It took years for the financial crisis of 2007–2008 to develop. By the summer of 2007, financial markets all across the world were indicating that a protracted binge on cheap borrowing was finally coming to an end. So, what happened in 2008?
BNP Paribas was alerting investors that they might not be able to withdraw money from three of its hedge funds, two Bear Stearns hedge funds had collapsed, and Northern Rock, a British bank, was preparing to apply for emergency assistance from the Bank of England.
Nevertheless, despite the warning indications, few investors were aware that the world financial system was going to be hit by the biggest crisis in nearly eight decades, which would knock Wall Street's titans to their knees and cause the Great Recession.
Many common people lost their jobs, their life savings, their houses, or all three as a result of this enormous financial and economic catastrophe.
What happened in 2008? What caused it?
Cheap credit and loose lending rules, which created a housing bubble, were the root causes of the financial crisis of 2008. The banks were left with trillions of dollars' worth of worthless investments in subprime mortgages after the bubble crashed. Following the Great Recession, many people lost their homes, savings, and jobs.
A house price bubble in the US and internationally was driven by years of historically low interest rates and lax lending rules, which laid the groundwork for the financial catastrophe.
As usual, things got off to a good start. The Federal Reserve reduced the federal funds rate from 6.5% in May 2000 to 1% in June 2003 in response to the September 11 terrorist attacks, the dot-com bubble crash, and a slew of corporate accounting scandals.
As a result of borrowers taking advantage of the cheap mortgage rates, housing values began to rise rapidly. Even subprime borrowers—those with bad credit histories or none at all—could fulfill their ambition of owning a home.
The Wall Street banks purchased the loans from the banks after which they were bundled into what were marketed as low-risk financial vehicles including mortgage-backed securities and collateralized debt obligations. Subprime loan origination and distribution soon saw the growth of a sizable secondary market.
The Securities and Exchange Commission lowered the net capital requirements for five investment banks—Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns, and Morgan Stanley—in October 2004, encouraging banks to take on more risk. As a result, they were able to multiply their initial investments by as much as 40 times.
Homeownership eventually reached its saturation point as interest rates began to increase. The Federal Funds Rate reached 5.25% two years after the Fed began hiking rates in June 2004, and it stayed there until August 2007.
Early indications of distress were present. Homeownership in the US reached a peak of 69.2% in 2004.
After that, property values began to decline in early 2006.
For many Americans, this was quite difficult. The value of their properties was lower than what they paid for them. They owed money to their lenders, therefore they were unable to sell their homes. If they had adjustable-rate mortgages, their expenses increased as the value of their properties decreased. The most vulnerable subprime borrowers were forced to stay in mortgages that they couldn't actually afford.
So, this economy nightmare happened in 2008 all around the world.
