The 2008 Financial Crisis in 12 Minutes (Casual Economics) — Transcript

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1. 0:00The 2008 financial crisis was the worst
2. 0:03economic disaster in living memory. Its
3. 0:06speed and impact unmatched since the
4. 0:08Great Depression. In the early 2000s,
5. 0:10people were buying homes at a record
6. 0:12pace. You didn't even need a job to get
7. 0:15a mortgage, just a pulse. Then, almost
8. 0:18overnight, the music stopped. Nearly $19
9. 0:21trillion in household wealth evaporated.
10. 0:24Unemployment hit 10% and half the stock
11. 0:27market's value vanished. But what
12. 0:29exactly went wrong and how could such a
13. 0:31disaster happen in modern times? Let's
14. 0:34rewind to how a booming housing market
15. 0:36nearly destroyed the global economy. The
16. 0:38year is 2000. The dotcom bubble has just
17. 0:41burst and the US economy is slowing. To
18. 0:45revive growth, the Federal Reserve cut
19. 0:47interest rates 11 times to 1.75%,
20. 0:50the lowest in 40 years. By the early
21. 0:532000s, the US government was determined
22. 0:55to expand home ownership, even pushing
23. 0:58legislation requiring mortgage giants
24. 1:00Fanny May and Freddy Mack bought more
25. 1:02loans for lower income buyers.
26. 1:05Fueled by low interest rates and pro
27. 1:07homeownership policies, the housing
28. 1:09market boomed. Home ownership hit a
29. 1:11record 69% in 2004, and lending
30. 1:15standards kept loosening to keep
31. 1:17mortgages flowing. Lenders started
32. 1:19writing subprime mortgages for borrowers
33. 1:21with bad or no credit. Some were the
34. 1:24infamous ninja loans. No income, no job,
35. 1:27no assets. I lost my job. I'm looking
36. 1:30for a small loan to pay my rent for the
37. 1:32month. Perfect. You're approved for
38. 1:35$600,000 and a second home. Hold on. How
39. 1:38was any of this legal? After the Great
40. 1:41Depression, strict regulations kept
41. 1:43banks in check. But over time, a
42. 1:45parallel shadow banking system emerged
43. 1:48outside those rules. Investment banks
44. 1:50and other unregulated players took on
45. 1:52bank-like roles without oversight or
46. 1:55safety nets. They took huge risks with
47. 1:57complex bets and high leverage, and no
48. 2:00one was watching. In April 2004, the SEC
49. 2:04loosened the net capital rule, which had
50. 2:07been limiting these investment banks to
51. 2:09a 12:1 leverage ratio of debt to
52. 2:11equities. With these new changes, any
53. 2:14investment bank with over $5 billion in
54. 2:16assets could now leverage itself an
55. 2:18unlimited number of times. At the time,
56. 2:21the belief was that these banks could
57. 2:22internally manage risk better than any
58. 2:25rulebook could. A fatal mistake. In
59. 2:28fact, banks didn't care about risk
60. 2:30because they weren't holding on to these
61. 2:32loans. They bundled them into
62. 2:33mortgagebacked securities, MBS, and
63. 2:36collateralized debt obligations, CDOS.
64. 2:39Meanwhile, the credit rating agencies
65. 2:41relied on flawed risk models and were
66. 2:43paid by the investment banks that had
67. 2:45created the CDOS's. This feedback loop
68. 2:48resulted in agencies giving AAA ratings
69. 2:50on bundles of loans that were basically
70. 2:52junk. Wall Street was hooked on the
71. 2:55fees. Subprime lenders kept making risky
72. 2:57loans. Banks kept packaging and
73. 2:59reselling them, and investors kept
74. 3:01snapping them up. Everyone was making
75. 3:04money. The logic of the system was that
76. 3:06if you spread out enough risk, it
77. 3:08disappears. The reality was that if you
78. 3:10spread out enough garbage, the smell
79. 3:12just takes longer to notice. Soon
80. 3:15enough, as those garbage loans piled up,
81. 3:18the whole neighborhood started to stink.
82. 3:20The housing frenzy hit its peak in 2005.
83. 3:24Subprime loans swelled to nearly 20% of
84. 3:26new mortgages. Interestonly mortgages
85. 3:29became common, letting borrowers live
86. 3:31beyond their means. Meanwhile, global
87. 3:33investors couldn't get enough of
88. 3:35anything tied to US real estate, long
89. 3:37considered one of the world's safest
90. 3:39assets. On the surface, it seemed like
91. 3:41the money fountain would never stop
92. 3:43flowing. But underneath, small cracks
93. 3:46were starting to form. And soon,
94. 3:48everything would come crashing down.
95. 3:51By 2006, the US yield curve inverted, a
96. 3:55classic recession signal, and a growing
97. 3:57minority on Wall Street warned that the
98. 3:59housing boom was unsustainable. In 2007,
99. 4:03home prices peaked and then began to
100. 4:05fall. Suddenly, millions of borrowers
101. 4:08couldn't repay their loans and defaults
102. 4:10skyrocketed.
103. 4:12Those mortgagebacked securities and
104. 4:14CDOS's everyone was trading, well, they
105. 4:16turned out not to be safe as houses
106. 4:18after all. Banks, insurers, and pension
107. 4:21funds holding billions of dollars of
108. 4:23these assets began bleeding cash. In
109. 4:26early 2007, over two dozen subprime
110. 4:29lenders, including New Century and
111. 4:31Industry Juggernaut, went bust amid the
112. 4:33surge in defaults and foreclosures. In
113. 4:36mid 2007, two Bear Sterns hedge funds
114. 4:39imploded under the weight of bad
115. 4:40mortgage debts, sending shock waves
116. 4:42through Wall Street. Subprime loans made
117. 4:45up only 13% of all mortgages, but they
118. 4:48now accounted for about half of all
119. 4:50foreclosures. As panic spread, credit
120. 4:53markets went haywire. Bear Sterns froze
121. 4:55withdrawals and banks grew too afraid to
122. 4:58lend to each other. The Federal Reserve
123. 5:00stepped in with emergency moves, cutting
124. 5:02interest rates and injecting cash into
125. 5:04the system to keep money flowing. By
126. 5:06early 2008, the housing bust hit full
127. 5:09force. Roughly a quarter of subprime
128. 5:12mortgages had defaulted and millions of
129. 5:14homeowners went underwater, owing more
130. 5:17on their mortgages than their homes were
131. 5:18worth. Then in March 2008, Bear Sterns,
132. 5:22one of Wall Street's oldest investment
133. 5:24banks, neared collapse. In a lastditch
134. 5:27rescue, the Fed helped broker a fire
135. 5:29sale deal. JP Morgan Chase would buy
136. 5:31Bear Sterns for just $2 a share, later
137. 5:34raised to $10 with a $30 billion federal
138. 5:37guarantee to seal the deal. As the
139. 5:40crisis deepened, the US government
140. 5:42seized Fanny May and Freddy Mack on
141. 5:44September the 6th, 2008. These two
142. 5:47mortgage giants, responsible for about
143. 5:49half of all US home loans, were on the
144. 5:52verge of failure. So, the government
145. 5:54stepped in to prevent an even bigger
146. 5:56meltdown. Yet, the worst was still to
147. 5:59come. On September 15th, 2008, Lehman
148. 6:03Brothers, overexposed to toxic mortgage
149. 6:05assets, went bankrupt after the
150. 6:07government refused to save it. The
151. 6:09largest bankruptcy in US history. The
152. 6:12next day, the giant insurer AIG,
153. 6:14crippled by mortgage losses, was rescued
154. 6:17by the Fed with an $85 billion loan. By
155. 6:20then, credit markets were frozen and the
156. 6:22entire financial system was on the brink
157. 6:24of collapse. With the financial world in
158. 6:27freefall, Congress hurriedly passed a
159. 6:29$700 billion bank bailout known as the
160. 6:32Troubled Asset Relief Program, TARP, in
161. 6:35early October 2008. It was a desperate
162. 6:38bid to stabilize the banks and a stark
163. 6:40acknowledgement of how close the economy
164. 6:42was to total meltdown. The waves of
165. 6:45damage quickly moved through the rest of
166. 6:47the economy. The stock market collapsed
167. 6:49with the Dow Jones down nearly 40% from
168. 6:52its peak by October. Credit had dried
169. 6:55up. It was full-blown financial panic.
170. 6:59Lehman just filed for bankruptcy. It's
171. 7:01real. London wants to know if we're
172. 7:03still good for that $2 billion in CDS
173. 7:05exposure. What even is our exposure?
174. 7:08We're holding CDL's CDL squared
175. 7:11something called a synthetic mezzanine.
176. 7:14Those make up 90% of our firm and it's
177. 7:17all gone. What? Trenches defaulted,
178. 7:21swaps triggered, everything marked to
179. 7:23zero. All of it's gone. Poof. While the
180. 7:26crisis started on Wall Street, it didn't
181. 7:28end there. About 4 million Americans
182. 7:31lost their homes and another 4 and a
183. 7:33half million fell into foreclosure or
184. 7:35mortgage aras. Approximately 8.7 million
185. 7:38Americans lost their jobs and
186. 7:40unemployment hit 10%. The collapse
187. 7:43didn't stop at the US border. European
188. 7:45banks that had gorged on US mortgage
189. 7:47securities were on the brink of failure.
190. 7:50Iceland's entire banking system
191. 7:52collapsed. Global stock markets plunged.
192. 7:55Many were down 40 to 60% from their
193. 7:57highs. and world trade shrank by nearly
194. 8:0010% in 2009. What did we learn? First,
195. 8:04deregulation with no guardrails can be
196. 8:07dangerous. The financial sector had too
197. 8:09many loopholes and not enough oversight.
198. 8:12Banks and investors gambled on exotic
199. 8:14financial products like CDOS's and
200. 8:16credit default swaps without fully
201. 8:18understanding the risks. Second, the
202. 8:21watchdogs failed. Credit rating agencies
203. 8:23slapped AAA ratings on toxic mortgage
204. 8:26bonds because banks paid them to and
205. 8:29ultimately they underestimated the risk
206. 8:31of widespread mortgage defaults. Third,
207. 8:33the Federal Reserve dropped the ball.
208. 8:36Fed Chair Alan Greenspan's policies kept
209. 8:38interest rates too low for too long and
210. 8:40trusted banks to regulate themselves.
211. 8:43These economic conditions helped inflate
212. 8:45the housing bubble and no one stepped in
213. 8:47to rein it in. Finally, complex doesn't
214. 8:50mean safe. Wall Street's quants relied
215. 8:53on fancy risk models, but they wildly
216. 8:56underestimated how correlated everything
217. 8:58was. When the housing market cracked,
218. 9:00the entire global system shook. Lehman
219. 9:03Brothers collapse wasn't just one
220. 9:05company going under. It was the first
221. 9:07domino in a chain reaction that nearly
222. 9:09brought down the whole financial system.
223. 9:12After the crash, the US government and
224. 9:14the Federal Reserve intervened on an
225. 9:16unprecedented scale. They bailed out the
226. 9:19banks with the $700 billion TARP program
227. 9:22that injected capital into failing
228. 9:24financial institutions. These moves
229. 9:26stabilized the system but infuriated the
230. 9:29public. To many, it seemed like Wall
231. 9:31Street was being rewarded for its
232. 9:33misdeeds. Taxpayer money had saved the
233. 9:35very firms that caused the mess. The
234. 9:38backlash was fierce and people worried
235. 9:40about a moral hazard, the idea that
236. 9:43bailing out bad actors would encourage
237. 9:45more bad behavior in the future. At the
238. 9:48same time, policymakers scrambled to
239. 9:50restart the economy and reform the
240. 9:52system. The Fed cut interest rates to
241. 9:54near zero. And in early 2009, President
242. 9:57Barack Obama signed the American
243. 9:59Recovery and Reinvestment Act, a $787
244. 10:03billion stimulus bill to jumpstart
245. 10:05growth and jobs.
246. 10:08In 2010, Congress passed the DoddFrank
247. 10:10Act, the most sweeping financial reform
248. 10:13in decades to tighten oversight,
249. 10:15routinely stress test banks' health, and
250. 10:17prevent another crisis. DoddFrank
251. 10:20created a consumer financial protection
252. 10:21bureau to protect consumers, and imposed
253. 10:24the Vulkar rule to stop banks from
254. 10:26gambling with depositors money. Insurers
255. 10:29had it aimed to ensure that nothing like
256. 10:312008 would ever happen again. Globally,
257. 10:34policymakers rolled out Barasel 3, a set
258. 10:37of international banking rules that
259. 10:38forced banks to hold more capital and
260. 10:41take on less risk. The economy slowly
261. 10:44recovered, but the pain lingered. The
262. 10:46Great Recession officially ended in June
263. 10:492009, but it didn't feel that way for
264. 10:52ordinary Americans. Unemployment stayed
265. 10:54high for years, and it took until the
266. 10:56mid2010s for home values and household
267. 10:59incomes to get back to precrisis levels.
268. 11:02Even the stock market took 6 years to
269. 11:05regain its 2007 peak. The scars of 2008
270. 11:09foreclosed homes, lost jobs, and
271. 11:11shattered trust endured long after the
272. 11:14crisis. It wasn't just a few greedy
273. 11:17bankers or a handful of unlucky
274. 11:19homeowners that caused the crash. It was
275. 11:22an entire system, a house of cards built
276. 11:25on bad loans, fragile trust, negligence,
277. 11:28and the belief that housing prices would
278. 11:30never fall. Many on Wall Street truly
279. 11:32believed they had solved the problem of
280. 11:34risk. In truth, they simply buried it.
281. 11:37Financial innovation isn't bad, but
282. 11:39forgetting what you're investing in is.
283. 11:42If something sounds too complex to fail,
284. 11:44it's probably too complex to trust. If
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