The 2008 Financial Crisis: Crash Course Economics #12


Jacob: Welcome to Crash Course Economics.
My name is Jacob Clifford. Adrienne: And I’m Adrienne Hill. And today
we’re going to do something a little different. We’re going to explore one moment in history
in depth. We’re going to talk about how the 2008 Financial Crisis happened and the government
response to it in the United States. Jacob: So let’s get started. [Theme Music] Jacob: The 2008 Financial Crisis was a big
deal. Ben Bernanke said it could have resulted in a 1930s style global financial and economic
meltdown with catastrophic implications. But what happened? Why did it happen? And why
aren’t we all huddled around burning trash cans forming a raiding party to go steal gas
from other tribes in the wasteland? By the way, if you’re actually doing that,
you probably didn’t hear we survived the financial crisis. Things got better. Seriously. Put
down your crossbows. Adrienne: To explain what happened, first
we have to do a quick explainer about mortgages. And you might already know this, but basically
someone that wants to buy a house will often borrow hundreds of thousands of dollars from
a bank. In return, the bank gets a piece of paper, called a mortgage. Every month, the homeowner has to pay back
a portion of the principle, plus interest, to whomever holds the piece of paper. If they
stop paying, that’s called a default. And whomever holds that piece of paper gets the
house. The reason I’m saying whomever holds the paper,
rather than the bank, is because the bank, the original lender, often sells that mortgage
to some third party. And the reason I say often is because this happens all the time.
I’ve had my house for nine months, and three different banks have had the mortgage. Traditionally, it was pretty hard to get a
mortgage if you had bad credit or didn’t have a steady job. Lenders just didn’t want to
take the risk that you might “default” on your loan, but all that started to change
in the 2000s. And before we go further, a quick aside here.
The story gets complicated fast, and it’s a fascinating story. But we’re trying to keep
it relatively simple. So, I’ve asked Stan if we could put some additional resources in the YouTube
description. And Stan said “Yes.” Thanks Stan! Anyway, back to our story. In the 2000s, investors
in the U.S. and abroad looking for a low risk, high return investment started throwing their
money at the U.S. housing market. The thinking was they could get a better return from the
interest rates home owners paid on mortgages, than they could by investing in things like Treasury
Bonds, which were paying very, very low interest. But big money, global investors didn’t want
to just buy up my mortgage, and Stan’s mortgage. It’s too much hassle to deal with us as individuals.
I mean, we’re pains. Instead, they bought investments called mortgage backed-securities.
Mortgage backed-securities are created when large financial institutions securitize mortgages.
Basically, they buy up thousands of individual mortgages, bundle them together, and sell
shares of that pool to investors. Investors gobbled these mortgage backed-securities
up. Again, they paid a higher rate of return than investors could get in other places and
they looked like really safe bets. For one, home prices were going up and up. So lenders
thought, worse case scenario, the borrower defaults on the mortgage, we can just sell
the house for more money. At the same time, credit ratings agencies
were telling investors these mortgage backed-securities were safe investments. They gave a lot of
these mortgage backed-securities AAA Ratings–the best of the best. And back when mortgages
were only for borrowers with good credit, mortgage debt was a good investment. Anyway, investors were desperate to buy more
and more and more of these securities. So, lenders did their best to help create more
of them. But to create more of them, they needed more mortgages. So lenders loosened
their standards and made loans to people with low income and poor credit. You’ll hear these
called sub-prime mortgages. Eventually, some institutions even started
using what are called predatory ending practices to generate mortgages. They made loans without
verifying income and offered absurd, adjustable rate mortgages with payments people could afford
at first, but quickly ballooned beyond their means. But these new sub-prime lending practices
were brand new. That meant credit agencies could still point to historical data that
indicated mortgage debt was a safe bet. But it wasn’t. These investments were becoming
less and less safe all the time. But investors trusted the ratings, and kept
pouring in their money. Traders also started selling an even riskier
product, called collateralized debt obligations, or CDOs. And again, some of these investments
were given the highest credit ratings from the ratings agencies, even though many of
them were made up of these incredibly risky loans. While, the investors and traders and bankers
were throwing money into the U.S. housing market, the U.S. price of homes was going
up and up and up. The new lax lending requirements and low interest rates drove housing prices
higher, which only made the mortgage backed securities and CDOs seem like an even better
investment. If the borrowers defaulted, the bank would still have this super valuable house, right?
No. Wrong. Let’s go to the Thought Bubble. Actually, let’s go to the Housing Bubble.
You remember bubbles, right? Rapid increases, driven by irrational decisions. Well, this
was a bubble, and bubbles have an annoying tendency to burst. And this one did. People
just couldn’t pay for their incredibly expensive houses, or keep up with their ballooning mortgage
payments. Borrowers started defaulting, which put more
houses back on the market for sale. But there weren’t buyers. So supply was up, demand was
down, and home prices started collapsing. As prices fell, some borrowers suddenly had
a mortgage for way more than their home was currently worth. Some stopped paying. That
led to more defaults, pushing prices down further. As this was happening, the big financial institutions
stopped buying sub-prime mortgages and sub-prime lenders were getting stuck with bad loans.
By 2007, some really big lenders had declared bankruptcy. The problems spread to the big
investors, who’d poured money into these mortgage backed securities and CDOs. And they started
losing money on their investments. A bunch of money. But wait. There’s more. There was another financial instrument that
financial institutions had on their books that exacerbated all of these problems–unregulated,
over-the-counter derivatives, including something called credit default swaps, that were basically
sold as insurance against mortgage backed securities. Does AIG ring a bell? It sold tens of millions
of dollars of these insurance policies, without money to back them up when things went wrong.
And as we mentioned, things went terribly wrong. These credit default swaps were also
turned into other securities — that essentially allowed traders to bet huge amounts of money on whether
the values of mortgage securities would go up or down. All these bets, these financial instruments,
resulted in an incredibly complicated web of assets, liabilities, and risks. So that
when things went bad, they went bad for the entire financial system. Thanks Thought Bubble. Some major financial players declared bankruptcy,
like Lehman Brothers. Others were forced into mergers, or needed to be bailed out by the
government. No one knew exactly how bad the balance sheets at some of these financial
institutions really were–these complicated, unregulated assets made it hard to tell. Panic set in. Trading and the credit markets
froze. The stock market crashed. And the U.S. economy suddenly found itself in a disastrous
recession. Jacob: So what did the government do? Well,
it did a lot. The Federal Reserve stepped in and offered to make emergency loans to
banks. The idea was to prevent fundamentally sound banks from collapsing just because their
lenders were panicking. The government enacted a program called TARP, the troubled assets
relief program, and which the rest of us call the bank bailout. This initially earmarked
$700 billion to shore up the banks. It actually ended up spending $250 billion bailing out
the banks, and was later expanded to help auto makers, AIG, and homeowners. In combination with lending by The Fed, this
helped stop the cascade of panic in the financial system. The treasury also conducted stress
tests on the largest Wall Street banks. Government accountants swarmed over bank balance sheets
and publicly announced which ones were sound and which ones needed to raise more money.
This eliminated some of the uncertainties that had paralyzed lending among institutions. Congress also passed a huge stimulus package
in January 2009. This pumped over $800 billion into the economy, through new spending and
tax cuts. This helped slow the free fall of spending, output and employment. Adrienne: In 2010, Congress passed a financial
reform, called the Dodd-Frank law. It took steps to increase transparency and prevent
banks from taking on so much risk. Dodd-Frank did a lot of things. It set up a consumer
protection bureau to reduce predatory lending. It required that financial derivatives be
traded in exchanges that all market participants can observe. And it put mechanisms in place for
large banks to fail in a controlled predictable manor. But, there’s no consensus on whether this
regulation is enough to prevent future crises. Jacob: So, what have we learned from all this?
Well, one key factor that led to the 2008 financial crisis was perverse incentives.
A perverse incentive is when a policy ends up having a negative effect, opposite of what
was intended. Like, mortgages brokers got bonuses for lending out more money, but that encouraged
them to make risky loans, which hurt profits in the end. That leads us to moral hazard. This is when
one person takes on more risk, because someone else bears the burden of that risk. Banks and lenders
were willing to lend to sub-prime borrowers because they planned to sell mortgages to somebody else.
Everyone thought they could pass the risk up the line. The phrase “too big to fail” is a perfect example
of moral hazard. If banks know that they’re going to be bailed out by the government, they
have incentive to make risky, or perhaps unwise bets. Former Fed Chairman, Alan Greenspan
summed it up really nicely when he said, “If they’re too big to fail, they’re too big.” Adrienne: When something terrible happens,
people naturally look for someone to blame. In the case of the 2008 financial crisis,
no one had to look very far because the blame and the pain was spread throughout
the U.S. economy. The government failed to regulate and supervise
the financial system. To quote the bi-partisan, financial crisis inquiry commission report,
“the sentries were not at their posts, in no small part due to the widely accepted faith
in the self-correcting nature of the markets, and the ability of financial institutions
to effectively police themselves.” The report placed some of the blame on the
years of deregulation in the financial industry. And blamed regulators themselves for not doing
more. The financial industry failed. Everyone in the system was borrowing too much money
and taking too much risk, from the big financial institutions to individual borrowers. The
institutions were taking on huge debt loads to invest in risky assets. And huge numbers of home
owners were taking on mortgages they couldn’t afford. But the thing to remember about this massive
systemic failure, is that it happened in a system made up of humans, with human failing.
Some didn’t understand what was happening. Some willfully ignored the problems. And some
were simply unethical, motivated by the massive amounts of money involved. I think we should give the last word today
to the financial crisis inquiry commission report. To paraphrase Shakespeare, they wrote,
“The fault lies not in the stars, but in us.” Thanks for watching. Crash Course Economics is made with the help
of all of these nice people. We’re able to stave off our own financial crisis each month,
thanks to your support at Patreon. You can help keep Crash Course free for everyone,
forever, and get great rewards at patreon.com. And given today’s subject, be exuberant, but
keep it rational.

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Comments

  1. Should have never done the bailouts, should have let the Ship sink… not moral to steal Tax payers money… And to have intrest rates low so low in the first place…

  2. Another cause not mentioned is the commodities super cycle going on at the same time, along with banks betting on mortgages they also bet on commodities continuing to go up. This worked for awhile but eventually prices got so high people couldn't afford basic goods and had to make choices on what bills to pay, many choose to fill their car up with $4 gas to continue going to their job instead of paying their mortgage.

  3. This is what scares me. There is not one cause to blame, but many, and the fingers are being pointed everywhere from what I've been learning. It's almost like it's too complex to prevent when the issues are multifactorial, but at least we are able to prevent it from going too far? I also wonder if that is also outside of our scope in certain circumstances and the 2008 recession was lucky being contained. Well, there's apparently a cycle that is occurring (current yield curve is giving pause), so I guess we'll see, lol.

  4. If you aren't angry about the 1% then you don't understand. 3 trillion up in smoke 6 million left homeless and then the little guy pays the mega rich huge bonuses for destroying the economy.

  5. It's only been 10 years, and the Congress has already rolled back some of the protections of Dodd-frank. Stand by, another major crash is coming.

  6. People… the great recession was not the fault of banks, the government caused it. Misguided affirmative action-type government policy lead to the crisis.

    Ask this: why were banks lending subprime mortgages?

    Here's why:

    Back in the 1980s and 1990s the political discourse was a lot about the fact that, for the inner city and ethnic minority groups:
    1. mortgage origination rate was the lowest
    2. the mortgage denial rate was the highest

    Research by academics during the period concluded that the reason behind this was racism and discrimination.

    The financial sector explained that these groups had:
    1. the lowest credit scores
    2. highest default and delinquency rates
    3. less likely to have life savings
    4. have the highest levels of unemployment.

    …….. as the explanation for that reality.

    The government then started an initiative – I think under the housing and development Act probably – to use a sort of affirmative action to help those Americans have the American dream of owning a home.

    Fannie Mae and Freddie Mac were set up way before to provide liquidity in the housing market and were meant to compete with each other to improve their efficiency.

    These government sponsored entities were mandated to make the dream happen in the government's plan.

    How?

    Banks were asked to provide mortgages to these subprime borrowers. The plan was that these loans would then be secularized and sold off to Fannie and Freddie.

    The whole scheme was backed by the US government's guarantee.

    This then caused the banks to start lending mortgages like there was no tomorrow.

    During this time period, regulations (glass-Steagal) preventing banks holding derivatives on their balance sheets were rolled back.

    This opened the door for wall street to get in on the action. The financial industry from wall street to London invested in these mortgage-backed securities.

    Why?

    THEY WERE GUARANTEED BY THE US GOVERNMENT…..!!!!!!!

    This is why they all got tipple A ratings, these assets were as good as gold due to the US government guarantee.

    The thing spread like wildfire throughout the world… after all, the US is the global safe haven for investment, as an added bonus the US government backs the underlying assets to these securities.

    China is said to have lost 5 times as much as American banks during the crisis.

    Here's the thing, the HUD did not have regulatory oversight of Fannie and Freddie and its head went to Congress to complain and warn about the dangers inherent to what was happening.

    … that video is now missing from YouTube

    The man was berated for attacking a system that was working. They just stopped short of calling him a racist.

    Here's where it climaxed, when the resulting bubble burst in 2007/8, the government was MIA on their guarantee. They then shifted blame to the banks and their greed. Bailed out some that were too integrated into the global system for them to fail and not destroy the western way of life.

    The narrative was set, nothing of the seminal role of government policy was ever mentioned in any of the coverage.

  7. I have a feeling that something much worse is right around the corner, worse than Great Depression and 2008 Financial Crisis.

  8. Most borrowers for home loans never had good credit and still don't today.
    Banks were giving loans to people in the 90s with no job.

    And this 2000 banking problems and housing bubble. Is the same that happened in the 1980s.

  9. The BIG question is : Who approved lowering government regulated lending guidelines ? CLUE: It happened during the Clinton Presidency.

  10. This just sounds like a whole lot of greed, and at the same time the banks knew that the government would have to step in and fix it for them if their subprime mortgage loans didn't work out. greed greed greed

  11. @4:00 Thanks for making this excellent point! Professionals referenced historical data to validate their current decisions, but the economic practices were changing faster than people kept up with, thus financial decisions superficially endorsed by history lacked an assessment of contemporary context, and mob mentality did the rest (even if you noticed this was wrong, could everyone be this wrong? So people doubted themselves). This happens across all aspects of society – not just economics, for all 'professionals' – not just economists.

    One of the most ubiquitous lessons history has taught us: beware of false equivalencies.

  12. Mentions predatory lending, blames victims for borrowing to much, 😂 barely mentions AIG who was the biggest at fault player, this video is stuoid, this channel sux

  13. Moral of the story dont take out loans unless you are able to pay it back and quit blaming the bankers and the rich for being greedy becuase the real greedy people are those who get loans becuase they arent satisfy with what they got

  14. Wow! Great job skipping the fact that the federal government promised to back these sub prime mortgages, and that federal reserve artificially lowered the interest rates which sent false signals to borrowers.

  15. I was working for progressive lighting for 5 year around that time, they laid alot of people off including me because nobody was buying any homes lightning and fixtures

  16. It was a govt created problem.
    1. Community reinvestment act in the 1970s said banks had to make loans to the community the serve. Well just because you have an account doesnt mean you wualify for a loan.

    2..glas steagle repealed.

    3. Civil rights groups pressured the congressional banking committee to loosen their standards. Which led to fannie mae and freddie mac to buy dubprime loans. And here we are. Snd the people they tried to help lost anyway and they cried racism.

  17. Oh wow I get the impression that economic booms happen after economic "slowdowns" , apparently though this is not the case anymore.
    Get ready folks one dollar stores and liberal printage of money won't save this shitty system much longer.

  18. You should do another video of what to expect like the water and utilities may shut off. Greg Hunter, Bo Pony, Greg Manarino, Itm expecting the grandfather of all economic collapses this year 2019.

  19. don't get in debt damn it, it is easy, just a bit of patience is better than 20 years of headache< only get loans when it is a life or death matter.

  20. @8:45 Perverse Incentive is what got Wells Fargo in trouble last year with signing people up for credit cards without their knowledge, HUUUGE lawsuit

  21. The market was in the process of correcting itself, and then the government stepped in and bailed them out w/ tax payer money. The market didn't fail us, the government did by allowing those assholes to continue doing business.

  22. And now here's Trump and the Republican Party to Get Rid of those protections so the Super Greedy can rise again.

  23. Government was most responsible for the crash. It was Congress that forced banks into making bad loans with accusations of racism and threats against bank expansion plans. It was the Federal gov't that required only 4 specific rating agencies to supply ratings to mortgage-backed securities and CDOs; rating agencies which were in competition over Wall Street firms creating the securities and given no government instructions on how the ratings would be accomplished. It was government requirement that these exotic securities be valued at mark-to-market despite the fact that the underlying assets for the securities were real estate which is traditionally valued at book value and not market value until it is actually sold. Additionally, CRA, the community reinvestment act was put on steroids by President Clinton. On and on, it was government rules, regulations, and market influences, government fingers on the economic scales, that caused that crash. Remember, it all started with the subprime loans marketed by the GSEs, government sponsored enterprises such as Fannie Mae and Freddie MAC that got this train running towards ruin.

  24. No real words on the absolute fraud that occurred by many and no words that said no one went to jail over all this fraud,,, Compare all this the the 1980s, when rebumpins were in charge again, and the S&L crisis happened and several hundred people went to jail over their fraud,,, 2007, no one went to jail,,,

    America, sorry, but many of you are ignorant at best and many of you are just stupid, PERIOD

  25. Would you put your credit card number and your ssn online with a message saying dont use it and expect people to listen or better frame As president do you give banks full access to America's wallet and expect them not to retire early with money hidden overseas because they can.

  26. Institutions didn't "just start"…..lending money to subprime…in fact they rejected the idea as BAD business…..you don't loan money to someone which will not pay it back….Jimmy Carter, Bill Clinton, Obama ( lawyer for ACORN )….etc….were the prime reasons….Jimmy I let off the hook as he "meant well"….but it was Bill that kicked this can down the road……and it has and will cost us taxpayers over a trillion dollars…

  27. and now we have stopped stress tests and also reversed the dodd-frank law… keeping my money in cash to short the next crash XD

  28. They were very sneaky about it put the word "ninja" in the loan description, which the literal translation from Japanese is assassin so the banks decided to give out assassin lons 😂 what? what some of these people might not be qualified? " just don't look at the paperwork" ok that works ! " is it okay this guy put Street pharmacist as in job description? " best not to think about it bro! "Ok that works!" This stripper wants five houses can we do it? Sure just have her put down "emotional therapist" as their job description! Ok this economy is on fire we're going to sell a million houses this year! "Is this normal? How much did the loan office Selling Houses in the previous five years ? I think like 20 thousand? Gee how did we get so much capital investment to cover all these loans? " we didn't! "What!" Can you tell me why this person who was previously a Pizza Boys all of a sudden a loan underwriter and asking intelligent questions based on sound economic information and advice ? ….. And leading up to 2008 crisis this did not happen, what happened was a series of bro chest bumping and fist-bumping to the sounds of their Banger like commission checks every week and month where they spent the majority of the money on cocaine strippers and booze had no budget no savings plan or solid investment strategy, just a year after the crisis the same banger loan Underwriters they thought themselves Masters of the Universe found themselves working at Wendy's and McDonald's what would sadly lament to the 16 year old kids standing next to them behind the counter of Mcyee D's where once paid more money than their dads did their whole year in one week where they would just point and laugh at them and say Yeah Right loser !

  29. no mention of who is to Blame and what happened to the average person!! and who benefited from the government support… A scam video …

  30. THE BORROWERS LOST VALUE AND HAD TO SELL OUT. THE RECEIVER BANKS THEN, REFUSED TO SAY THERE WAS A LOSS

  31. In a nut shell politicians got rid of the regulations that make banks act responsibly. Wham, the consumer gets screwed, and then Uncle Sam gives millions of our tax dollars to the banks to bail them out. Double whammy, consumer gets screwed again, meanwhile we got nothing. Banks either made money or broke even while the end user paid the ultimate price, like me. We paid 143k in April 07 and by the end of the year our house was valued at 68k. Ten years later only raised to 86k. trump is getting rid of the bank regulations again, go figure.

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  33. I came out of this with a lot of money LMAO. I was 18 at the time an had a well paying job. I invested it in the stock market do to I wasn't good at saving an the stock market all around was low. Now like 11 years later I can retire if I what'd to. Note I am single so it's not like I have a family to take care of but I made out great.

  34. Please make subtitle in indonesiaa… this channel so help me to improve my self. Subtitle indonesia just available ini 1st-2nd episode. For the next episode nothing subt in indonesian. Im so sad.

  35. They should make it punishable by law the group of people who should have screamed STOP when they knew that something wasn't right. And even bigger punishment to those group of people who should have regulated the whole process but did nothing but sit down and wait for everything to blow up.

  36. Sounds very much like Australia right now. Sadly our Goverment plus the Banks are only selling to the people right now that's it's a Great time to buy (Safe as house's). Lot's of heartache, pain & blood in the streets to come.

  37. rating agency were involved in ensuring these mortgage backed asset as AAA.. When it was subprimed. And aig London ceo was involved in credit default swap, who was fired in 2008

  38. Hey it would be very helpful if someone tells me the exact role of the Federal Reserve system in the crisis

  39. This happened before 2008 because people were complaining about president Obama's selecting these crooks into his administration,but suppossingly because of their expertise they were reelected into the Obama administration,Then they finance the crooks and gave them millions of dollars annual fees even to the ones that had to retire because of their criminal activity.The federal Reserve printed the money for them,I assume this what you call residual income,let your money work for you 24 7 even while you sleep.

  40. We didn't used to see rough-sleepers in my home town and now there are many. The crash is still affecting us, it's very sad. Banks do whatever they want and then they get bailed out by the hard working ordinary people… it's so messed up. I wonder how long till the next crash??

  41. they sold 99 cent 2X4 built houses like candy to people that didn't know that the house only cost $8,000 to build we use to build um & the banks would sell um to a Mexican boarder jumpers that couldn't even speak English. these people eat um up. they would pay ah $120 thousand 4 um plus interest.

  42. The very crux of the problem is why did people stop buying houses? I lived through this and this is really the reason. You won’t hear this on The Big Short or anywhere. Lower lax lending requirements and lower interest rates drove the markets higher.

    The main reason people quit buying houses was because of the following:
    1. Ballon mortgages were extremely popular. In these mortgages the payment is extremely low for 1-5 years because you only pay on the interest. But then they readjust to prime rate plus something. This type of loan literally allowed the borrower of a million dollar mortgage to pay 2k/ month payment.
    2. Interest rates were lowered by the fed and requirements to qualify lowered because the demand became greater for more housing debt instruments and the housing market was at a saturation point.
    3. When the fed finally began to raise interest rates the ballon/ interest only mortgages were at the point of coming due for their balloon refinance. They readjusted to a much higher prime rate. The borrowers had to refinance against the mortgage balance not just the interest only. This caused many many people to walk away from their mortgage because they could not refinance because their loan to value ratio made it so upside down the bank wouldn’t refinance, so they walked away and gave the bank the house. People literally had 1million dollar houses financed but would only appraise out at 250k. It made more sense to walk away.

  43. This is inaccurate in several critical and important ways.

    1) Mortgages have been securitized for almost 100 years
    2) AIG wasn't in the CDS business. They provided insurance wraps to mortgage pools and other asset backed securities (that is a technical distinction). Credit default swaps are one of the oldest derivative instruments traded today, used by banks for over 100 years.
    3) Home prices and mortgage levels ballooned due to reductions in lending standards first in GSE lenders like Fannie Mae in the late 90's. Ballooning home prices which started from poor lending standards from agencies with an implied government guarantee pushed underwriting standards down all the way down stream and drove up the price of homes. The repeal of Glass Steagal also compounded the problem, also in the late 90's.
    3) The Federal Reserve pushed interest rates too low for too long in response to temporary economic shocks and benign recessions starting again in the late 90's and artificially low interest rates push home prices higher along with lots of other things.

    Key takeaways:

    1) The lack of mortgage regulation (an express federal government policy implemented in the 90's and continued in the early 2000's to increase home ownership rates) caused lending standards to decline first in GSE's and then downstream in private lenders.

    2) Dangerous monetary policies holding interest rates too low for too long exacerbated the problem.

    3) The end of Glass Steagal which prevented commercial lenders from merging with investment banks gave rise to too much leverage in the financial system creating systemic risk in major financial institutions, in turn triggering government bailouts and artificially low interest rates… Which reinflated an overinflated housing market… Cause, you know, we'll get it right this time…

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