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The TED spread (in red) increased significantly during the financial
crisis, reflecting an increase in perceived credit risk.
World map showing real GDP growth rates for 2009. (Countries in
brown were in recession.)
agencies and investors failed to accurately price the risk involved with
mortgage-related financial products, and that governments did not adjust
their regulatory practices to address 21st-century financial markets.[17]
Research into the causes of the financial crisis has also focused on the
role of interest rate spreads.[18]
In the immediate aftermath of the financial crisis palliative fiscal and
monetary policies were adopted to lessen the shock to the economy.[19] In
July 2010, the DoddFrank regulatory reforms were enacted in the U.S.
to lessen the chance of a recurrence.[20]
Contents
[hide]
1Background
o 1.1Subprime lending
o 1.2Growth of the housing bubble
o 1.3Easy credit conditions
o 1.4Weak and fraudulent underwriting practices
o 1.5Predatory lending
o 1.6Deregulation
o 1.7Increased debt burden or over-leveraging
o 1.8Financial innovation and complexity
o 1.9Incorrect pricing of risk
o 1.10Boom and collapse of the shadow banking system
o 1.11Commodities boom
o 1.12Systemic crisis
o 1.13Role of economic forecasting
2Impact on financial markets
o 2.1US stock market
o 2.2Financial institutions
3IndyMac
o 3.1Collapse
o 3.2Credit markets and the shadow banking system
o 3.3Wealth effects
o 3.4European contagion
4Effects on the global economy (as of 2009)
o 4.1Global effects
o 4.2U.S. economic effects
4.2.1Real gross domestic product
4.2.2Distribution of wealth in the US
o 4.3Official economic projections
5Government responses
o 5.1Emergency and short-term responses
o 5.2Regulatory proposals and long-term responses
types (e.g., mortgage, credit card, and auto) were easy to obtain and
consumers assumed an unprecedented debt load.[23][24][25]
As part of the housing and credit booms, the number of financial
agreements called mortgage-backed securities (MBS) and collateralized
debt obligations (CDO), which derived their value from mortgage
payments and housing prices, greatly increased.[7] Such financial
innovation enabled institutions and investors around the world to invest
in the U.S. housing market. As housing prices declined, major global
financial institutions that had borrowed and invested heavily in subprime
MBS reported significant losses.[26]
Falling prices also resulted in homes worth less than the mortgage loan,
providing a financial incentive to enter foreclosure. The ongoing
foreclosure epidemic that began in late 2006 in the U.S. continues to
drain wealth from consumers and erodes the financial strength of
banking institutions. Defaults and losses on other loan types also
increased significantly as the crisis expanded from the housing market to
other parts of the economy. Total losses are estimated in the trillions of
U.S. dollars globally.[26]
As of March 2011 the FDIC has had to pay out $9 billion to cover losses
on bad loans at 165 failed financial institutions.[52] The Congressional
Budget Office estimated, in June 2011, that the bailout to Fannie Mae
and Freddie Mac exceeds $300 billion (calculated by adding the fair
value deficits of the entities to the direct bailout funds at the time). [53]
Economist Paul Krugman argued in January 2010 that the simultaneous
growth of the residential and commercial real estate pricing bubbles and
the global nature of the crisis undermines the case made by those who
argue that Fannie Mae, Freddie Mac, CRA, or predatory lending were
primary causes of the crisis. In other words, bubbles in both markets
developed even though only the residential market was affected by these
potential causes.[54]
Countering Krugman, Peter J. Wallison wrote: "It is not true that every
bubbleeven a large bubblehas the potential to cause a financial
crisis when it deflates." Wallison notes that other developed countries
had "large bubbles during the 19972007 period" but "the losses
associated with mortgage delinquencies and defaults when these bubbles
deflated were far lower than the losses suffered in the United States
when the 19972007 [bubble] deflated." According to Wallison, the
reason the U.S. residential housing bubble (as opposed to other types of
bubbles) led to financial crisis was that it was supported by a huge
number of substandard loans generally with low or no downpayments.
[55]
A graph showing the median and average sales prices of new homes sold
in the United States between 1963 and 2008 (not adjusted for inflation)
[59]
Between 1998 and 2006, the price of the typical American house
increased by 124%.[60] During the two decades ending in 2001, the
national median home price ranged from 2.9 to 3.1 times median
household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[61]
This housing bubble resulted in many homeowners refinancing their
homes at lower interest rates, or financing consumer spending by taking
out second mortgages secured by the price appreciation.
In a Peabody Award winning program, NPR correspondents argued that
a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed
income investments) sought higher yields than those offered by U.S.
Treasury bonds early in the decade. This pool of money had roughly
doubled in size from 2000 to 2007, yet the supply of relatively safe,
income generating investments had not grown as fast. Investment banks
on Wall Street answered this demand with products such as the
Bernanke explained that between 1996 and 2004, the U.S. current
account deficit increased by $650 billion, from 1.5% to 5.8% of GDP.
Financing these deficits required the country to borrow large sums from
abroad, much of it from countries running trade surpluses. These were
mainly the emerging economies in Asia and oil-exporting nations. The
balance of paymentsidentity requires that a country (such as the U.S.)
running a current account deficit also have a capital account
(investment) surplus of the same amount. Hence large and growing
amounts of foreign funds (capital) flowed into the U.S. to finance its
imports.
All of this created demand for various types of financial assets, raising
the prices of those assets while lowering interest rates. Foreign investors
had these funds to lend either because they had very high personal
savings rates (as high as 40% in China) or because of high oil prices.
Ben Bernanke has referred to this as a "saving glut".[76]
A flood of funds (capital or liquidity) reached the U.S. financial markets.
Foreign governments supplied funds by purchasing Treasury bonds and
thus avoided much of the direct impact of the crisis. U.S. households, on
the other hand, used funds borrowed from foreigners to finance
consumption or to bid up the prices of housing and financial assets.
Financial institutions invested foreign funds in mortgage-backed
securities.
The Fed then raised the Fed funds rate significantly between July 2004
and July 2006.[77] This contributed to an increase in 1-year and 5-year
adjustable-rate mortgage (ARM) rates, making ARM interest rate resets
more expensive for homeowners.[78] This may have also contributed to
the deflating of the housing bubble, as asset prices generally move
inversely to interest rates, and it became riskier to speculate in housing.
[79][80]
U.S. housing and financial assets dramatically declined in value
after the housing bubble burst.[81][82]
Weak and fraudulent underwriting practices[edit]
Testimony given to the Financial Crisis Inquiry Commission by Richard
M. Bowen III on events during his tenure as the Business Chief
Underwriter for Correspondent Lending in the Consumer Lending
Group for Citigroup (where he was responsible for over 220 professional
underwriters) suggests that by the final years of the U.S. housing bubble
(20062007), the collapse of mortgage underwriting standards was
endemic. His testimony stated that by 2006, 60% of mortgages
purchased by Citi from some 1,600 mortgage companies were
"defective" (were not underwritten to policy, or did not contain all
Behavior that may be optimal for an individual (e.g., saving more during
adverse economic conditions) can be detrimental if too many individuals
pursue the same behavior, as ultimately one person's consumption is
another person's income. Too many consumers attempting to save (or
pay down debt) simultaneously is called the paradox of thrift and can
cause or deepen a recession. Economist Hyman Minsky also described a
"paradox of deleveraging" as financial institutions that have too much
leverage (debt relative to equity) cannot all de-leverage simultaneously
without significant declines in the value of their assets.[107]
During April 2009, U.S. Federal Reserve vice-chair Janet Yellen
discussed these paradoxes: "Once this massive credit crunch hit, it didnt
take long before we were in a recession. The recession, in turn, deepened
the credit crunch as demand and employment fell, and credit losses of
financial institutions surged. Indeed, we have been in the grips of
precisely this adverse feedback loop for more than a year. A process of
balance sheet deleveraging has spread to nearly every corner of the
economy. Consumers are pulling back on purchases, especially on
durable goods, to build their savings. Businesses are cancelling planned
investments and laying off workers to preserve cash. And, financial
institutions are shrinking assets to bolster capital and improve their
chances of weathering the current storm. Once again, Minsky
understood this dynamic. He spoke of the paradox of deleveraging, in
which precautions that may be smart for individuals and firmsand
indeed essential to return the economy to a normal statenevertheless
magnify the distress of the economy as a whole."[107]
Financial innovation and complexity[edit]
$2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion.
The combined balance sheets of the then five major investment banks
totaled $4 trillion. In comparison, the total assets of the top five bank
holding companies in the United States at that point were just over
$6 trillion, and total assets of the entire banking system were about
$10 trillion. The combined effect of these factors was a financial system
vulnerable to self-reinforcing asset price and credit cycles.[28]
Paul Krugman, laureate of the Nobel Prize in Economics, described the
run on the shadow banking system as the "core of what happened" to
cause the crisis. He referred to this lack of controls as "malign neglect"
and argued that regulation should have been imposed on all banking-like
activity.[97]
The securitization markets supported by the shadow banking system
started to close down in the spring of 2007 and nearly shut-down in the
fall of 2008. More than a third of the private credit markets thus became
unavailable as a source of funds.[136] According to the Brookings
Institution, the traditional banking system does not have the capital to
close this gap as of June 2009: "It would take a number of years of
strong profits to generate sufficient capital to support that additional
lending volume." The authors also indicate that some forms of
securitization are "likely to vanish forever, having been an artifact of
excessively loose credit conditions."[137]
Economist Mark Zandi testified to the Financial Crisis Inquiry
Commission in January 2010: "The securitization markets also remain
impaired, as investors anticipate more loan losses. Investors are also
uncertain about coming legal and accounting rule changes and
regulatory reforms. Private bond issuance of residential and commercial
mortgage-backed securities, asset-backed securities, and CDOs peaked
in 2006 at close to $2 trillion...In 2009, private issuance was less than
$150 billion, and almost all of it was asset-backed issuance supported by
the Federal Reserve's TALF program to aid credit card, auto and smallbusiness lenders. Issuance of residential and commercial mortgagebacked securities and CDOs remains dormant."[138]
Commodities boom[edit]
Main article: 2000s commodities boom
Rapid increases in a number of commodity prices followed the collapse
in the housing bubble. The price of oil nearly tripled from $50 to $147
from early 2007 to 2008, before plunging as the financial crisis began to
take hold in late 2008.[139] Experts debate the causes, with some
attributing it to speculative flow of money from housing and other
investments into commodities, some to monetary policy,[140] and some to
the increasing feeling of raw materials scarcity in a fast-growing world,
leading to long positions taken on those markets, such as Chinese
increasing presence in Africa. An increase in oil prices tends to divert a
larger share of consumer spending into gasoline, which creates
downward pressure on economic growth in oil importing countries, as
wealth flows to oil-producing states.[141] A pattern of spiking instability
in the price of oil over the decade leading up to the price high of 2008
has been recently identified.[142] The destabilizing effects of this price
variance has been proposed as a contributory factor in the financial
crisis.
In testimony before the Senate Committee on Commerce, Science, and
Transportation on June 3, 2008, former director of the CFTC Division of
Trading & Markets (responsible for enforcement) Michael Greenberger
specifically named the Atlanta-based IntercontinentalExchange, founded
by Goldman Sachs, Morgan Stanley and BP as playing a key role in
speculative run-up of oil futures prices traded off the regulated futures
exchanges in London and New York.[143] However, the
IntercontinentalExchange (ICE) had been regulated by both European
and U.S. authorities since its purchase of the International Petroleum
Exchange in 2001. Mr Greenberger was later corrected on this matter.[144]
IndyMac[edit]
The first visible institution to run into trouble in the United States was
the Southern Californiabased IndyMac, a spin-off of Countrywide
Financial. Before its failure, IndyMac Bank was the largest savings and
loan association in the Los Angelesmarket and the seventh largest
mortgage originator in the United States.[184] The failure of IndyMac
Bank on July 11, 2008, was the fourth largest bank failure in United
States history up until the crisis precipitated even larger failures,[185] and
the second largest failure of a regulated thrift.[186] IndyMac Bank's parent
corporation was IndyMac Bancorp until the FDIC seized IndyMac Bank.
[187]
IndyMac Bancorp filed for Chapter 7 bankruptcy in July 2008.[187]
borrowed from a Federal Home Loan Bank (FHLB) and from brokered
deposits, led to its demise when the mortgage market declined in 2007.
IndyMac often made loans without verification of the borrowers income
or assets, and to borrowers with poor credit histories. Appraisals
obtained by IndyMac on underlying collateral were often questionable as
well. As an Alt-A lender, IndyMacs business model was to offer loan
products to fit the borrowers needs, using an extensive array of risky
option-adjustable-rate-mortgages (option ARMs), subprime loans, 80/20
loans, and other nontraditional products. Ultimately, loans were made to
many borrowers who simply could not afford to make their payments.
The thrift remained profitable only as long as it was able to sell those
loans in the secondary mortgage market. IndyMac resisted efforts to
regulate its involvement in those loans or tighten their issuing criteria:
see the comment by Ruthann Melbourne, Chief Risk Officer, to the
regulating agencies.[191][192][193]
May 12, 2008, in a small note in the "Capital" section of its what would
become its last 10-Q released before receivership, IndyMac revealed
but did not admit that it was no longer a well-capitalized institution
and that it was headed for insolvency.
IndyMac reported that during April 2008, Moody's and Standard &
Poor's downgraded the ratings on a significant number of Mortgagebacked security (MBS) bonds including $160 million of those issued by
IndyMac and which the bank retained in its MBS portfolio. IndyMac
concluded that these downgrades would have negatively impacted the
Company's risk-based capital ratio as of June 30, 2008. Had these
lowered ratings been in effect at March 31, 2008, IndyMac concluded
that the bank's capital ratio would have been 9.27% total risk-based.
IndyMac warned that if its regulators found its capital position to have
fallen below "well capitalized" (minimum 10% risk-based capital ratio)
to "adequately capitalized" (810% risk-based capital ratio) the bank
might no longer be able to use brokered deposits as a source of funds.
Senator Charles Schumer (D-NY) would later point out that brokered
deposits made up more than 37 percent of IndyMac's total deposits and
With $32 billion in assets, IndyMac Bank was one of the largest bank
failures in American history.
IndyMac Bancorp filed for Chapter 7 bankruptcy on July 31, 2008.[187]
Initially the companies affected were those directly involved in home
construction and mortgage lending such as Northern Rock and
Countrywide Financial, as they could no longer obtain financing through
the credit markets. Over 100 mortgage lenders went bankrupt during
2007 and 2008. Concerns that investment bank Bear Stearns would
collapse in March 2008 resulted in its fire-sale to JP Morgan Chase. The
financial institution crisis hit its peak in September and October 2008.
Several major institutions either failed, were acquired under duress, or
were subject to government takeover. These included Lehman Brothers,
Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual,
Wachovia, Citigroup, and AIG.[207]
Credit markets and the shadow banking system[edit]
interrupted the ability of corporations to rollover (replace) their shortterm debt. The U.S. government responded by extending insurance for
money market accounts analogous to bank deposit insurance via a
temporary guarantee[208] and with Federal Reserve programs to purchase
commercial paper. The TED spread, an indicator of perceived credit risk
in the general economy, spiked up in July 2007, remained volatile for a
year, then spiked even higher in September 2008,[209] reaching a record
4.65% on October 10, 2008.
In a dramatic meeting on September 18, 2008, Treasury Secretary Henry
Paulson and Fed chairman Ben Bernanke met with key legislators to
propose a $700 billion emergency bailout. Bernanke reportedly told
them: "If we don't do this, we may not have an economy on
Monday."[210] The Emergency Economic Stabilization Act, which
implemented the Troubled Asset Relief Program (TARP), was signed
into law on October 3, 2008.[211]
Economist Paul Krugman and U.S. Treasury Secretary Timothy Geithner
explain the credit crisis via the implosion of the shadow banking system,
which had grown to nearly equal the importance of the traditional
commercial banking sector as described above. Without the ability to
obtain investor funds in exchange for most types of mortgage-backed
securities or asset-backed commercial paper, investment banks and other
entities in the shadow banking system could not provide funds to
mortgage firms and other corporations.[28][97]
This meant that nearly one-third of the U.S. lending mechanism was
frozen and continued to be frozen into June 2009.[136] According to the
Brookings Institution, the traditional banking system does not have the
capital to close this gap as of June 2009: "It would take a number of
years of strong profits to generate sufficient capital to support that
additional lending volume". The authors also indicate that some forms of
securitization are "likely to vanish forever, having been an artifact of
excessively loose credit conditions". While traditional banks have raised
their lending standards, it was the collapse of the shadow banking
system that is the primary cause of the reduction in funds available for
borrowing.[212]
Wealth effects[edit]
bank UBS stated on October 6 that 2008 would see a clear global
recession, with recovery unlikely for at least two years.[227] Three days
later UBS economists announced that the "beginning of the end" of the
crisis had begun, with the world starting to make the necessary actions to
fix the crisis: capital injection by governments; injection made
systemically; interest rate cuts to help borrowers. The United Kingdom
had started systemic injection, and the world's central banks were now
cutting interest rates. UBS emphasized the United States needed to
implement systemic injection. UBS further emphasized that this fixes
only the financial crisis, but that in economic terms "the worst is still to
come".[228] UBS quantified their expected recession durations on October
16: the Eurozone's would last two quarters, the United States' would last
three quarters, and the United Kingdom's would last four quarters.[229]
The economic crisis in Iceland involved all three of the country's major
banks. Relative to the size of its economy, Icelands banking collapse is
the largest suffered by any country in economic history.[230]
At the end of October UBS revised its outlook downwards: the
forthcoming recession would be the worst since the early 1980s
recession with negative 2009 growth for the U.S., Eurozone, UK; very
limited recovery in 2010; but not as bad as the Great Depression.[231]
The Brookings Institution reported in June 2009 that U.S. consumption
accounted for more than a third of the growth in global consumption
between 2000 and 2007. "The US economy has been spending too much
and borrowing too much for years and the rest of the world depended on
the U.S. consumer as a source of global demand." With a recession in
the U.S. and the increased savings rate of U.S. consumers, declines in
growth elsewhere have been dramatic. For the first quarter of 2009, the
annualized rate of decline in GDP was 14.4% in Germany, 15.2% in
Japan, 7.4% in the UK, 18% in Latvia,[232] 9.8% in the Euro area and
21.5% for Mexico.[233]
Some developing countries that had seen strong economic growth saw
significant slowdowns. For example, growth forecasts in Cambodia
show a fall from more than 10% in 2007 to close to zero in 2009, and
Kenya may achieve only 34% growth in 2009, down from 7% in 2007.
According to the research by the Overseas Development Institute,
reductions in growth can be attributed to falls in trade, commodity
prices, investment and remittances sent from migrant workers (which
reached a record $251 billion in 2007, but have fallen in many countries
since).[234] This has stark implications and has led to a dramatic rise in
the number of households living below the poverty line, be it 300,000 in
Bangladesh or 230,000 in Ghana.[234] Especially states with a fragile
political system have to fear that investors from Western states withdraw
their money because of the crisis. Bruno Wenn of the German DEG
recommends to provide a sound economic policymaking and good
governance to attract new investors[235]
The World Bank reported in February 2009 that the Arab World was far
less severely affected by the credit crunch. With generally good balance
of payments positions coming into the crisis or with alternative sources
of financing for their large current account deficits, such as remittances,
Foreign Direct Investment (FDI) or foreign aid, Arab countries were able
to avoid going to the market in the latter part of 2008. This group is in
the best position to absorb the economic shocks. They entered the crisis
in exceptionally strong positions. This gives them a significant cushion
against the global downturn. The greatest impact of the global economic
crisis will come in the form of lower oil prices, which remains the single
most important determinant of economic performance. Steadily
declining oil prices would force them to draw down reserves and cut
down on investments. Significantly lower oil prices could cause a
reversal of economic performance as has been the case in past oil
shocks. Initial impact will be seen on public finances and employment
for foreign workers.[236]
U.S. economic effects[edit]
Real gross domestic product[edit]
The output of goods and services produced by labor and property located
in the United Statesdecreased at an annual rate of approximately 6%
in the fourth quarter of 2008 and first quarter of 2009, versus activity in
the year-ago periods.[237] The U.S. unemployment rate increased to
10.1% by October 2009, the highest rate since 1983 and roughly twice
the pre-crisis rate. The average hours per work week declined to 33, the
lowest level since the government began collecting the data in 1964.[238]
[239]
With the decline of gross domestic product came the decline in
innovation. With fewer resources to risk in creative destruction, the
number of patent applications flat-lined. Compared to the previous 5
years of exponential increases in patent application, this stagnation
correlates to the similar drop in GDP during the same time period.[240]
Distribution of wealth in the US[edit]
The U.S. Federal Reserve and central banks around the world have taken
steps to expand money supplies to avoid the risk of a deflationary spiral,
in which lower wages and higher unemployment lead to a selfreinforcing decline in global consumption. In addition, governments
have enacted large fiscal stimulus packages, by borrowing and spending
to offset the reduction in private sector demand caused by the crisis. The
U.S. executed two stimulus packages, totaling nearly $1 trillion during
2008 and 2009.[246] The U.S. Federal Reserve's new and expanded
liquidity facilities were intended to enable the central bank to fulfill its
traditional lender-of-last-resort role during the crisis while mitigating
stigma, broadening the set of institutions with access to liquidity, and
increasing the flexibility with which institutions could tap such liquidity.
[247]
This credit freeze brought the global financial system to the brink of
collapse. The response of the Federal Reserve, the European Central
Bank, and other central banks was immediate and dramatic. During the
last quarter of 2008, these central banks purchased US$2.5 trillion of
government debt and troubled private assets from banks. This was the
largest liquidity injection into the credit market, and the largest monetary
policy action, in world history. The governments of European nations
and the USA also raised the capital of their national banking systems by
$1.5 trillion, by purchasing newly issued preferred stock in their major
banks.[207] In October 2010, Nobel laureate Joseph Stiglitz explained how
the U.S. Federal Reserve was implementing another monetary policy
creating currency as a method to combat the liquidity trap.[248] By
creating $600 billion and inserting[clarification needed] this directly into banks,
the Federal Reserve intended to spur banks to finance more domestic
loans and refinance mortgages. However, banks instead were spending
the money in more profitable areas by investing internationally in
emerging markets. Banks were also investing in foreign currencies,
which Stiglitz and others point out may lead to currency wars while
China redirects its currency holdings away from the United States.[249]
Governments have also bailed out a variety of firms as discussed above,
incurring large financial obligations. To date, various U.S. government
liquidity requirements.[258] Critics argue that Basel III doesnt address the
problem of faulty risk-weightings. Major banks suffered losses from
AAA-rated created by financial engineering (which creates apparently
risk-free assets out of high risk collateral) that required less capital
according to Basel II. Lending to AA-rated sovereigns has a risk-weight
of zero, thus increasing lending to governments and leading to the next
crisis.[259]Johan Norberg argues that regulations (Basel III among others)
have indeed led to excessive lending to risky governments (see
European sovereign-debt crisis) and the ECB pursues even more lending
as the solution.[260]
United States Congress response[edit]
At least two major reports were produced by Congress: the Financial
Crisis Inquiry Commission report, released January 2011, and a report
by the United States Senate Homeland Security Permanent
Subcommittee on Investigations entitled Wall Street and the Financial
Crisis: Anatomy of a Financial Collapse (released April 2011).
On December 11, 2009 House cleared bill H.R.4173 Wall
Street Reform and Consumer Protection Act of 2009.[261]
On April 15, 2010 Senate introduced bill S.3217 Restoring
American Financial Stability Act of 2010.[262]
On July 21, 2010 the DoddFrank Wall Street Reform and
Consumer Protection Act was enacted.[263][264]
Court proceedings[edit]
In Iceland in April 2012, the special Landsdmur court convicted former
Prime Minister Geir Haarde of mishandling the 20082012 Icelandic
financial crisis.
Continuation of the financial crisis in the U.S. housing
market[edit]
China
United States
European Union
(03)
Brazil
(04)
India
(05)
Russia
(06)
Australia
(07)
Germany
(08)
Indonesia
(09)
(10)
Saudi Arabia
(11)
Nigeria
(12)
Canada
(13)
South Korea
(14)
Mexico
(15)
France
(16)
Switzerland
(17)
Argentina
(18)
Colombia
(19)
(20)
Japan
Turkey
2.
3.
4.
5.
"Danger Zones"
"Safe Havens"
Boston
Chicago
Cleveland
Las Vegas
Los Angeles
Columbus
Miami
New York
Dallas
Washington D.C. /
Northern Virginia
San Francisco /
Oakland
Houston
Phoenix
Seattle
Kansas City
Sacramento
Omaha
San Diego
Pittsburgh
6.
7.
8.
9.
10.
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Rosner as stating "It's not a liquidity problem, it's a valuation
problem.". Bloomberg. Retrieved June 27, 2010.
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Article
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Written by Joel Havemann
Table of Contents
Introduction
Origins
International Repercussions
In 2008 the world economy faced its most dangerous crisis since the
Great Depression of the 1930s. The contagion, which began in 2007
when sky-high home prices in the United States finally turned decisively
downward, spread quickly, first to the entire U.S. financial sector and
then to financial markets overseas. The casualties in the United States
included a) the entire investment banking industry, b) the biggest
insurance company, c) the two enterprises chartered by the government
to facilitate mortgage lending, d) the largest mortgage lender, e) the
largest savings and loan, and f) two of the largest commercial banks. The
carnage was not limited to the financial sector, however, as companies
that normally rely on credit suffered heavily. The American auto
industry, which pleaded for a federal bailout, found itself at the edge of
an abyss. Still more ominously, banks, trusting no one to pay them back,
simply stopped making the loans that most businesses need to regulate
their cash flows and without which they cannot do business. Share prices
plunged throughout the worldthe Dow Jones Industrial Average in the
U.S. lost 33.8% of its value in 2008and by the end of the year, a deep
recession had enveloped most of the globe. In December the National
Bureau of Economic Research, the private group recognized as the
lenders with more money to lend. Fannie Mae and Freddie Mac might
then sell the mortgages to investment banks that would bundle them with
hundreds or thousands of others into a mortgage-backed security that
would provide an income stream comprising the sum of all of the
monthly mortgage payments. Then the security would be sliced into
perhaps 1,000 smaller pieces that would be sold to investors, often
misidentified as low-risk investments.
The insurance industry got into the game by trading in credit default
swapsin effect, i