A Millennials’ Guide to the 2008 Financial Crisis
Tl;dr: when banks started giving out mortgages to people that could not refund them, it created a bubble in both real estate and loans which exploded and bankrupted the Western financial systems due to the volume of losses that banks couldn’t take on themselves, creating the 2008 financial crisis.
The current economic situation (bond yield curve inversion, real estate prices as high as they never have been, overpriced stock market, USD 1.3 trillion students’ debt) shows many signs of an upcoming financial crisis.
After all, economic cycles last on average ten years and the last one started with the 2008 crisis.
The upcoming end of this current cycle has therefore been long overdue.
Millennials were quite young when the 2008 crisis happened and we never really got to understand how it unfolded.
Follow through for a sound explanation.
A Millennials’ Guide to the 2008 Financial Crisis
When the Internet bubble exploded in 2000, investors looked for new high-yielding investments and turned to real estate loans given to US consumers.
These loans offered an advantageous yield for investors.
They pushed banks to distribute them to as many people as possible and soon, all of the financially-sound people had their houses and loans.
But investors were hungry.
Banks started distributing loans to not-so-financially-secured customers for the sake of ever-lasting profits.
And this is how people started buying houses they couldn’t afford with loans they wouldn’t be able to repay.
Since the risk on these loans was greater, the yield was greater too.
These risky loans were called “subprimes”.
Subprimes were then cut into pieces and reassembled into packages (to decrease risks) sold to other banks around the world, mainly Western.
As long as the US economy did not slow down, the subprime owners were able to repay their debt.
However, from 2005 onward, the economy started slowing down.
People defaulted on their loans after which banks inherited the house to sell it.
As more and more people defaulted, banks inherited more and more houses which drove prices of houses down while putting banks in a dangerous financial situation: they couldn’t retrieve the money that had been lent as no one was buying houses anymore and were therefore incapable to repay their debt.
This played out for quite some time until Lehman Brothers declared itself bankrupted and collapsed.
Three events simultaneously happened:
1. The real estate market bubble exploded. You see, a bubble is an unrealistic estimation of prices.
When everyone realized a good is overpriced, the price of the good (be it houses, shares, bonds, computers) suddenly drops in value.
In our case, the bubble exploded when houses bought with subprimes flooded the market.
2. Lehman collapsed: when a bank collapses, it is usually saved by the government.
Indeed, if banks collapse, people lose their savings and can’t buy anything anymore which paralyzes the economy.
This is why banks get (usually) saved.
Except for Lehman.
Now, Lehman was not the only bank to crash because they had sold many of these subprimes to other Western banks that therefore, crashed too (but most of them were saved by their governments).
3. This is how one bank, by behaving ruthlessly, provoked one of the biggest worldwide recession ever.
Before we go on, I must explain why Lehman wasn’t saved.
At the time, two big banks were fighting over the financial market: Lehman Brothers and Goldman Sachs.
Advisors of President Obama in 2008 had formerly been bankers at Goldman Sachs.
With Lehman out of the way, they thought, this would make things much easier for Goldman.
Advisors advised not to save Lehman, which was duly followed by Obama.
That’s the unofficial version, because, well…there is no official one (The US Congress later led an investigation).
What Measures Have Been Taken?
In 2008 and prior, people were getting loans worth up to 125% percent of the value of the house.
The discussion between the banker and Mr. and Mrs. Smith must have unfolded like this: “your house costs US $100 000? Let us give you US $125 000 and buy yourself a nice car to celebrate!”.
After the crisis, rules were established that banks could not loan more than x% of the value of the house (in Belgium, for example, it is 90%, with an exception for young first-time buyers that are allowed to borrow more.
Chances are they’ll live longer so they’ll have time to repay. That being said, with €30 000, you can buy a €300 000 apartment…)
Second, banks could not invest all their money into financial products anymore, they had to keep some cash to “save themselves” and resist in case of a financial meltdown.
These are tested through “stress tests” you may have heard on the news.
Where Is the Next Crash Going to Come From?
If only I knew, I wouldn’t be writing this in Brussels right now…I would be writing it on my private Caribbean island instead.
In fact, nobody knows for sure.
Some say it will come from companies’ debt, some say it’ll come from US student debt.
It’s nearly impossible to predict a financial crisis even though some rare people had seen the one of 2008 coming (see the Big Short)
What Should You Do?
Money in itself is not worth anything.
The money you own today will not worth anything in 20 years because it loses value over time, that’s the inflation process.
This is why people invest (gold, bonds, shares, real estate, etc).
At the dawn of a financial, social, economic, and environmental collapse, the best thing you can do for yourself is cultivating independence.
Get a farm, around 15 chickens, 4 or 5 cows, and learn how to grow potatoes.
Complete independence is your best shot at making it through any future crisis.