‘The economic meltdown that happened in 2008 devastated the sophisticated, but conceptually hollow premise based on how the self-regulating markets framework functioned’ (Singh 2017). The 2008 financial crisis is the worst economic decline since the Great Depression in 1929. Although the financial crisis was not new, but rather part of the growing financial liberalization and deregulation since the 1970s, this one had a profound difference: ‘…it marked the conclusion of a phase of the basis of credit development on the dollar as the global reserve currency’ (Oasis 2017). As explained by this article, one realizes that the 2008 financial crisis was the culmination of a boom-bust cycle over an extended period. Not only does the paper analyze the history of the 2008 financial crisis but also the consequences (including new regulations and other reforms), international repercussions, and the part played by credit assessment agencies in the disaster.
The Origins of the Crisis
The financial crisis began escalating on August 2007. This was during the central bank’s interference by providing liquidity to all the various banks. The American Home Mortgage (AHM), was among the biggest home loan agencies in the U.S, laid off the majority of their staff and filed for bankruptcy. The firm stated that it had fallen victim to the decline in the U.S real estate market, which had been hurt by too many subprime lenders and borrowers. Banks began to take caution. Freezing of the short-term credit markets occurred ‘the largest French owned Bank, BNP Paribas, postponed over 2 billion euros in three of its venture funds’ (Singh 2017).
The bank indicated that they could not value their assets contained in the venture fund because of the disappearing market. They cited problems with the U.S subprime mortgage sector. The European Central Bank funded the Eurozone banking system with ’95 billion euros to ease the subprime credit crunch’ (Singh 2017), while the Bank of Japan and U.S Federal Reserve followed suit. Later, ‘…the European Central Bank gave an additional 61 billion euros to the various banks’ (Singh 2017). The U.S Federal Reserve stated it would continuously pump as many resources as required to the banks to avoid the credit crunch.
The central bank of the US, and the Bank of Japan added earlier injections into the money markets. ‘Goldman Sachs pumped 3 billion dollars into a particular fund that had suffered during the credit crisis to bring up its value while the European Central Bank added 47 billion Euros’ (Havemann 2009). The biggest mortgage prime mover in the US, Countrywide Financial, brought down its whole ‘11.5 billion-dollar credit line’ (Singh 2017). Likewise, Rams, the Australian mortgage lender admitted to grappling with liquidity. The Federal Reserve in the United States decreased their deduction rates by half to the various banks to aid them to combat their credit crisis. However, this did not help as the central banks in developed world nations subsequently injected more funds on larger scales for more extended periods in order to prop up different securities.
The Financial Housing Crisis and Credit Rating Agencies Culpability
The crisis should have been anticipated before it happened, as it was slow enough in coming. It originated from the bursting Internet bubble at the end of 2000. As a response, the federal funds rate was reduced by the Fed to ‘3.5 percent from 6.5 percent’ (Singh 2017) within just a few months. The September 11th terrorist attack further worsened the situation and further disrupted the economy. ‘As counteract, the Fed continually lowered rates up to 1 percent by July 2003 which lasted for a whole year’ (Zaidi 2016). As a result, there was a negative base inflation-adjusted short-term interest rate for thirty-one months. Therefore, the cheap money engendered leveraged buyouts explosions, a housing bubble, and other excesses. When the situation of free money presents itself, any sensible creditor will go on lending until they have no more customers to credit. The mortgage banks invented new forms of generating fees and stimulating business while relaxing their standards. These funds were hungry for yields while the structured investment vehicles (SVIs) kept these banks off of the balance sheets.
Existing homes in the US ‘increased by over 50 percent in market value between 2000 and mid-2005’ (Singh 2017). Consequently, a frenzy developed for new construction. The former chairperson of the Council of Economic Advisers, Martin Feldstein, ‘estimated that between 1997 and 2006, customers drew over nine trillion dollars in money out of their home-based equity Alan Greenspan also concluded that these withdrawals through home equity financed three percent of all personal consumption in the 2000s’ (Zaidi 2016). As the credit standards collapsed, there were readily available mortgages for people with low credit ratings (subprime mortgages). The lenders strained ingenuity and made houses appear affordable even for the poor and created liar loans with no or low documentation. These also included the ‘ninja’ loans provided to ‘people with no assets, not income and no job from the active connivance of the mortgage lenders and brokers’ (Zaidi 2016). The lenders assumed that after the higher rates kicked in after two years, they would refinance the mortgage and generate new fees.
Then came another problem that fueled the crisis by the name of collateralized debt obligations (CDOs). As the name suggests, they were various forms of debts that were bundled and sold to investors. ‘Merrill Lynch reported on October 24th, 2007 their most massive quarterly loss of $2.3 billion in its ninety-three-year history’ (Zaidi 2016). It announced for the first time that it had ’15 billion in complex collateralized debt obligations (CDOs)-backed by subprime mortgage securities on its books’ (Zaidi 2016). These CDO’s channeled cash flows from other mortgages through a chain of tiered bonds with yields and risks of different financier tastes. To sell the top-tier with an AAA rating, they would have the first call on all underlying cash flows. They consisted of approximately 80 percent of the bonds.
At the beginning of 2005, securitization became a mania whereby mortgage banks created synthetic securities that mimicked real securities risks but never carried the expense of assembling and buying actual loans (Zaidi 2016). ‘This deception of earning fees devoid of sustaining risks encouraged deceptive and lax business activities’ (Zaidi 2016). The subprime lenders that relied on uninformed and inexperienced customers thrived on such fraudulent activities as ‘teaser rates’, which should have given them away. However, while structured credit products seemed for a time to meet the massive demand for safe assets, they had a critical defect: The