2008 Financial Crisis 2008 Research Paper
Financial Crisis of 2008
Before the financial crisis of 2008, houses had always been rising in value so why would this all of a sudden change? Investors had found a great way to make money in the mortgage market and it was not just benefiting them, it was benefiting everyone. Exploring the lack of regulation in the market and also human behavior, I am going to break down what caused the financial crisis of 2008. The two videos, “Crisis of Credit,” and “Mind Over Money,” are my main sources of information.
Investors with a lot of money would buy treasury bills from the Federal Reserve because it was a safe investment. Alan Greenspan who was the Chairman of the Federal Reserve lowered the interest rates on the treasury bills to 1 percent …show more content…
after the .com bust on September 11th (Crisis). His reason for doing this was to keep the economy strong. Investors decided it was not worth buying these treasury bills anymore because of the low return on investment. By lowering the interest rates to 1 percent, however, this meant it was very cheap for banks to borrow money from the Federal Reserve. This gave the banks a lot more leverage. Before 2008 the price of houses had always continued to rise and this gave families an incentive to buy a house because they thought no matter what happened, their house would be worth more than what they paid for it so it was a good investment. Everything started with a family looking to buy a home. The family than contacted a mortgage broker who connected them with a mortgage lender. The mortgage lender than provided the family with a mortgage and both the mortgage broker, and the mortgage lender make money.
At this point is where the investors got involved and since they quit buying the treasury bills they were looking for a new investment to increase their wealth. Investors looked to the mortgage market and found an easy way to make money. The investors decided to take out large loans from banks and use the loans to buy mortgages from the mortgage lenders. These loans taken out by the investors were for millions to pay the mortgage lenders. Now the Investors had a monthly income from the homeowners who were paying their mortgages. The Investors than took the money coming in and put it into a Collateralized Debt Obligation, also known as a CDO (Crisis). Other investors, bankers, and hedge funds bought into these CDOs and the initial investor made millions to pay off his loans from the bank. The CDOs are than broken up into three parts safe, okay, and risky. The “safe” part was given a AAA rating which was the safest rating (Crisis). The safe part turned out to have a higher rate of return than the treasury bills that investors previously bought. The higher the risk brought a higher rate of return. Than the process repeated itself starting with the initial investor asking the mortgage lender for more mortgages. The mortgage lender than went to the mortgage broker and had him find more families looking for homes. At this point however the mortgage broker struggled to find more families looking for homes because everyone who qualified for a mortgage already had one. This is when things started to go wrong.
The Community Reinvestment Act was pushed hard by Bill Clinton, although it originated under Jimmy Carter (Miller). The CRA forced the country 's biggest buyers of mortgages to lower the qualifications of applicants, in order to increase the percentage of poor that were given mortgages. By 2006, 30 percent of all mortgages went to people who previously would not have qualified (Miller). This added risk to the mortgages because the new homeowners did not have to make a down payment, they did not need any proof of income, and or any other documents. The mortgage lenders did not have to worry about the homeowners defaulting on their monthly mortgage payment because the mortgage lender was covered and would get the house.
When the process started over again there were less prime mortgages and most new homeowners qualified as a subprime mortgage. This lasted for a little while making everyone involved rich, and everything seemed to be good until all of those subprime mortgages started defaulting on their payments that caused families to foreclose on their house. While this was happening the prices of houses dropped and people walked away from their house because they were paying a mortgage that was more than what the house was actually worth. The money stopped coming in on the mortgage payments and the initial investor, who had made millions, was now stuck with a bunch of mortgages with no demand for them. Nobody in the past who had invested in the CDOs would buy anymore because they too were stuck with worthless CDOs. This left the mortgage brokers out of work and the mortgage lenders could not sell any more mortgages to the investors so they too were stuck with mortgages. Everyone who had bought a CDO from the investor was also stuck. The Financial system froze and almost everyone involved went bankrupt. It even hurt the homeowner’s investments that had invested in any of the companies that had CDOs. What once seemed like a perfect and safe investment turned into a massive financial crisis.
Money has a powerful effect on the brain. Researchers from Stanford did a study on emotion and the brain reacted to money like it would too a drug, food, and sex (Mind). People are greedy and are constantly thinking of ways to increase their wealth. American’s greed played a big part in the financial crisis, many people found an easy way to make money and invested more than what they were worth into the housing market. As we learned from the twenty-dollar bill auction in “Mind Over Money,” emotions and fear of losing, drives people to pay a lot more for something than it is worth. I believe the housing market would have been just fine if the regulations to qualify for a mortgage were more strict and forced people to show proof of income. Giving out all of these subprime mortgages was where everything failed because after that it was only a matter of time before people could not pay their mortgages and once it caught up to them the whole financial system froze. If there would have been restrictions on who qualified for a mortgage, the value of houses would not have skyrocketed the way that they did and it would not have attracted so many investors. By having restrictions however, people would not be able to make as much money as they were making at the time. Once everything started, investors were greedy and invested extreme amounts of money because the more they invested the more money they made for themselves. With the restrictions less people would have been homeowners that does not mean they would have been homeless, there are many other options than buying a house. The reason everyone was trying to buy a home was because housing prices had risen 25 percent in 2004 and 2005 (Miller). If the family could not afford the mortgage it did not matter to them because they could just turn around and sell it to someone else for more than what they paid for it.
Adam Smith said that, “people behaving rationally keeps the economy stable” (Mind). Economists created tons of formulas for the way they thought a rational person would act and spend their money. As we learned in the video “Mind Over Money,” people get caught up emotionally in what they are doing and they buy things at a price a lot higher than what it is actually worth, behaving irrational.
This financial crisis has actually happened before but instead of houses, the hot commodity was tulip bulbs.
The Dutch economy experienced their own financial crisis in the 1630’s. In Holland, during a three-year period the price of a tulip bulb was about the same as the price of a house. It was said that around half of the money in the Dutch economy was caught up in trades dealing with tulip bulbs (Mind). People kept buying tulip bulbs at extremely high prices because they thought they would be able to turn around and resell them for more money. When the most expensive tulip failed to sell, everyone who had invested into tulip bulbs panicked. The prices dropped drastically and everyone tried to sell but nobody would buy because the tulips had become worthless. Many people went bankrupt and the Dutch economy took an entire generation to recover. This parallels the financial crisis of 2008 very well. Greed and emotion was driving the Dutch citizens to buy tulip bulbs for more than what they were worth with the mindset that they would just resell them when the price went up. We need to learn from past mistakes and have more regulation to prevent these things from happening. This example and the financial crisis show why there needs to be regulation in the market. It might cut down on some opportunities to make a lot of money but it would saved these economies from crashing the way they
did.
After watching “Crisis of Credit” and “Mind Over Money,” I have come to the conclusion that greed and lack of regulation in the market were the main reasons for the financial crisis in 2008. Banks were granting huge loans, risk was being passed to the next guy so nobody worried about defaulting mortgages, before 2008 the value of houses had never fallen, and investors thought they had found the perfect/safe investment. The whole system was a ticking time bomb and once it went off, people lost everything. Since people are greedy and do just about anything to make money, having more regulation would have not allowed this crisis to happen.
Works Cited
Crisis of Credit Visualized. Dir. Johnathan Jarvis. N.p., n.d. Web. 30 Jan. 2013. .
Mind Over Money. Dir. Malcolm Clark. N.p., 26 Apr. 2010. Web. 30 Jan. 2013. .
Miller, Abraham H. "The Financial Mess: How We Got Here." American Thinker. N.p., 29 Sept. 2008. Web. 30 Jan. 2013. .
Before the financial crisis of 2008, houses had always been rising in value so why would this all of a sudden change? Investors had found a great way to make money in the mortgage market and it was not just benefiting them, it was benefiting everyone. Exploring the lack of regulation in the market and also human behavior, I am going to break down what caused the financial crisis of 2008. The two videos, “Crisis of Credit,” and “Mind Over Money,” are my main sources of information.
Investors with a lot of money would buy treasury bills from the Federal Reserve because it was a safe investment. Alan Greenspan who was the Chairman of the Federal Reserve lowered the interest rates on the treasury bills to 1 percent …show more content…
after the .com bust on September 11th (Crisis). His reason for doing this was to keep the economy strong. Investors decided it was not worth buying these treasury bills anymore because of the low return on investment. By lowering the interest rates to 1 percent, however, this meant it was very cheap for banks to borrow money from the Federal Reserve. This gave the banks a lot more leverage. Before 2008 the price of houses had always continued to rise and this gave families an incentive to buy a house because they thought no matter what happened, their house would be worth more than what they paid for it so it was a good investment. Everything started with a family looking to buy a home. The family than contacted a mortgage broker who connected them with a mortgage lender. The mortgage lender than provided the family with a mortgage and both the mortgage broker, and the mortgage lender make money.
At this point is where the investors got involved and since they quit buying the treasury bills they were looking for a new investment to increase their wealth. Investors looked to the mortgage market and found an easy way to make money. The investors decided to take out large loans from banks and use the loans to buy mortgages from the mortgage lenders. These loans taken out by the investors were for millions to pay the mortgage lenders. Now the Investors had a monthly income from the homeowners who were paying their mortgages. The Investors than took the money coming in and put it into a Collateralized Debt Obligation, also known as a CDO (Crisis). Other investors, bankers, and hedge funds bought into these CDOs and the initial investor made millions to pay off his loans from the bank. The CDOs are than broken up into three parts safe, okay, and risky. The “safe” part was given a AAA rating which was the safest rating (Crisis). The safe part turned out to have a higher rate of return than the treasury bills that investors previously bought. The higher the risk brought a higher rate of return. Than the process repeated itself starting with the initial investor asking the mortgage lender for more mortgages. The mortgage lender than went to the mortgage broker and had him find more families looking for homes. At this point however the mortgage broker struggled to find more families looking for homes because everyone who qualified for a mortgage already had one. This is when things started to go wrong.
The Community Reinvestment Act was pushed hard by Bill Clinton, although it originated under Jimmy Carter (Miller). The CRA forced the country 's biggest buyers of mortgages to lower the qualifications of applicants, in order to increase the percentage of poor that were given mortgages. By 2006, 30 percent of all mortgages went to people who previously would not have qualified (Miller). This added risk to the mortgages because the new homeowners did not have to make a down payment, they did not need any proof of income, and or any other documents. The mortgage lenders did not have to worry about the homeowners defaulting on their monthly mortgage payment because the mortgage lender was covered and would get the house.
When the process started over again there were less prime mortgages and most new homeowners qualified as a subprime mortgage. This lasted for a little while making everyone involved rich, and everything seemed to be good until all of those subprime mortgages started defaulting on their payments that caused families to foreclose on their house. While this was happening the prices of houses dropped and people walked away from their house because they were paying a mortgage that was more than what the house was actually worth. The money stopped coming in on the mortgage payments and the initial investor, who had made millions, was now stuck with a bunch of mortgages with no demand for them. Nobody in the past who had invested in the CDOs would buy anymore because they too were stuck with worthless CDOs. This left the mortgage brokers out of work and the mortgage lenders could not sell any more mortgages to the investors so they too were stuck with mortgages. Everyone who had bought a CDO from the investor was also stuck. The Financial system froze and almost everyone involved went bankrupt. It even hurt the homeowner’s investments that had invested in any of the companies that had CDOs. What once seemed like a perfect and safe investment turned into a massive financial crisis.
Money has a powerful effect on the brain. Researchers from Stanford did a study on emotion and the brain reacted to money like it would too a drug, food, and sex (Mind). People are greedy and are constantly thinking of ways to increase their wealth. American’s greed played a big part in the financial crisis, many people found an easy way to make money and invested more than what they were worth into the housing market. As we learned from the twenty-dollar bill auction in “Mind Over Money,” emotions and fear of losing, drives people to pay a lot more for something than it is worth. I believe the housing market would have been just fine if the regulations to qualify for a mortgage were more strict and forced people to show proof of income. Giving out all of these subprime mortgages was where everything failed because after that it was only a matter of time before people could not pay their mortgages and once it caught up to them the whole financial system froze. If there would have been restrictions on who qualified for a mortgage, the value of houses would not have skyrocketed the way that they did and it would not have attracted so many investors. By having restrictions however, people would not be able to make as much money as they were making at the time. Once everything started, investors were greedy and invested extreme amounts of money because the more they invested the more money they made for themselves. With the restrictions less people would have been homeowners that does not mean they would have been homeless, there are many other options than buying a house. The reason everyone was trying to buy a home was because housing prices had risen 25 percent in 2004 and 2005 (Miller). If the family could not afford the mortgage it did not matter to them because they could just turn around and sell it to someone else for more than what they paid for it.
Adam Smith said that, “people behaving rationally keeps the economy stable” (Mind). Economists created tons of formulas for the way they thought a rational person would act and spend their money. As we learned in the video “Mind Over Money,” people get caught up emotionally in what they are doing and they buy things at a price a lot higher than what it is actually worth, behaving irrational.
This financial crisis has actually happened before but instead of houses, the hot commodity was tulip bulbs.
The Dutch economy experienced their own financial crisis in the 1630’s. In Holland, during a three-year period the price of a tulip bulb was about the same as the price of a house. It was said that around half of the money in the Dutch economy was caught up in trades dealing with tulip bulbs (Mind). People kept buying tulip bulbs at extremely high prices because they thought they would be able to turn around and resell them for more money. When the most expensive tulip failed to sell, everyone who had invested into tulip bulbs panicked. The prices dropped drastically and everyone tried to sell but nobody would buy because the tulips had become worthless. Many people went bankrupt and the Dutch economy took an entire generation to recover. This parallels the financial crisis of 2008 very well. Greed and emotion was driving the Dutch citizens to buy tulip bulbs for more than what they were worth with the mindset that they would just resell them when the price went up. We need to learn from past mistakes and have more regulation to prevent these things from happening. This example and the financial crisis show why there needs to be regulation in the market. It might cut down on some opportunities to make a lot of money but it would saved these economies from crashing the way they
did.
After watching “Crisis of Credit” and “Mind Over Money,” I have come to the conclusion that greed and lack of regulation in the market were the main reasons for the financial crisis in 2008. Banks were granting huge loans, risk was being passed to the next guy so nobody worried about defaulting mortgages, before 2008 the value of houses had never fallen, and investors thought they had found the perfect/safe investment. The whole system was a ticking time bomb and once it went off, people lost everything. Since people are greedy and do just about anything to make money, having more regulation would have not allowed this crisis to happen.
Works Cited
Crisis of Credit Visualized. Dir. Johnathan Jarvis. N.p., n.d. Web. 30 Jan. 2013. .
Mind Over Money. Dir. Malcolm Clark. N.p., 26 Apr. 2010. Web. 30 Jan. 2013. .
Miller, Abraham H. "The Financial Mess: How We Got Here." American Thinker. N.p., 29 Sept. 2008. Web. 30 Jan. 2013. .