THE CAUSES OF THE 2008-2009 FINANCIAL CRISIS A financial crisis is when there is a run on the banks in which investors panic, try to sell off their assets, and withdraw their money from their banks accounts with the purpose of limiting their losses. A great recession is when the real GDP declines for two consecutive quarters. In 2008-2009, the United States of America suffered a financial crisis that turned into a great recession, and almost took down the whole economic system. This paper will address some of the major causes and effects that lead to the recent market instability. The great recession was primarily caused by deregulation from the government to the financial industry as well as irresponsible greed from financial institutions …show more content…
This encouraged people to take on bigger loans as well as for banks to take on much more leverage and to make riskier bets that they would not have made if interest rates weren’t that low. So, what was the turning point? By been able to borrow money at low interest rates, people started to buy houses and improving their life’s quality. Lenders started to increase profits by giving out more mortgages and brokers started selling more houses and getting commission fees on those sales. As the number of houses been sold started to increase, houses started to appreciate in value too. Investment banks saw an investment opportunity here, so they started buying bundles of mortgages from the lenders. Now, investment banks were profiting from mortgages too. Investment banks would have classified these mortgages into CDOs, Collateralized Debt Obligations. CDOs are rate by a credit rating agency as AAA, BBB and the risky unrated ones. AAA rating was the safer types of mortgages which were insured by a credit defaulted SWAP, the BBB which are not as good as the AAA were still attractive, and the last category was assigned to the riskier mortgages. When all the prime mortgage candidates that compose the AAA and BBB got all houses; The greedy financial institutions, lowered …show more content…
Since everybody was doing it, nobody imagine that anything could be going wrong. In 2004 the Federal Reserve raised the interest rate. Sub-prime mortgage borrowers started defaulting on their mortgage payments because now due to the raise in interests the payments were higher. The number of empty houses that banks had, started to go up. The number of people defaulting on their payments, went up too. less interest payments started to go back to the banks. Housing prices started falling as supply outpaced demand. The prime mortgages that could afford their mortgage payments realized that their house was depreciating in value, so they walk away too. Since most financial institutions had acquired some level of risk by buying and selling sub-prime loans; the problem started to get systematic. Most of the credit default SWAPS were written by AIG, the biggest insurance company in the America. AIG had also invested heavily in these high risky assets too. Everybody was doing it, why not them too? The problem arrived when people started to ask for their collateral back all at once. For AIG this meant to liquidate its long-term assets on short notice. The amount of liquidity was so high that the Federal Reserve Bank of New York stepped in preventing AIG from going under and taking