The Financial Crisis of 2008 popularly known as the Credit Crisis or the Subprime Crisis was the worst economic disaster since the Great Depression of 1929. Not only did it bring the financial institutions of US on its knees but also did it affect the financial markets overseas. A series of events which began in 2002 led to one another leaving no time for the banks to get back on their feet. Before they could identify the magnitude of the problem which had been coming towards them, half the economy was already in ruins. When the bubble of the housing sector of the US burst, the housing prices, which were believed to keep on soaring, came down rapidly. This largely affected the mortgage holders, banks and the investors as they considered the mortgage papers of the houses to be the security against the money which they lend to people.
Where did it begin?
The US economy experienced a minor recession in 2001. The economy was able to withstand the blows of the dotcom bubble, terrorist attacks and the accounting scandals in the beginning of the 21st century. But to drive away the fear of recession, the Federal Reserve of US lowered the federal fund’s rate. It led to a sudden liquidity of cash flow in the market. The bankers started offering home loans at a low-interest rate which led to a rise in the number of home buyers which ultimately led to an increase in the housing prices. The bubble of the housing estate was going up. The mortgage-backed securities were a win-win situation for the investors, the mortgage holders as well the borrowers. The lenders grew more eager to lend money. It led to a major fault – subprime mortgages. This is the name given to the loans granted to the borrowers whose income might be insufficient to pay back the money. The lenders fearlessly invested in this loan cycle as they were deemed safe investments by the rating agencies which wasn’t true on the inside and also because they were under the illusion that even if the borrowers defaulted on their loan, they would have the documents of the house against which they mortgaged. Little did they realize that the housing sector bubble which had been rising all these years until now could burst, leading to a sharp decline in the value of the houses. This is exactly what happened in 2004. The interest rates started rising and the market for buying homes closed. Not many people were interested in buying the homes anymore. Home prices started to fall. Many of the subprime mortgage holders were unable to pay back the money which they had borrowed earlier. Many of them defaulted on their loans; a lot of the houses came back to the investors. This added to the depleting values of the houses. The remaining subprime borrowers realized that the price they were paying was more than the house they owned. So they started defaulting on their loans as well. The subprime lenders ultimately started reaching bankruptcy by 2007 as the houses they now owned had very little value. The banks refused to offer loans as they weren’t under the impression to trust their borrowers anymore. It led to the crash of the stock market. And hence, the financial landslide began. It soon crumbled all the pillars of the United States and its effects were seen in various foreign companies who had invested in the US markets. This is when the crisis started crossing the international borders.
How was it dealt with?
Central banks and governments from various countries like England, China, Canada, Sweden, Switzerland and European Central banks started joining their front to deal with the crisis. Despite all joined efforts, several banks collapsed. Others were on the verge of bankruptcy. Then the US government came to the rescue and started printing dollars in a bulk, popularly coined as the Big Bank Bailout. They ‘created’ $700 billion to purchase the distressed assets including the mortgage-backed securities. It ultimately saved the banks. It is speculated that the bailout was in trillions and that it is still ongoing!