Financial Crisis of 2008
Before the financial crisis of 2008, houses had always been rising in value so why would this all of a sudden change? Investors had found a great way to make money in the mortgage market and it was not just benefiting them, it was benefiting everyone. Exploring the lack of regulation in the market and also human behavior, I am going to break down what caused the financial crisis of 2008. The two videos, “Crisis of Credit,” and “Mind Over Money,” are my main sources of information.
Investors with a lot of money would buy treasury bills from the Federal Reserve because it was a safe investment. Alan Greenspan who was the Chairman of the Federal Reserve lowered the interest rates on the treasury bills to 1 percent after the .com bust on September 11th (Crisis). His reason for doing this was to keep the economy strong. Investors decided it was not worth buying these treasury bills anymore because of the low return on investment. By lowering the interest rates to 1 percent, however, this meant it was very cheap for banks to borrow money from the Federal Reserve. This gave the banks a lot more leverage.
Before 2008 the price of houses had always continued to rise and this gave families an incentive to buy a house because they thought no matter what happened, their house would be worth more than what they paid for it so it was a good investment. Everything started with a family looking to buy a home. The family than contacted a mortgage broker who connected them with a mortgage lender. The mortgage lender than provided the family with a mortgage and both the mortgage broker, and the mortgage lender make money.
At this point is where the investors got involved and since they quit buying the treasury bills they were looking for a new investment to increase their wealth. Investors looked to the mortgage market and found an easy way to make money. The investors decided to take out large loans from banks and use the loans to buy mortgages from the mortgage lenders. These loans taken out by the investors were for millions to pay the mortgage lenders. Now the Investors had a monthly income from the homeowners who were paying their mortgages. The Investors than took the money coming in and put it into a Collateralized Debt Obligation, also known as a CDO (Crisis). Other investors, bankers, and hedge funds bought into these CDOs and the initial investor made millions to pay off his loans from the bank. The CDOs are than broken up into three parts safe, okay, and risky. The “safe” part was given a AAA rating which was the safest rating (Crisis). The safe part turned out to have a higher rate of return than the treasury bills that investors previously bought. The higher the risk brought a higher rate of return. Than the process repeated itself starting with the initial investor asking the mortgage lender for more mortgages. The mortgage lender than went to the mortgage broker and had him find more families looking for homes. At this point however the mortgage broker struggled to find more families looking for homes because everyone who qualified for a mortgage already had one. This is when things started to go wrong.
The Community Reinvestment Act was pushed hard by Bill Clinton, although it originated under Jimmy Carter (Miller). The CRA forced the country's biggest buyers of mortgages to lower the qualifications of applicants, in order to increase the percentage of poor that were given mortgages. By 2006, 30 percent of all mortgages went to people who previously would not have qualified (Miller). This added risk to the mortgages because the new homeowners did not have to make a down payment, they did not need any proof of income, and or any other documents. The mortgage lenders did not have to worry about the homeowners defaulting on their monthly mortgage payment because the mortgage lender was covered and would get the house.
When the process started over again there were less prime...
Cited: Crisis of Credit Visualized. Dir. Johnathan Jarvis. N.p., n.d. Web. 30 Jan. 2013. .
Mind Over Money. Dir. Malcolm Clark. N.p., 26 Apr. 2010. Web. 30 Jan. 2013. .
Miller, Abraham H. "The Financial Mess: How We Got Here." American Thinker. N.p., 29 Sept. 2008. Web. 30 Jan. 2013. .
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