A Perfect Storm: Reflecting on the Financial Crisis of 2008

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As MBSs took hold of the market, some investors began to understand the massive risk being created by the housing bubble. Insurance policies in the form of credit default swaps were purchased against the mortgage pools. Banks were unable to detect the risk of these securities, resulting in low premiums for the speculators due to the perfect credit ratings of the securities. As the housing market shifted into a decline, banks began packaging the cash flows from CDSs into collateralized debt obligations (essentially the same as a MBS), unwittingly “doubling-down” on the risk they had taken on from the risky MBSs.

By the time the market realized that the real estate bubble had come to an end, it was too late. The housing market was flooded with properties put up for sale by people that were no longer able to meet their mortgage commitments and banks were too highly leveraged to deal with the defaults caused by the oversupplied market and falling prices. Consumer confidence turned and the stage was set for a financial crisis, the likes of which the United States had not experienced since the Great Depression.

The Collapse

When the real estate bubble burst, it sent housing prices into a downward spiral. The housing market was flooded with properties put up for sale by people that were no longer able to meet their mortgage commitments and banks were too highly leveraged to deal with the defaults caused by the oversupplied market and falling prices. As investment banks began seeing losses from MBSs and CDOs, consumer confidence sank. Consumers began pulling their deposits out of banks, fearing they would be unable to if the bank became insolvent. Economic confidence came to a major turning point when Bear Stearns, a prominent large Wall Street investment bank, saw its stock collapse amid reports of potential insolvency. When the United States government allowed Bear Stearns to go bankrupt, it triggered a panic. Banks, fearing collapse themselves, virtually froze commercial lending, which hurt business globally and contributed to a global financial decline. As businesses became starved for cash, workers paid the price. Unemployment increased rapidly, leading to a depletion of many savings and retirement accounts. As AIG and other large banks faced potential failure, the United States government intervened. Deemed “Systemically Important Financial Institutions”, banks received bailouts totaling $500 billion from the government in exchange for preferred stock in the banks.

Concerns and Implications

Looking back at the financial crisis, now seven years in the past, much of the information that has come out about the results of the bailout are disconcerting and bring forward many questions. Executives of the banks that were bailed out in 2008 were able to walk away with billions of taxpayer dollars in the form of bonuses, taking a personal gain from the financial crisis they orchestrated themselves. In addition to this ethical issue, there is also the issue of the massive amount of debt that now burdens the shoulders of generations of Americans to come. Is this burden of debt a fair price for the American people to pay to bailout a financial system that many would argue is corrupt and still broken? By extending a saving hand to the financial industry, did we prevent a worse recession or merely defer an impending collapse? For many, a collapse of the system seems favorable to the course that was taken, as a true collapse would serve as a longstanding reminder of the consequences of unchecked greed and irresponsibility.

How do we prevent another collapse?

Financial regulators have made great strides to reduce the risk of another financial meltdown. Banks now have increased capital requirements to provide a cushion against losses, preventing the insolvency that fueled the panic and subsequent failures in 2008. In order to take control of the future of the American financial system, things have to change. No matter how closely regulators watch over corporations, they will always push back against the types of regulation that may be necessary to protect the economy.

It is ultimately up to the people that are responsible for the actions of banks and corporations to move away from the culture of corporate greed. Greed takes hold in the corporate world through the endlessly increasing demand for earnings growth for both public and private corporations. Wall Street chases returns with reckless abandon, evidenced by their endangerment of the entire global financial system. Whether intentional or not, the system is not safe with greed in the driver’s seat.

Big banks and corporations are not entirely to blame, however. Consumers in America must take it upon themselves to foster an environment of financial intelligence. When regulation doesn’t prevent situations like the growth of subprime lending, it is up to the consumer not to take the bait when the opportunity arises. Consumers who make poor decisions such as taking out huge mortgages that they are unable to pay primarily hurt themselves by destabilizing their own finances, but they also hurt the economy as a whole. It is important to make people aware of the consequences of their financial decision making.