - this is the turning point. The cycle is back in play. Due to the more ‘less responsible’ homeowners the frequency of defaults started increasing which means that the banker has many houses. So they put it up for sale, which means there are many houses for sale on the market. This creates more supply than there is demand and housing prices start decreasing. People who were paying back mortgages stopped paying as the value of their house decreased from what it was when they bought it. Default rates increased significantly throughout the country. This meant than investment banker couldn't sell his his CDO to anyone as they were worthless; the investors who already had purchased CDO’s wasn't making any money from it; the mortgage lender trying to sell the mortgage couldn't sell it to the investment banker and the mortgage broker was out of work. The whole financial system froze and all people in play become bankrupt.
The 2008 financial crisis was a very important event in the world’s history, greed playing a key role in this. Millions of people were left unemployed and more than 12 trillion US dollars was lost in America - ‘the cost of the crisis’.