How did the 2008 financial crisis happen
Excess capital chasing few good borrowers: Following the dotcom crash, an excess of money started flowing into US bonds (with no other suitable investment) leading many lenders to look for risky borrowers to park their cash. Financial Innovation: The nature of bank lending changed substantially with new financial technology that allowed lenders to aggregate the risky loans and pass them off like hot potatoes. Credit raters get in the game: The new types of investments entered the market and due to
- Proprietary trading: Since the early 1990s, Wall Street Investment banks changed substantially (partly due to their IPOs), changing their focus from their traditional business of helping manage other's investments to actively trading on their own.
- Commercial banks get in the game: In 1999, the Glass–Steagall Legislation was repealed, paving way for big banks such as Citi & JPM to play actively in Wall Street. Until that time, banks that got public deposits were barred from trading in the markets.
- Drastic interest rate cuts: Following the 2001 recession, the US Federal reserve substantially cut interest rates, allowing home buyers to borrow at absurdly low interest rates.
competitive pressure the credit rating agencies fight hard to provide an optimistic outlook to risky loans. Quant guys get in the game: Investing used to be a game of judgment & reasoning, but were getting reduced to math equations that completely stripped off the psychological element of markets. Risk equations assumed failures were all independent while they turned out otherwise. Home prices rocket: With low interest rates and people available to lend to risky borrowers, everyone bought a home and prices skyrocketed in a sort of spiralling reaction. An emperor with no clothes: Beginning in August 2007, smart money began to realize that the whole market was built on shallow foundation, and the game started to reverse. September 15, 2008: Fed & US Treasury let Lehman Brothers go into bankruptcy, leading to widespread panic among the "dumb money," leading to a massive market crash.
During the week of the 2008 crash, I was interviewing at various Wall Street banks and it was a really crazy & giddy time. I bought a huge amount of SKF calls and sold SKF puts the weeks before that to save myself from the crisis.
Category: Personal Finance
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