The fault lines of the 2008-2009 crisis extended to the 1990s. At that time the economy appeared to have recovered from the recession that began in 1973. But while the stock market soared, wages lagged far behind. Consumers, reasoning that the Cold War was over and the economy healthy, went on a spending spree. Within a decade their savings were gone. By 2005, for the first time since the Great Depression, the American people spent more than they earned. Mostly they bought houses. But how, without savings, could they afford down payments? Politicians, bankers, and financial “wizards” had devised several solutions. In 2002 President George W. Bush declared that the government should “encourage folks to own their own home.”
Homeowners, he believed, were more responsible citizens than renters. Democrats, too, regarded home ownership as a crucial step out of poverty. Leaders in both parties advocated easier lending requirements and prodded the huge federally owned mortgage companies to issue more mortgages. Private mortgage companies followed suit. They reasoned that as house prices increased, the ability of homeowners to repay loans mattered less: A repossessed house could be sold for more than the original mortgage loan.
Granted easier credit, millions of Americans for the first time bought homes. In 1994, 64 percent of U. S. families owned homes; by 2004, the percentage had increased to 69 percent, the highest ever. Housing prices soared. Many homeowners bought bigger ones—“McMansions,” in the slang of the day. By 2008, one in every five new houses had three or more garages.
Soon banks and mortgage companies had exhausted their capital. Large international investment banks such as Goldman Sachs, Lehman Brothers, and
All of the homes in this new neighborhood of Brentwood, California are for sale, evidence of the collapse of the mortgage market in 2008-2009.
Bear Stearns more than filled the void. They bought tens of thousands of mortgages from the original banks and lending institutions. Lending banks used this revenue to loan out more mortgages—thereby generating more profits (and bonuses). International investment firms chopped up the mortgages like sausages, clumped them into complicated investment bundles, and sold the bundles to investors worldwide. Credit-rating companies, such as Moody’s and Standard
And Poor’s, pronounced the bundles to be sound investments. And many investors bought insurance from the American Insurance Group (AIG) to protect them if the bundles somehow went bad. AIG, perceiving little risk, failed to set aside much money to cover potential losses.
By late 2008, however, millions of homeowners were swamped with bills they could not pay. Total household debt in the United States exceeded
Table 32.1 Causes of the 2008-2009 Financial Crisis
Consumers exhaust savings to buy houses
The president and Congress call on federally owned mortgage companies to relax lending requirements Global investment bankers devise complicated bundles of mortgages and market them globally Credit-rating agencies grade these mortgage investments as solid and AIG insures them Lending banks issue mortgages greatly in excess of available reserves Millions of homeowners fall into debt and cannot make mortgage payments
Collapse of mortgage investments brings down investment banks
Capital evaporates, leading to layoffs and threatening a second Great Depression
$14.5 trillion—twenty times more than in 1974. Nearly 10 percent of all American mortgages were delinquent or in foreclosure. Goldman Sachs quietly placed bets that the mortgage bundles it had mass-marketed would lose their value!
Investors suddenly caught on and dumped their mortgage bundles. Panic selling hit financial markets worldwide. Almost overnight, Bear Stearns collapsed and Lehman Brothers went bankrupt. The Dow Jones Industrial Average plunged from over 14,000 to under 9,000; stocks lost $8 trillion. Pension funds, corporate reserves, and personal accounts for retirement and college education lost one-third of their value. AIG, swamped with claims, neared bankruptcy. Its failure would take down many of the world’s major banks and investment firms.
Nearly all banks and investment houses ran low on capital; many struggled to stave off bankruptcy. Few could make new loans. But most businesses, hospitals, schools, state and municipal governments relied on short-term loans, which were repaid as revenues came in. In the absence of these customary loans, few employers could pay bills or cover payrolls. A global calamity loomed.
In the final months of 2008, Bush and his chief financial advisers raced to avert catastrophe. Ben Bernanke, head of the Federal Reserve and a scholar of the Great Depression, pleaded with Congress to authorize over $700 billion to buy up the “toxic” mortgage bundles, an indirect way of preserving the banks and global investment firms that had issued them. He also proposed to pump hundreds of billions directly into Goldman Sachs, AIG, and scores of other investment banks. Such companies, he warned, were “too big to fail.” Congress seethed at using taxpayers’ money to bail out avaricious corporate executives; but political leaders could not risk a second Great Depression. Congress passed the emergency bail-out bills with few modifications.
World History
