What Changes Have Been Made Since 2008 So Same Banking Mistakes Dont Happen Again

A trader works on the flooring of the New York Stock Exchange on September 15, 2008 in New York City. In afternoon trading the Dow Jones Industrial Average barbarous over 500 points as U.S. stocks suffered a steep loss later news of the financial firm Lehman Brothers Holdings Inc. filing for Chapter 11 defalcation protection.

Spencer Platt/Getty Images

The warning signs of an epic fiscal crisis were blinking steadily through 2008—for those who were paying close attention.

One clue? According to the ProQuest newspaper database, the phrase "since the Great Depression" appeared in The New York Times nearly twice as oftentimes in the start eight months of that year—virtually 2 dozen times—as information technology did in an entire ordinary yr. As the summertime stretched into September, these nervous references began to noticeably accumulate, speckling the broadsheet columns similar a first, warning sprinkle of ash before the ruinous arrival of wildfire.

In mid-September ending erupted, dramatically and in full public view. Fiscal news became front-page, pinnacle-of-the-60 minutes news, every bit hundreds of dazed-looking Lehman Brothers employees poured onto the sidewalks of Seventh Artery in Manhattan, clutching office furnishings while struggling to explain to the swarming reporters the shocking turn of events. Why had their venerable 158-year-onetime investment banking firm, a bulwark of Wall Street, gone broke? And what did it mean for most of the planet?

The superficially composed assessments that emanated from Washington policymakers added no clarity. The secretary of the treasury, Hank Paulson, had—reporters said—"concluded that the financial arrangement could survive the collapse of Lehman." In other words, the U.S. regime decided not to engineer the firm'south salvation, as information technology had for Lehman'due south competitor Merrill Lynch, the insurance giant American International Group (AIG) or, in the bound of 2008, the investment depository financial institution Acquit Stearns.

Lehman, they thought, was not too large to fail.

Then-President George W. Bush had no explanations. He could but urge fortitude. "In the short run, adjustments in the financial markets tin can exist painful—both for the people concerned about their investments and for the employees of the affected firms," he said, attempting to quell potential panic on Chief Street. "In the long run, I'm confident that our capital markets are flexible and resilient and can deal with these adjustments." Privately, he sounded less sure, saying to advisors, "Anytime you guys are going to need to tell me how we ended up with a system like this.… We're non doing something right if nosotros're stuck with these miserable choices."

And because that system had get a globally interdependent 1, the U.Due south. financial crisis precipitated a worldwide economical collapse. And so…what happened?

The American Dream was sold on too-easy credit

The 2008 financial crisis had its origins in the housing market, for generations the symbolic cornerstone of American prosperity. Federal policy conspicuously supported the American dream of homeownership since at least the 1930s, when the U.S. authorities began to back the mortgage marketplace. Information technology went further after WWII, offer veterans cheap domicile loans through the One thousand.I. Beak. Policymakers reasoned they could avoid a render to prewar slump conditions so long as the undeveloped lands effectually cities could fill up with new houses, and the new houses with new appliances, and the new driveways with new cars. All this new ownership meant new jobs, and security for generations to come.

Fast frontwards a half-century or and then, to when the mortgage market was bravado upwardly. According to the Terminal Report of the National Commission on the Causes of the Financial and Economical Crunch of the Us, between 2001 and 2007, mortgage debt rose about as much equally information technology had in the whole residuum of the nation'south history. At about the same time, habitation prices doubled. Around the land, armies of mortgage salesmen hustled to get Americans to borrow more money for houses—or even just prospective houses. Many salesmen didn't ask borrowers for proof of income, chore or assets. Then the salesmen were gone, leaving behind a new debtor holding new keys and perhaps a faint suspicion that the deal was too good to be true.

Mortgages were transformed into ever-riskier investments

The salesmen could make these deals without investigating a borrower's fitness or a holding'south value because the lenders they represented had no intention of keeping the loans. Lenders would sell these mortgages onward; bankers would bundle them into securities and peddle them to institutional investors eager for the returns the American housing market had yielded so consistently since the 1930s. The ultimate mortgage owners would often be thousands of miles away and unaware of what they had bought. They knew only that the rating agencies said it was equally safe every bit houses always had been, at least since the Depression.

The fresh 21-century interest in transforming mortgages into securities owed to several factors. After the Federal Reserve System imposed depression involvement rates to avert a recession afterwards the September 11, 2001 terrorist attacks, ordinary investments weren't yielding much. Then savers sought superior yields.

To meet this demand for higher returns, the U.S. financial sector developed securities backed by mortgage payments. Ratings agencies, similar Moody's or Standard and Poor's, gave loftier marks to the processed mortgage products, grading them AAA, or every bit adept as U.South. Treasury bonds. And financiers regarded them as reliable, pointing to information and trends dating back decades. Americans almost ever fabricated their mortgage payments. The only problem with relying on those data and trends was that American laws and regulations had recently changed. The financial environment of the early 21st century looked more like the Usa earlier the Low than after: a country on the brink of a crash.

An employee of Lehman Brothers Holdings Inc. carrying a box out of the company's headquarters after information technology filed for bankruptcy.

Chris Hondros/Getty Images

Post-Depression bank regulations were slowly chipped away

Ringlet to Continue

To foreclose the Bully Depression from always happening once again, the U.S. government subjected banks to stringent regulation. Franklin Roosevelt had campaigned on this issue every bit part of his New Deal in 1932, telling voters his administration would closely regulate securities trading: "Investment banking is a legitimate concern. Commercial banking is another wholly separate and singled-out business. Their consolidation and mingling is contrary to public policy. I propose their separation."

He and his party kept this promise. First, they insured commercial banks and the savers they served through the Federal Deposit Insurance Corporation (FDIC). And so, with the Banking Act of 1933 (a.k.a. the Glass-Steagall Act), they separated these newly secure institutions from the investment banks that engaged in riskier financial endeavors. For decades afterward, such restrictive regulation ensured, equally the adage went, that bankers had but to follow dominion 363: pay depositors iii percent, charge borrowers 6 per centum, and striking the golf game course by 3 p.m.

This steady land persisted until the latter 1970s, when politicians hoping to jolt a stagnant economy pushed deregulation. Over several decades, policymakers eroded Drinking glass-Steagall separations. Most of what remained was repealed in 1999 by act of Congress, allowing big commercial banks, flush with the deposits of savers, to lumber into parts of the financial concern that had, since the New Bargain, been the province of the smaller, more specialized investment banks.

Investment banks jumped cervix-deep into chance

These nimbler firms, crowded past bigger brethren out of deals they might one time take fabricated, now had to seek riskier and more complicated ways to brand money. Congress gave them one way to practise so in 2000, with the Commodity Futures Modernization Act, deregulating over-the-counter derivatives—securities that were essentially bets that two parties could privately make on the time to come price of an nugget.

Like, for example, bundled mortgages.

stage was now ready for investment banks to reap immense near-term profits by betting on the continuing rise of real-estate values—and also for such banks to fail once the billions on their counterbalanced sheets proved illusory because ultimately, overextended American borrowers— who had been sold more than debt than they could beget, secured on ephemeral assets—began to default. In an ever-speeding screw, the bundled mortgage securities lost their AAA credit ratings, and banks fell headlong into bankruptcy.

Former employees of financial giant Lehman Brothers leaving the New York Urban center headquarters.

(Susan Watts/NY Daily News Archive/Getty Images

The Bush administration, criticized for earlier bailouts, cut Lehman loose

In March 2008, the investment bank Bear Stearns began to go under, so the U.Southward. treasury and the Federal Reserve arrangement brokered, and partly financed, a deal for its acquisition by JPMorgan Hunt. In September, the treasury announced it would rescue the government-supervised mortgage underwriters nearly universally known every bit Fannie Mae and Freddie Mac.

President George West. Bush was a conservative Republican who, along with virtually of his appointees, believed in the virtue of deregulation. Only with a crunch upon them, Bush and his lieutenants, particularly Treasury Secretary Paulson and Federal Reserve Chair Ben Bernanke, decided not to bet on leaving the markets unfettered. Although non required by constabulary to bail out Behave, Fannie or Freddie, they did and then to avoid disaster—merely to be castigated by young man Republican believers in deregulation. Senator Jim Bunning of Kentucky called the bailouts "a calamity for our free-marketplace arrangement" and, essentially, "socialism"—albeit the sort of socialism that favored Wall Street, rather than workers.

Earlier in the year, Paulson had identified Lehman as a potential problem and spoke privately to its chief executive, Richard Fuld. Months passed as Fuld failed to detect a buyer for his firm. Exasperated with Fuld and stung past criticism from his fellow Republicans, Paulson told Treasury staff to annotate—anonymously but on the record—that the government would not rescue Lehman.

Past the weekend of September 13-14, 2008, Lehman was conspicuously finished, with perhaps tens of billions of dollars in overvalued avails on its balance sheets. Anyone who even so held Lehman securities on the assumption that the government would bail them out had bet wrong.

One such establishment was the Reserve Management Corporation, which in September re-valued its Lehman securities at zero and and then had to announce it could no longer afford to redeem shares in its money-market fund at par value. Shares in RMC'south money-market place fund were now worth less than a dollar apiece—in the language of finance, RMC had "cleaved the buck," something no money-market fund had done to individual investors before. The money market, some $3.5 trillion in size, provided vital curt-term financing to U.S. corporations—but now it joined banks, mortgage lenders, and insurance firms among the faithless giants of the financial system that had suddenly proven spectacularly unworthy of conviction.

A series of bankruptcies and mergers followed as skittish investors, seeking safe harbor, pulled their money out of supposedly loftier-return vehicles. Their preferred shelter: the U.Due south. treasury, into whose bonds and bills the terrified financiers of the world poured what liquid wealth they had left. After decades of trying to push the U.South. government out of banking, it turned out that in the end, the U.S. government was the only institution the bankers trusted. Starved of capital and credit, the economy faltered, and a long slump began.

Eric Rauchway is the writer of several books on Us history includingWintertime War andThe Money Makers. He teaches at the University of California, Davis, and you lot tin can find him on Twitter @rauchway.

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Source: https://www.history.com/news/2008-financial-crisis-causes

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