Financial Crisis of 2008

There is not one specific reason for the financial crisis, but rather a combination of many events that caused the unusual market collapse of 2008. One explanation can be traced back to 1995 when the Clinton administration attempted to improve the Community Reinvestment Act, which required banks to distribute more loans in lower income areas. If the banks failed to abide by this new law, they would face harsh penalties, such as receiving limits on approvals for mergers and could even be hit with lawsuits. To avoid such severe consequences, banks began to lower their standards for issuing loans and required little documentation of the borrower’s information. These loans were mostly given out in the form of mortgage backed assets and the brokers who approved these loans would bundle the new, risky subprime loans with other prime loans and resell them as investments to other institutions. Most individuals would use one of these new loans to buy a house they could not afford in hopes of refinancing later at a lower rate. It sounded like a good idea at the time, until it eventually caught up with our economy and had a part in the market crash of 2008. (O’Neil) The housing slump then set off a chain reaction of problems in our county. Foreclosures drastically increased, leaving investors and financial institutions with the mess. This forced banks to tighten their lending requirements, but for most of them, the damage had already been done. Banks were on the verge of collapsing, so to prevent this from happening, government run companies like Fannie Mae and Freddy Mac bailed out most of the failing banks by providing them with more of these risky subprime loans. Not only did Fannie and Freddy save many banks, they also offered huge bonuses to their employees and certain members of Congress. Eventually, this would cause the bankruptcy of Fannie and Freddie along with many other banks that would further add to the failing economy and the 2008 financial

Cited: Kumar, Patrick. The 2008-2009 Financial Crisis – Causes and Effects. 29 September 2008. <http://cashmoneylife.com> O’Neil, William J. “How to Make Money in Stocks†. McGraw-Hill. 2009.