Introducton
The financial crisis of 2008 now seems a distant event, especially given the developments surrounding the COVID-19 pandemic. Many of the mistakes made in 2008, experts say, could have been easily avoided, and it already seems evident that the economy has changed so much that it will not allow a repeat of this crisis. The 2008 crisis is a product of its time, an unprecedented housing boom and cash flows from emerging to developed economies. The event was possible due to mistakes made by investors who felt comfortable in the market; the government helped them; COVID-19 and this crisis have reasons and points for comparison.
Primary Triggers
The real estate sector in the 1990s and 2000s was heavily regulated by banks, and managers placed high demands on mortgage borrowers. Initially, banks demanded 20-25% housing fees, a stable job, no gray and black earnings, and a good credit rating (Chen). It demotivated the masses to buy housing, and only people who were confident that they would fit the criteria could afford houses. In the early 2000s, banks cut rates to 10% and lowered job requirements. In 2003, the initial contribution was no longer needed, and banks fell the criteria for professional activity again (Chen). Getting a mortgage has become a reality for migrants, people with unstable incomes, and those who often change jobs. It was the main reason why people started applying for mortgages.
Banks and agencies created a real estate bubble in the market, and reduced criteria forced banks to develop a system of subprime mortgages (they set out the rules in the Community Reinvestment Act). These were loans with special conditions for people who could not get a regular loan (Bartmann). It was the beginning of the crisis; banks played with risks without thinking that borrowers might let them down. Ironically, the Fanny Mae and Freddie Mac agencies were the centers of support for subprime loans, even though they went on to carry some of the worst debt obligations. The state deregulation of financial instruments and the banking sector, initiated by President Reagan, allowed banks to create any conditions for lending.
A high level of development initiated the residential building; a semi-public mortgage agency, was created particular mortgage-backed securities thanks to a system of checks and balances. It seemed that insurance companies would cover the possible risks, and managers decided to create share packages for families. Loans were placed at different conditions and rates (CDO, a new instrument, product). Due to the high level of investment, institutions trusted these securities and shares in the market, and CDS even bought pension funds (Chen). The increased involvement of various financial institutions has led to the lost connection between borrowers and lenders. The bank did not incur any losses if the borrower could not pay the mortgage, so the managers were not afraid to give a loan.
Subprime mortgages forced borrowers to pay each year at a higher rate (floating rate terms), which was impossible for them. For a migrant or person with an unstable income, a rate of 4%, then 7%, and then about 15% is unbearable (Bartmann). The CDO system did not help such people by creating a bond package taxed with something tangible (Bartmann). Bankers and investors helped the CDS, and they were bought for insurance against credit risk. Further problems in the market showed that any movement of bankers and investors towards safekeeping was a sham. None of them imagined real danger and did not protect themselves from real risks. Later, bankers created synthetic CDS funded not by mortgage-backed securities but by swaps. ‘Synthetic’ tells readers that tangible assets did not back such CDS. It is where investors and banks go from manipulating money to manipulating the air, creating almost fake deals. Investors did not lose motivation, as they received bonuses for selling all their instruments. People began to buy and resell obligations and responsibilities, trying not to keep them for a long time.
Solutions
Random investment in housing-related derivatives caused the real estate bubble to burst. Banks have failed to keep their promise of risk-free operation in pursuit of a lucrative derivatives market; they were only interested in low-risk securities. Nevertheless, people stopped paying their loans repeatedly, and some who still could do it saw the price of the identical houses they owned and considered it irrational to make further payments. More and more bank payments turned into real estate in their full possession, which they could resell for a little less than the previous price. Banks and investors went into a wave of bankruptcies, losing the cash flows that had been spinning for years. Central support for the banks came from the US government, which demonstrated no need to panic (Bartmann). The government pursued a debt repayment policy, despite its seeming absurdity. In this context, politicians have shown that they can take risks for the sake of business development and make concessions to investors.
The direct business support was the Troubled Asset Relief Program (TARP). This program provided many options for helping wealthy banks like Lehman Brothers and insurance agencies (Chen). The government also brought in the Federal Reserve System (FRS) to buy distressed assets. Bank of America was directly involved in purchasing assets as a government trustee. It was essential to restore clarity in the market because it undermined people’s confidence in the financial system and harmed trust between banks and investors. In general, the government has allocated 700 billion to help banks.
Meanwhile, the consequences of the crisis affected the economies of Spain, Italy, Iceland, and the UK, which bought out some companies. The government initiated the creation of temporary funds to help with the repurchase and provision of loans. It was crucial to restoring confidence in banks and insurance, so the Federal Deposit Insurance Corporation participated (Chen). The government planned to raise taxes on citizens to restore the financial system, which President Barack Obama did in 2009.
Lessons
Investors and bankers do not need to feel this increased comfort and confidence in cash flow. In addition, this experience has taught investors and housing agents that home prices will not permanently rise by high amounts. The third lesson is to carefully consider borrowers’ credit history and consider whether they can repay the debt (Bartmann). The most apparent address is the unreasonably high level of lending.
COVID-19 and the Crisis
Points of comparison between COVID-19 and the 2008 crisis are the freeze on trade, the global collapse, and the size of the countries’ economies where the events took place. The level of uncertainty and the inability to predict was high in both cases (Chen and Yeh). Many people remember how predictions about a pandemic failed many times and did not come true (Notteboom). In both situations, governments supported industries and banks with special funds.
Conclusion
The financial crisis was due to a series of mistakes by the institutions involved in selling real estate on mortgages. These mistakes were caused by excessive comfort and confidence in cash flows. People who got easy mortgage terms failed to pay it off, leaving banks with real estate but no money; the bubble burst. The banks needed government support, and they got it. Subsequently, they could settle accounts with the state and learn from the crisis. COVID-19 has points of contact with the collapse of 2008, such as the freeze of trade and total support of funds and the state.
Works Cited
Bartmann, Raphael. Causes and Effects of 2008 Financial Crisis. Hochschule Furtwangen, 2017.
Chen, Hsuan-Chi, and Chia-Wei Yeh. “Global Financial Crisis and COVID-19: Industrial Reactions.” Finance Research Letters, vol. 42, 2021. Crossref, doi:10.1016/j.frl.2021.101940.
Chen, Wenjie, et al. The Global Economic Recovery 10 Years After the 2008 Financial Crisis. International Monetary Fund, 2019.
Notteboom, Theo, et al. “Disruptions and Resilience in Global Container Shipping and Ports: The COVID-19 Pandemic Versus the 2008–2009 Financial Crisis.” Maritime Economics & Logistics, vol. 23, no. 2, 2021, pp. 179–210. Crossref, doi:10.1057/s41278-020-00180-5.