The Financial Bubble of 2008

Topics: Subprime mortgage crisis, Collateralized debt obligation, Debt Pages: 3 (696 words) Published: September 16, 2014
The Inside Job - Sub Prime Crisis
Sub Prime Crisis was the financial crisis which hit the global markets in 2008. This was caused in general because of subprime loans being given out by banks w/o working out the due diligence required to check the credibility of the borrowers.

The key cause of the subprime crisis was the instability of the derivatives market. Prior to the housing bubble, there was widespread initiative to regulate the derivatives market so as to bring the stability necessary to prevent the Alan Greenspan and Robert Rubin. In 2008, the housing sector in US boomed.

People started taking loans from banks with meagre down payments. Also the bankers did not check the credibility of the borrowers.
The Securitisation Food Chain:
In the old system, people took loans from banks and paid EMI’s to repay the loan. In the new system, what the banks did was sell all the mortgages to the investment bankers. From here the investment banks collated all the loans (house loans, car loans, personal loans etc.) into single entity/derivatives called as Collateralized Debt Obligations (CDO). The investment banks sold these CDOs to investors. These CDOs had a high rating given to them by rating agencies. The rating agencies were paid by the investment banks to give these derivatives a high rating. These CDOs were then sold to investors such as old age pension homes.

So in short,
Lenders did not care whether the borrowers could repay the loans. Investment bankers did not care because they made profits in proportion to the CDO they sold. Rating agency did not care because they were off the hook if their ratings failed. The investment banks actually preferred subprime loans, as they carried higher interest rates. This led to an increase in predatory lending. Borrowers were needlessly placed in subprime loans and many loans were given to people who could not repay them.

The formation of Bubble:
The bubble formation took place when the Federal Reserve...
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