The Coming Crash, Part 1: Remembering 2008

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The Coming Crash is a four-part series examining the 2008 Financial Crisis and current economic conditions. I am not a licensed financial expert. I’m not an economist. I’m just a guy trying to learn each day and share my thoughts with others. Consult your own financial adviser when deciding how to allocate your personal wealth.

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“For fifteen thousand years, fraud and short sighted thinking have never, ever worked. Not once. Eventually you get caught, things go south.” – Mark Baum, The Big Short

The Big Short – a movie based on a book about what caused the housing meltdown ten years ago. It’s a very good movie. It’s funny. It’s informative. It’s sad. It’s also Hollywood. But the overall thesis of the film is fairly on point. If you’ve seen it, you already know most of what I’m about to tell you. If you haven’t, I’d recommend watching it after you read this post. The film does a great job simplifying complex financial concepts. Mortgage Backed Securities, Collateralized Debt Obligations, Adjustable Rate Mortgages – all of these things contributed to the housing crisis and the financial crisis in 2008. The one common thing that all of these instruments represent: risk. And that’s really the simple explanation as to what caused the financial crisis of 2008 – completely absurd levels of risk. Also, some straight up fraud. There was some of that. Greed. And, of course, debt.

Sub-Prime Lending

In the case of housing, awful sub-prime mortgages were bundled into packages and sold as AAA-rated securities (that’s the fraud part). When the Federal Reserve raised interest rates, adjustable rate mortgages suddenly became more expensive, all while the prices of homes plummeted because the housing bubble popped. People ended up completely underwater on their homes and many just walked away. With crashing home values and mortgage delinquency rates moving higher, the banks were left holding a bag of their own creation.

Banks on the Brink

The banks, somehow, completely caught off guard by all of this, were short on liquidity and up to their eyeballs in leverage (there’s the risk part). Rumor spread that Bear Stearns was in trouble. When the masses caught wind, they wanted their money back and came looking for deposits. This is called a bank run and it’s what killed Bear Stearns.

Lehman Brothers, which at the time was the fourth largest investment bank in America, had way too much exposure to the sub-prime loan debacle through lender subsidiaries that it owned. Somewhat surprisingly, the Federal Government was unwilling to give Lehman Brothers the same bailout treatment provided to AIG, and Lehman filed for bankruptcy. With over $600 Billion in assets, to this day, Lehman is still the largest bankruptcy in history. Washington Mutual also folded. The issue there was over-exposure to California housing; this was a market hit particularly hard by the bubble pop. Those accounts, like Bear Stearns, were absorbed by JP Morgan. And Bank of America did the same for Merrill Lynch.

No More Steroids

With Banks now in awful financial shape and panic mode, credit lending froze up. This was  a necessary step given how much credit was already in the system. This was an economy completely on steroids from easy credit. And like any drug addict going into rehab, the pain of withdrawal hurt the US economy. With lending dried up, and no more money to borrow, recession hit America.

Wrapping it all Together

Debt, Risk, Fraud, and Greed. Greed is harder to fix. How did we do with the rest? We’ll explore in this series.

Disclaimer: Views and opinions expressed by Mike are not necessarily the views and opinions of CLNS Media. You can follow Mike on twitter @MikeFay34 and read his stock market technical analysis at faybomb.blogspot.com