Global Financial Crisis 2008

Posted: January 22, 2009 in Industri Kreatif, Kebijakan, Kegiatan, Pameran
The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems.

On the one hand many people are concerned that those responsible for the financial problems are the ones being bailed out, while on the other hand, a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The problem could have been avoided, if ideologues supporting the current economics models weren’t so vocal, influential and inconsiderate of others’ viewpoints and concerns.

This article provides an overview of the crisis with links for further, more detailed, coverage at the end.

A crisis so severe,

the world financial system is affected

Following a period of economic boom, a financial bubble—global in scope—has now burst.

A collapse of the US sub-prime mortgage market and the reversal of the housing boom in other industrialized economies have had a ripple effect around the world. Furthermore, other weaknesses in the global financial system have surfaced. Some financial products and instruments have become so complex and twisted, that as things start to unravel, trust in the whole system started to fail.

Terdampar "Kapitalisme" terdampar

Terdampar: Perahu "Kapitalisme"

The extent of the problems has been so severe that some of the world’s largest financial institutions have collapsed. Others have been bought out by their competition at low prices and in other cases, the governments of the wealthiest nations in the world have resorted to extensive bail-out and rescue packages for the remaining large banks and financial institutions.

John Bird, John Fortune, Subprime Crisis, February 14, 2008

While there are many technical explanations of how the sub-prime mortgage crisis came about, the mainstream British comedians, John Bird and John Fortune, describe the mindset of the investment banking community in this satirical interview, explaining it in a way that sometimes only comedians can.

Together with impressionist Rory Bremner, derivatives (securities derived from other securities) are also explained:

Bremner, Bird, and Fortune, Silly Money: Where did all the money go?, Part 3, November 10, 2008

Bremner, Bird, and Fortune, Silly Money: Where did all the money go?, Part 4, November 10, 2008

The betting of practically anything helped create enormous sums of money out of almost nothing. However, as former US Presidential speech writer, Mark Lange, notes, “because [derivatives are] entirely unregulated and trade on no public exchanges, their originators can deliberately hide their vulnerabilities.”

The subprime crisis came about in large part because of financial instruments such as securitization where banks would pool their various loans into sellable assets, thus off-loading risky loans onto others. (For banks, millions can be made in money-earning loans, but they are tied up for decades. So they were turned into securities. The security buyer gets regular payments from all those mortgages; the banker off loads the risk. Securitization was seen as perhaps the greatest financial innovation in the 20th century.)Towards the end of October, the Bank of England said the world’s financial firms had now lost £1.8 trillion ($2.8 trillion) as a result of the continuing credit crisis. Global taxpayers have now spent around $8 trillion to shore up the world’s banks. These amounts will increase as the crisis spreads into the real economy.

As BBC’s former economic editor and presenter, Evan Davies noted in a documentary called The City Uncovered with Evan Davis: Banks and How to Break Them (January 14, 2008), rating agencies were paid to rate these products (risking a conflict of interest) and invariably got good ratings, encouraging people to take them up.

Starting in Wall Street, others followed quickly. With soaring profits, all wanted in, even if it went beyond their area of expertise. For example,

  • Banks borrowed even more money to lend out so they could create more securitization. Some banks didn’t need to rely on savers as much then, as long as they could borrow from other banks and sell those loans on as securities; bad loans would be the problem of whoever bought the securities.
  • Some investment banks like Lehman Brothers got into mortgages, buying them in order to securitize them and then sell them on.
  • Some banks loaned even more to have an excuse to securitize those loans.
  • Running out of who to loan to, banks turned to the poor; the subprime, the riskier loans. Rising house prices led lenders to think it wasn’t too risky; bad loans meant repossessing high-valued property. Subprime and “self-certified” loans (sometimes dubbed “liar’s loans”) became popular, especially in the US.
  • Some banks evens started to buy securities from others.
  • Collaterized Debt Obligations, or CDOs, (even more complex forms of securitization) spread the risk but were very complicated and often hid the bad loans. While things were good, no-one wanted bad news. Side Note»When asked what if someone raised concerns, Peter Harn, one of the innovators of CDOs, an even more complex version of securitization, told the BBC such people would likely lose their job; anyone trying to slow down would have seen a decline in their market share compared to others, for example.

valas-dalamdok-detikcomHigh street banks got into a form of investment banking, buying, selling and trading risk. Investment banks, not content with buying, selling and trading risk, got into home loans, mortgages, etc without the right controls and management.

Many banks were taking on huge risks increasing their exposure to problems. Perhaps it was ironic, as Evan Davies observed, that a financial instrument to reduce risk and help lend more—securities—would backfire so much.

When people did eventually start to see problems, confidence fell quickly. Lending slowed, in some cases ceased for a while and even now, there is a crisis of confidence. Some investment banks were sitting on the riskiest loans that other investors did not want. Assets were plummeting in value so lenders wanted to take their money back. But some investment banks had little in deposits; no secure retail funding, so some collapsed quickly and dramatically.

The problem was so large, banks even with large capital reserves ran out, so they had to turn to governments for bail out. New capital was injected into banks to, in effect, allow them to lose more money without going bust. That still wasn’t enough and confidence was not restored. (Some think it may take years for confidence to return.)

Shrinking banks suck money out of the economy as they try to build their capital and are nervous about loaning. Meanwhile businesses and individuals that rely on credit find it harder to get. A spiral of problems result.

As Evan Davies described it, banks had somehow taken what seemed to be a magic bullet of securitization and fired it on themselves.

The effect of this, the United Nation’s Conference on Trade and Development says in its Trade and Development Report 2008 is, as summarized by the Third World Network, that

the global economy is teetering on the brink of recession. The downturn after four years of relatively fast growth is due to a number of factors: the global fallout from the financial crisis in the United States, the bursting of the housing bubbles in the US and in other large economies, soaring commodity prices, increasingly restrictive monetary policies in a number of countries, and stock market volatility.

… the fallout from the collapse of the US mortgage market and the reversal of the housing boom in various important countries has turned out to be more profound and persistent than expected in 2007 and beginning of 2008. As more and more evidence is gathered and as the lag effects are showing up, we are seeing more and more countries around the world being affected by this rather profound and persistent negative effects from the reversal of housing booms in various countries.

Kanaga Raja, Economic Outlook Gloomy, Risks to South, say UNCTAD, Third World Network, September 4, 2008

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