The immediate trigger of the 2008 financial crisis that started on the United States was the bursting of the US housing bubble, which saw its peak from the years of 2005-2006. Incredibly high default rates on “subprime” and on “adjustable rate mortgages” began to increase immediately after. From 2004-2007, lenders began originating big amounts of high risk mortgages.A long term trend of housing prices and an increase in incentives such as easy initial terms and conditions, ended up encouraging borrowers to assume difficult mortgages, believing they would be able to refinance these loans at favorable terms. Some of the worst performing loans were securitized by diverse private investment banks. By the time interest rates rose in the US, housing prices beganto drop moderately around 2006 and 2007 in several regions of the US. Consequently, the process of refinancing these loans became more expensive. By then, defaults increased dramatically, the home prices didn’t go up as expected, and the mortgages interest rates reached higher levels.
In the years anticipating the financial crisis, the US received significant amounts of foreign investments, whichhad their attention caught by the great inflows of money entering the American economy, combined with low interest rates. A mix of low interest rates with easy credit conditions encouraged millions of people to invest, contributing to the development of both housing and credit bubbles. With tons of varieties of loans and the facility to obtain credit, consumers assumed huge amounts of debt.
Animportant contributor to the financial crisis was the “mortgage backed securities – MBS”, which have their value derive from mortgage payments and housing prices. With the housing boom that took place on the years leading up to the crisis, MBS were extremely common, and enabled various investors and financial institutions such as banks, hedge funds etc. to invest on the housing market. As thehousing prices dropped significantly in 2008, many global financial institutions that had borrowed huge amounts of money to invest in these MBS, reported significant losses. As the crisis expanded and contaminated the economy, defaults and losses increased all over, causing trillions of loss to the world economy.
The presence of financial institutions and hedge funds on the subprime market wasmisjudged by government policy makers, who did not recognize the extremely important role these institutions played on the market. Such institutions, assumed significant debt burdens while providing loans, and in the other hand did not have something to absorb the large losses caused by these loan defaults and MBS losses. Consequently, these losses ended up impacting these financial institutions’spower to lend, which ended up decreasing dramatically the economic activity. Soon, the concern with these financial institutions were so big, that the government started taking actions to encourage the lending in order to restore the financial system, and in many cases had to bail out several financial institutions who were no longer capable of operating their business. Soon enough, governments allover the world had to implement a series of actions such as reduction of interest rates or credit incentives in order to try and restore not only investor’s confidence, as well as the financial system as a whole. Financial institutions had generated losses that affected various regions of the world, and the recovery would not be easy. The effects on global stock markets were dramatic. BetweenJanuary and October 2008, owners of stock in the US corporations, had suffered about US$ 8 trillion in losses. In other countries, losses averaged around 40%.
The financial crisis can be attributed to various factors such as inabilities of homeowners to make their mortgage payments, creation of financial products that distributed the default risk, risky mortgage products, high levels of debt and...