The financial crisis: a summary

By KRISTINE WONG

In recent months, Americans have seen their financial credit system crumble. According to U.C. Berkeley economist Martha Olney, the root cause of this crisis was the millions of subprime mortgages that went into default over the past few years, when monthly payments rose to unaffordable levels. This resulted in a glut of homes on the market, which decreased housing values. Decreased housing values created a crisis of epidemic proportions, as those who had borrowed against the value of their home suddenly found themselves “underwater” – as the market value of their house was less than what they owed on paper.

One of the first signs of crisis dates back to June 2007, when two hedge funds managed by investment bank Bear Stearns collapsed. (Mortgage-backed securities — comprised of bundles of sliced-up mortgages — were sold on Wall Street to individuals and institutions as investments). Bear Stearns’ funds failed due to its heavy investment in subprime mortgages.

By March 2008, it was evident that the crisis had reached a systemic level, when the U.S. Federal Reserve saved Bear Stearns from collapse by taking on $30 billion of its financial liabilities, and selling the rest to JP Morgan. In September, dominoes fell in full force, with the Federal Reserve first rescuing mortgage giants Fannie Mae and Freddie Mac, and AIG Insurance. Shortly thereafter, a whirlwind of takeovers took place among the nation’s largest banks, as Lehman Brothers declared bankruptcy, Merrill Lynch was taken over by Bank of America, and Washington Mutual was taken over by JP Morgan. Such consolidation will lead to greater regulation of the industry. As U.C. Berkeley business professor Jim Wilcox explained to the Los Angeles Times, “The organizing principle is that if an institution is big enough to pose a risk to the overall system, it may need to be subject to federal regulation.” In addition, Americans will find it much more difficult to access credit, which will result in lower consumer spending.

The effects of this crisis have also had a serious ripple effect on the global financial system, as banks around the world also held bad investments in American funds. Across Europe, Britain, Germany, Belgium, and the Netherlands all took steps to rescue banks and mortgage lenders in recent weeks.  The mass bailouts have lowered consumer and investor confidence around the world, creating plunges in the American, Asian, and European stock markets. 

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