Behind every big fortune lies a great crime:
History of Capitalism is replete with
euphoric booms followed by persistent recession initiated by free fall in
economic activity hence boom and bust. World of Economics still saw it’s first
modern fall from grace economic activity in 1637 – named Tulip Mania, where
value of an asset was artificially inflated.
Many other bubbles followed ever since with
the most deeply damaging depression of 1930’s followed by roaring 20’s – that
inspired the great novel by Fritzgerald – The Great Gatsby, the opulence and
the flagrant exhibition of wealth was unseen before, it seemed good times are here
to stay., alas, it resulted in what’s known to us now as The Great Depression
of 1930’s where people lost their wealth, privilege and mass unemployment was
the norm of the day, what started as the crash – Black Thursday and Black
Tuesday made many a wealthy pauper overnight., impact was devastation and
poverty that spread all around the globe.
Fast forward to 1987 and the story hasn’t
changed except it’s Black Monday now – Oct 19, 1987, Stock Markets plunged
worldwide and investors saw their worth deplete enormously. The massive damage
done is still being remembered by the followers of economic trends:
It’s fair to say that the story is more than
400 years old but is being repeated with shocking naivety of investors who fall
for the up and up economic activity and get sucked into the vortex of deception
ignoring ‘all the glitters is not gold’.
crisis of 2008 Background
As evident from past stories that boom is
bound to be followed by bust and in that aspect 2008 was no different, the
difference, however, is the underlying asset. The assets at the core were
Houses – hence what formed the bubble namely every increasing prices of Houses
with lot more coming into fold and further inflating the bubble, giving more
impetus to prices were a classic case of a bubble being formed and should have
raised alarm, Alan Greenspan former Head of Fed
used the term “irrational
exuberance” for IT bubble in the year 2000 and they dynamics of full
blown housing bubble were no different except , of course, they underlying
asset – Housing.
To see how oblivious the then Fed Head
Bernanke was can be summed up in his own words that smack of utter incapacity
to understand reality at the highest level: Bernanke famously said, much later:
“One of the thing I learned from our
experience in the crisis with respect to the housing bubble is the Fed spent a
lot of tim debating is it a bubble, is it not a bubble, and if it is a bubble
how big is it? That wasn’t the right way to think about it”
What made the bubble even more dangerous was
the Mortgage backed financial instruments – derivatives which were designed to
extend loans after loans with fixed underlying asset – Homes, it was a clear
case of expanding credit against an asset to the level where it was going to
become unsustainable. A house being mortgaged was loaned out again and again
fuelled by ever increasing housing prices, it’s staggering to think leading
financial institutions of decades of experience couldn’t think what if prices fall,
what if a few default what if trend is reversed, they all got sucked into the
euphoria of all rise together, everyone making good money. And so in the end in
the words of Myles Udland of Business Insider:
“And so in the end it didn’t matter whether
the Fed saw a too-fast and unsustainable appreciation in home prices or not,
because the home price appreciation and resulting deflation in and of itself wasn’t
the trigger for the crisis. What triggered the crisis was the evaporation in
value of derivative products tied to the value of the mortgages attached to
All safe financial instruments turned toxic
when the trend reversed and the impact was not soft, it was catastrophic.
Since Housing was at the heart of it, it’s
fair to say that bubble was being built up with Human Beings at the center of
it, houses being the most valuable in terms of person’s financial well-being
was now being threatened to be taken away. A brief introduction encapsulates it
well on Investopidia:
September 15, 2008, Lehman Brothers
filed for bankruptcy. With $639 billion in assets and $619
billion in debt, Lehman’s bankruptcy filing was the largest in history, as its
assets far surpassed those of previous bankrupt giants such as world com
and Enron. Lehman was the fourth-largest U.S. investment bank
at the time of its collapse, with 25,000 employees worldwide.
demise also made it the largest victim of the U.S. subprime mortgage-induced financial crisis
that swept through global financial markets in 2008. Lehman’s collapse was a seminal
event that greatly intensified the 2008 crisis and contributed to the erosion
of close to $10 trillion in market capitalization from global equity markets
in October 2008, the biggest monthly decline on record at the time”
And houses did get taken away.
Foreclosure rates which results from failing
to pay mortgage payment peaked, over a million houses were lost in the US alone
and one can only imagine the impact on ordinary lives – people and their
families being thrown out from the houses because of toxic financial
instruments devised by the most astute investor geeks came to nothing cutting
through people’s lives.
Stock Markets plummeted around the globe and
wiped out many a investors net worth from high, medium to small investors, this
itself was damaging to stall economic activity and the virus permeated
industry, cash flows choked, credit lines were gone, production hampered and
many a business went in the red.
Unemployment rose it’s ugly head in the face of economic demolition.
The contagion spread across the globe, it
engulfed housing in Europe, destroyed asset base of banks, SOS were sent out to
the Government by the big banks to save them or see the entire financial system
being eroded and collapsed, it virtually came to the level where money could
dry up and ATMs were ready to cash out Nothing.
U.S. foreclosure filings spiked by
more than 81% in 2008, a record, according to a report released Thursday, and
they’re up 225% compared with 2006.
A total of 861,664 families lost
their homes to foreclosure last year, according to RealtyTrac, which released
its year-end report Thursday. There were more than 3.1 million foreclosure
filings issued during 2008, which means that one of every 54 households
received a notice last year.
Extreme crisis required extreme measures,
Global powers got together to save the system, because of integration and
crisis being hit in the digital age it meant the ripples across the world
spread faster and there was increased urgency to address the issue. Enter:
A measure by the State Banks to increase
money supply by buying back bonds from the institutions increasing bond prices
and lower interest rates, this was to fight deflation and, ironically, ever
falling prices which was a reflection of erosion of confidence. To restore confidence
interest rates were lowered, money dished out to increase loans and jump start
Government Take over
“November 2008: The Government takes
a 58pc in RBS for £15bn, with a further £5bn of preference shares. Sir Fred
Goodwin steps down as RBS chief executive, and is replaced by Stephen Hester”
This headline captures the culmination of
crisis where Royal Bank of Scotland was left at the mercy of Government to save
itself from utter collapse.
Federal takeover of Fannie Mae and Freddie
Mac is another outcome and recovery measure.
The difference in the route followed by the
US and EU determined the longevity of crisis, where US handled it by defying
market policies and made strong interventions, abandoning austerity and
injecting money, granting more loans. EU relatively stuck to austerity measures
choking the system further that created failed economic models of Greece and
Iceland which brought the countries to their knees.
It has to be said that recovery from 2008
financial crisis is extremely slow and it took more than six years to say that
world is on the path of recovery, however, there’s still skepticism as voiced
by the Nobel Laureate Joseph Stiglitz, a strong advocate of strict market
regulations to prevent repeat of toxic mortgage backed securities that were the
root of devastation and damage done to millions of lives around the world.
“American capitalism in recent years has been
marked by unbridled greed – the 2008 financial crisis provides ample
confirmation of that….”