Almost 10 years after the crisis I think it is important to remember the causes of it in order not to repeat the same mistakes.
The globalisation of financial market began in the early 19th century and quickly some fundamental questions rose up such as the vulnerability of this globalisation to crises or the policies that must be took by governments. Because globalisation means that various financial actors are connected in different countries, this connection creates a sort of dependance.
As communication technologies became more and more sophisticated and powerful it increased this globalisation permiting financial flows to cross the entire world almost instentaneously. With these technologies banks and investors trade with the world beyond national borders exchanging large amount of secured data. This context saw a new type of financial product created : the derivate instruments, these products take into account the risk of a loan, so it allows banks, borrowers, investor, lenders, speculators, etc to play on the inequal repartition of informations. Idealy, in a totaly globalized markets the prices should be the same everywhere, it is not depending on the location, but financial markets aren’t truly global. If someone in China don’t know the risk of your product you can sell him a higher price than its real price for example. Consequently this system is based on trust.
We can say that the globalisation of financial markets is a new playground for financial actors seeking for profit, that is why it needs to be regulated.
After the Great Depression of the 1930’s the US government took mesures in order to prevent from another crisis, banks are prohibited from using the money of their customers to invest. Follows a 40 years period of gross without any crisis.
Gradually some bankers and economists having a position in the government will start to deregulate the financial market: the 1934 law prohibiting investments is repeal, attempts to regulate the new derivates product are blocked.
Using this favorable context and the globalized financial markets a Ponzi pyramide is set up with the securitization. The lender provide a loan to home buyer materialized by a financial security, the lender sells this security to investments bank which aggregate various securities to create a CDO, the bank sells this CDO at investors allover the world.
- CDO is a way to hide dodgy securities
- CDOs are rated based on their repayment capacity by notation agencies, this agencies are payed by the bank, the better the rate is the more they earn
- Due to high rates subprimes (dodgy securities) are interesting for banks
- All these things encourage the financial actors to take higher risks
- Leverage: Banks borrow to buy CDOs
Another process to increase even more these profits is to take out insurance at the AIG, an institution which pay the investor at the amount of its losses if the CDO goes wrong. Investment banks such as Goldman Sachs, Lehman Brothers, etc used this to take out an insurance against there own CDOs, knowing that they were full of dodgy securities.
Even if the crisis started in the US the impact on the rest of the world was significant because of the globalisation, the american investments banks couldn’t have played alone, CDOs travelled abroad and european banks used the same mechanism to make profit. The non-regulation of the financial market was generalized and governments of different countries didn’t do anything. The IMF warned of the danger but due to the power of the lobbyists nobody listened.
The day Lehman Brothers was declared in bankruptcy banks around the world became suspicious about others and the financial markets seems to stop. One by one banks of different countries went bankrupt squeezed by the weight of their huge debts and possessing CDOs that is worth nothing. And then you know what happened …
– Théo Quint
– Inside Job, Charles Ferguson, 2010
– Economist.com. (2017). [online] Available at: https://www.economist.com/news/schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-article [Accessed 17 Jul. 2017].
– Globalissues.org. (2017). Global Financial Crisis — Printer friendly version — Global Issues. [online] Available at: http://www.globalissues.org/print/article/768#Africaandthefinancialcrisis [Accessed 17 Jul. 2017].
– Bank, E. (2017). The globalisation of financial markets. [online] European Central Bank. Available at: https://www.ecb.europa.eu/press/key/date/2000/html/sp000912_2.en.html [Accessed 17 Jul. 2017].