Seeds: You may not know this, but the seeds of the 2008 financial crisis were planted back in 1970 when the first mortgage-backed security (MBS) was formed (Don’t worry about what that means just yet. We’ll get there). That’s right, the Great Recession and national treasure Vince Vaughn were born in the very same year.
Core: Alright, so in order for any of this to make sense, I’m gonna have to define a few terms. They sound a lot more complicated than they actually are, but don’t worry, it’ll hopefully all make sense in the end.
First up, the MBS. This is basically a fancy name for a bunch of mortgages that have been lumped together and sold to investors. MBSs encourage banks to give out as many mortgage loans as possible so that they can go sell even more MBSs so they can give out even more loans and… well, you get the picture. Originally these MBSs were made up of prime mortgages (ones that are likely to get paid off) called AAA mortgages. However, as time went on and banks got greedier, mortgage loans were given out to anyone who wanted one, no matter whether or not they seemed likely to pay them back. This resulted in thousands of subprime mortgages (aka crappy mortgages). Furthermore, the banks did nothing to stop this kind of activity because, well, they got rich.
Up next, the CDO, or collateralized debt obligation. These are pretty similar to to MBSs, but worse. Basically, CDOs are made up of mortgages with such bad ratings that they couldn’t be sold. To fix this, big banks took thousands of crappy mortgages, repackaged them, and put them back on the market with good ratings, ready for selling. Despite this, the general consensus was that the real estate market was golden and investing in these MBSs and CDOs was a good idea.
Lastly, we have the synthetic CDO. Essentially, it is a crappy bet on an already crappy investment in a CDO. Don’t quite understand this? Let Selena Gomez explain. Whew, ok, so now that that’s all out of the way, we can talk about what really happened.
Basically, the big banks saw an opportunity to make money by selling these MBSs and CDOs. They were ultimately able to trick investors into thinking that they were good quality by paying rating agencies to give the subprime mortgages false AAA ratings. Then, as people continued to believe that the real estate market was on the rise, they invested in synthetic CDOs, tying up even more money into these mortgages. Finally, once the time came around for these mortgages to be paid off, people defaulted on their loans and the American housing market came crumbling down, along with the global economy.
Skin: The 2008 stock market crash is often a point of discussion whenever the activities of the financial sector are brought up. However, the crisis often seems so complicated that many people do not actually understand what happened to cause the crash. A recent Oscar nominated film, The Big Short, has brought the issue back into the limelight and offers a comprehensive look at what happened in 2008.
Leaves: In the aftermath of the economic collapse, the big banks got a $700 billion bailout from the government with the Emergency Economic Stability Act of 2008, an action that big banks were counting on. You see, the banks knew that for the sake of the American economy, the government could not let the banks go under. When all was said and done, only one top banker was punished for his involvement in illegal activity that led to the economic crisis.
Food For Thought: Do you think more bankers should have been punished for their actions? Do you think something like the 2008 financial crisis could ever happen again?