The 2008 global financial crisis happened in no small part because US banks sold portfolios of debt that they had issued to US consumers to investment bank clients who did not understand the risk in those portfolios, and subsequently discovered that the supposed AAA debt they had acquired was nothing of the sort, and banking balance sheets collapsed as a result all over the world.
The AAA tranches were good. Near none of them failed. That the banks were putting the C – the equity – tranches in their own books financed with massive leverage is what caused the problem. Because slicing and dicing loan pools actually worked – the equity tranches went bust first and protected the synthetic AAA tranches from default even as the underlying mortgages went kablooie.
Spud’s got 2008 wholly and entirely the wrong way around.
Now there’s a surprise, eh?
Maybe not the straightforward early securisations, but quite a few AAA tranches failed in bollocks like CDOs and CDO².
Maybe politicians telling the banking industry who they should be lending money too didn’t help…..
I seem to remember that there had to be a massive bail out of Fannie Mae & Freddie Mac.
Politicians in there wisdom, forced them to relax their lending criteria which moved things along the risk curve. Republicans liked it as it expanded the home – owning classes, Dems liked it as it allowed a lot of minorites to buy houses that they wouldn’t otherwise have been able to afford.
What could possibly go wrong?
Some Republicans tried to reign in the sub prime loans within Fannie and Freddie, I believe around the 2000 mark, but as you say, probably plenty on both sides making out of it so on it continued. Until it didn’t.
The Republicans were dreaming.
Yes, home owners tended to vote R. But expanding the home owners doesn’t translate into more R votes, because causation is the other way around.
The people who vote R are the ones who saved up for a house. Basically giving people a house doesn’t change their habits of thought.
Wasn’t the very first collapse that of the Insurer(s) who insured these bundled securities at (what turned out to be) prices way below the risk level, so when the first shortfalls in payment occurred, the insurance companies suddenly found that they had claims way in excess of their assets (including any re-insurance). That collapse immediately put a lot more securities at risk as they now lacked any insurance. There was quite a lot of uninformed buying of these “high yield” investments based on the premise that even if some were based on a lot of rather dodgy loans, they were rated much higher because of the insured aspect. And nobody looked at the basis for the confidence in the insurers. I understand that brokers and management at the insurers made a shed load of money for a couple of years selling the cover, and the smart ones got out early with the money. I have a vague recollection that a company called American Insurance was the first to go ?
As ever, slightly more complex.
So, it was CDS. Which is a mark to market contract. So it’s like inurance, yes, but it’s really a derivative. And so if your position is losing money then you’ve got to put up that amount that you’ve lost. Equally, your winning contracts pay you money. You don;t actually lose the money until the end of the contract – but you’ve got to put it up while you’re loising.
Except if you’ve an AAA credit rating. Then you’re just good for your losses.
So AIG had written lots of CDS. Lots were losing money. AIG had an AAA credit rating. Then the rating agencies ha a look a those losses and decided that AIG should have its credit rating down graded. Which meant they had to put up, in cash, all those losses. Nt lose them, not yet, but put up the cash against the losing positions. Hundereds of billions, right now.
Which they couldn’t and thus……
If they’d had to put up the cash margin all along they’d not have got in so deep. Today you put up margin whatever your credit rating…..
Pretty sure there was also mis-rating of risk, because they assumed the CDS (not sure how you pluralize those) were uncorrelated. Which they weren’t.
Also because some of the New York bankers did not realise that some of the mortgages were “non-recourse loans” – i.e. that the borrower had no liability beyond the house on which they were secured.