THE 2008 FINANCIAL CRISIS EXPLAINED

It was in 2008, that one of the biggest financial crises ever hit the US. It was a situation so bad, that entire companies were going bankrupt and the U.S government had to step in to save the whole economy from crashing down. It was a chain effect and it was almost like a repeat of the Great Depression that hit the U.S in the 1920’s. The government had to give out loans to banks, insurance companies and also a lot of mainstream Wall Street companies, just to prevent the effect from spreading to the whole system. So how did it happen?

It all started out in the early 2000’s when the U.S economy was in a recession. The banks were instructed to give out loans at a lower interest rate than usual. This was used by American citizens to buy homes through mortgages. Around this time, the practice of securitization became popular. Securitization, basically involved pooling mortgages of many individuals and selling them to investors and banks. Many major banks started to do that and sell them to investors. This meant that the individuals that owed money to the bank, paid back money to the investors.

At this point of time, the bank realized that they could make a profit. They started loaning out to individuals who fell under the subprime categories that is, individuals with low income who in no way could pay back the loan taken by them. The banks started clubbing the loans of these subprime individuals together. They went to the rating agencies, and bribed them and had these subprime mortgages rated as AAA which is a high rating. The banks called these bundles as Collateralized Debt Obligations or CDO’S. This was purchased by the investors, because they thought that the ratings would speak for itself.

The investors, however were worried that they might not get their money back. The banks however had succeeded in making a little money of what they thought was a lost cause. The investors who had paid a fair share of money for these bundles, decided that they needed to make sure they do not lose out on a lot. After some thinking, these investors decided to approach the insurance companies and ensure their CDO’S.

They agreed on a system called as Credit Default Swaps, which ensured that if there was ever a loss, the insurance company would cover the portions for those losses. The Insurance companies agreed too. One of the biggest insurance companies that provided a lot of insurance for these CDO’S was American International Group or AIG, and they too fell for the false ratings.

The investors began pressuring the banks to give out loans to more people and the banks obliged. The demand for the houses grew, and so the prices of those houses grew too. But after some time, the people who could not pay back the loans declared bankruptcy.

This led to the CDO’S purchased being invalid and this literally led to losses for millions of investors. The biggest fall was for the insurance companies, and more particularly, AIG. The government tried and interfered by giving out loans at 0% interest, but there were still people who thought that this whole situation would repeat again.

The government finally fixed it all, and appointed financial advisors, who worked as supervisors in the economy. Although the situation finally improved, and the U.S economy finally came back on track, experts still believe that there is a chance of this happening again.