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The Great Recession of 2008
Sit back. Get comfy.
In this thread, I'll highlight the main causes that led to the downfall of global economies in '08.
You'll know what exactly went wrong. So be with me.
Here's Margot Robbie to cheer you up.
The Great Recession of 2008Sit back. Get comfy.
In this thread, I'll highlight the main causes that led to the downfall of global economies in '08.
You'll know what exactly went wrong. So be with me.
Here's Margot Robbie to cheer you up.
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Before we begin, you must understand the term 'mortgage'.
Now imagine, you want to buy a house but you don't have the money. What will you do?
Naturally, you'll ask your bank to loan you out. They will give you the money you need today and keep your property as security.
Before we begin, you must understand the term 'mortgage'.
Now imagine, you want to buy a house but you don't have the money. What will you do?
Naturally, you'll ask your bank to loan you out. They will give you the money you need today and keep your property as security.
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This act of creating security over your loan is called a 'collateral'.
Your house is now collateral against your loan. Which means if you don't pay up in future, your property will be seized and sold to settle the loan.
This entire arrangement is called a 'housing mortgage'
This act of creating security over your loan is called a 'collateral'.
Your house is now collateral against your loan. Which means if you don't pay up in future, your property will be seized and sold to settle the loan.
This entire arrangement is called a 'housing mortgage'
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So banks give out loans, they get decent interest incomes from it. Simple right?
But back in the early '70s, banking in the US was considered a boring job.
Fixed returns with no roof-smashing surge in wealth. Banks wanted a dopamine shot!
Enter, the man, Lewis Ranieri.
So banks give out loans, they get decent interest incomes from it. Simple right?
But back in the early '70s, banking in the US was considered a boring job.
Fixed returns with no roof-smashing surge in wealth. Banks wanted a dopamine shot!
Enter, the man, Lewis Ranieri.
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Lewis created what we call a 'Mortgage-backed security' or an MBS.
Remember the loan you took to buy your house? Yeah. An MBS is a collection of such loans, nicely bundled together ready to be sold to an investor.
It's called 'Securitization'.
Lewis created what we call a 'Mortgage-backed security' or an MBS.
Remember the loan you took to buy your house? Yeah. An MBS is a collection of such loans, nicely bundled together ready to be sold to an investor.
It's called 'Securitization'.
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But why did the banks do it?
Well, securitization increases the bank's liquidity. What you pay on your loans will now be used to pay off the investor who bought an MBS.
In turn, banks got the entire loan amount from the investor, upfront! More liquidity, more commission!
But why did the banks do it?
Well, securitization increases the bank's liquidity. What you pay on your loans will now be used to pay off the investor who bought an MBS.
In turn, banks got the entire loan amount from the investor, upfront! More liquidity, more commission!
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In case if you are wondering, yes, all of this was absolutely legal.
In early 2000, the housing market in the US was considered rock-solid with negligible defaults happening on the underlying loan mortgages.
Housing bonds were stronger more than ever with a strong future.
In case if you are wondering, yes, all of this was absolutely legal.
In early 2000, the housing market in the US was considered rock-solid with negligible defaults happening on the underlying loan mortgages.
Housing bonds were stronger more than ever with a strong future.
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Markets were on another high. Banks were pumping cash into the economy because their liquidity had increased.
So what really went wrong?
Let us understand the overall scenario that led to it.
Markets were on another high. Banks were pumping cash into the economy because their liquidity had increased.
So what really went wrong?
Let us understand the overall scenario that led to it.
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Bonds undergo credit checks by government-certified credit rating agencies.
Top 3 global credit rating agencies :
Standard & Poor's
Moody's
Fitch group
If loan default rates go up, these agencies downgrade the bond rating, indicating it as a riskier investment.
Bonds undergo credit checks by government-certified credit rating agencies.
Top 3 global credit rating agencies :Standard & Poor'sMoody'sFitch groupIf loan default rates go up, these agencies downgrade the bond rating, indicating it as a riskier investment.
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Another important ratio to learn is the Loan-to-value ratio (LTV).
It calculates what % of the value of the property is financed by the loan.
Higher the ratio, riskier it is for the banks. The borrower has lesser equity in the property.
Another important ratio to learn is the Loan-to-value ratio (LTV).
It calculates what % of the value of the property is financed by the loan.
Higher the ratio, riskier it is for the banks. The borrower has lesser equity in the property.
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Mortgages with higher LTV to borrowers with good credit rating are called prime loans.
Mostly 'AA' rated.
Mortgages to clients having low credit rating are called sub-prime loans.
Mostly 'B/BB' rated.
It is these sub-prime loans that caused the market to plummet.
Mortgages with higher LTV to borrowers with good credit rating are called prime loans.
Mostly 'AA' rated.Mortgages to clients having low credit rating are called sub-prime loans.
Mostly 'B/BB' rated.It is these sub-prime loans that caused the market to plummet.
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To sell more loans in the form of an MBS, banks repackaged bad loans (basically NPAs) with good loans.
They created a new product to facilitate this arrangement.
A group of these repackaged MBSs is called a 'Collateralized debt obligation' or CDO.
To sell more loans in the form of an MBS, banks repackaged bad loans (basically NPAs) with good loans.
They created a new product to facilitate this arrangement.
A group of these repackaged MBSs is called a 'Collateralized debt obligation' or CDO.
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Heavy repackaging of loans done in the name of diversification.
Hundreds of loans underlying in one CDO. Even the banks were clueless which were bad loans and which were good.
Imagine you have ordered an i-phone, you open it only to find a bar of soap inside.
Heavy repackaging of loans done in the name of diversification.
Hundreds of loans underlying in one CDO. Even the banks were clueless which were bad loans and which were good.
Imagine you have ordered an i-phone, you open it only to find a bar of soap inside.
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Most of these sub-prime loans were adjustable loans.
Meaning, if the rates went up, borrowers end up paying a higher interest cost. This increases the probability of default.
Strippers ended up owning 5 houses. All of them mortgaged. Hence, unlimited exposure.
Most of these sub-prime loans were adjustable loans.
Meaning, if the rates went up, borrowers end up paying a higher interest cost. This increases the probability of default.
Strippers ended up owning 5 houses. All of them mortgaged. Hence, unlimited exposure.
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Banks lent money without conducting any credit checks. Receiving fat commissions.
Borrowers refinanced their original loans with a secondary loan. On the same property.
And guess what? most of them owned more than one property. All of them refinanced with multiple loans.
Banks lent money without conducting any credit checks. Receiving fat commissions.
Borrowers refinanced their original loans with a secondary loan. On the same property.
And guess what? most of them owned more than one property. All of them refinanced with multiple loans.
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Ratings were sold like noodles with agencies giving out AAA ratings to a BB bond.
All in the name of business
The bonds were soaring high, but the underlying loans which made the bonds were getting defaulted, left-right-centre. Nobody had a clue
This is called a 'Bubble'
Ratings were sold like noodles with agencies giving out AAA ratings to a BB bond.
All in the name of business
The bonds were soaring high, but the underlying loans which made the bonds were getting defaulted, left-right-centre. Nobody had a clue
This is called a 'Bubble'
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"People hate to think that bad things are happening, so they underestimate their likelihood."
"People hate to think that bad things are happening, so they underestimate their likelihood."
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"Truth is like poetry. And most people fucking hate poetry".
Eventually, in '08 the bubble burst, followed by losses in the financial and economic domain close to $12.8 trillion.
Unemployment rose with the closure of firms like Lehman brothers.
"Truth is like poetry. And most people fucking hate poetry".
Eventually, in '08 the bubble burst, followed by losses in the financial and economic domain close to $12.8 trillion.
Unemployment rose with the closure of firms like Lehman brothers.
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Imagine the leaning tower of Pisa, except, it has already fallen.
That was America's housing market.
Millions left homeless and without any jobs, living out of their cars.
It raises a question who was to blame?
Imagine the leaning tower of Pisa, except, it has already fallen.
That was America's housing market.
Millions left homeless and without any jobs, living out of their cars.
It raises a question who was to blame?
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"It ain't what you don't know that gets you in trouble. It's what you know for sure that just ain't so."
Banks - Over lent
Rating agencies - Overrated
Government - Overlooked
In the absence of due diligence and ethical behaviour, collective failure occurs on every front.
"It ain't what you don't know that gets you in trouble. It's what you know for sure that just ain't so."
Banks - Over lent
Rating agencies - Overrated
Government - Overlooked
In the absence of due diligence and ethical behaviour, collective failure occurs on every front.
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If you have reached here, thanks for reading! Much appreciated.
If you have reached here, thanks for reading! Much appreciated.
