A post submitted by CGI member Dave68.

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The 2008 economic crisis, often referred to as the Global Financial Crisis, was a significant financial downturn that had widespread effects on economies around the world. Below are the primary causes and consequences.

Causes:

Vast amounts of money were invested in real estate assets or loans after the 1997 Asian financial crisis (which led to foreign inflows) and the burst of the dotcom bubble in 2000-2002 (which led to Fed target rate cuts); let’s stick to safe yield-generating investments!

Real estate prices began to increase at a fast pace (1997-2006), thus attracting more and more speculation; after all, land is fixed and population is growing so prices can only go up, right? plus look at all the money Joe next door made flipping land in Florida: if he can do it, so can I!

Loans were made on aggressive terms (>100% LTV, adjustable rate mortgages with low initial payments and subsequent step-ups) to unworthy borrowers (insufficent cash flows) as mortgage lenders competed for market share; after all, real estate prices keep increasing so the borrowers will be able to refinance their loans down the line, right? Plus, as long as I’m getting my commission and can distribute the mortgage loan to someone else, who cares right?

These loans were often bought by investment banks and sold (by the hundreds) to special purpose vehicles financed with borrowed money (90% LTV), the latter being insured against defaults by insurance companies (via credit default swaps) and vetted by rating agencies (who gave their AAA blessing to senior tranches); after all, not all the loans will default at the same time so we are protected by diversification, right?