Traditionally, it is extremely hard to get a mortgage if you have poor credit or don’t have a steady job. Lenders will never risk their money if they think that you are to default on your loan. But all of this changed at the beginning of the 2000s. Investors who were looking for a low-risk high return on investment started splurging on the US housing market. The thinking was that they could get better returns than homeowners paid on mortgages. For mortgage lenders, these bonds were more like bonds with bonuses where they receive regular interest payments and if the borrower were to default, they would get possession of the property. With the real estate prices on the rise recovering your money would be no problem at all, thus making it a good deal for the investors. But for these big-time global investors, it was too much hassle to buy individual mortgages. So, this is where the investment banks come in. These institutions with their large capital and industry expertise decided to buy out all these individual mortgages, pool them together, and sell out a share of the pool to investors as a mortgage-backed security. The credit agencies also backed these (gave AAA ratings) and said that the mortgage-backed security was a safe investment. Soon enough investors were swarming toward these banks to buy out their securities and the lenders did their best to create more of them. Therefore, the lenders lost their standards and started giving out mortgages to people with low-income and poor credit. These are known as Sub-Prime Mortgages. Most institutions started using predatory lending practices where they offered mortgages without verifying income and offered adjustable-rate mortgages with payments that people could afford at first but quickly ballooned beyond their means. Because of this, real estate prices were going up and up. The insurance companies wanting into cash in as well started to sell credit default swaps.
But soon enough people could not afford to pay for their incredibly expensive houses or their incessantly increasing mortgage payments. Most people were now in payback defaults because they did not wish to pay for a house whose value was much lower than the mortgage amount.
As this was happening the big financial institutions stopped buying subprime mortgages and subprime lenders were stuck with bad loans. (“The 2008 financial crisis – EconomyClub”) By 2007, most big lenders had declared bankruptcy like Lehman Brothers, and others were forced into mergers or had to be bailed out by the government.
Panic set in. Trading and the credits market froze. The stock markets crashed. The US economy suddenly found itself in a disastrous recession. On 15 September 2008, we see the largest US bankruptcy. The government saved few of the big banks from collapsing by sending out loans. They spent 250 billion dollars bailing out the banks. Countries with ties to the US got caught up in the disaster too.
By 2009 the global economic engine stalls. Over 2 million jobs were lost in the last 4 months of 2008 alone. While the recession itself would end in June of 2009, the effect of this crisis would be felt long afterward.
In 2010 the government passed the Dodd-Frank Law. It took steps to introduce more transparency and to prevent banks to take more such risks.
As of today, the world economy is speeding towards a cliff edge. Stocks are down, inflation is up, and the investors are moody. The GDP in the US is going down. Major US stocks have lost almost 7 trillion dollars in damages since the start of 2022. This has happened almost 11 times before, 9 of these were linked to recessions. Even the head of the federal reserve’s said the recession is ‘certainly a possibility.
This time tech will be the one to take the biggest hit. Big companies like Apple, Tesla, and Amazon are down 16%, 28%, and 31% respectively. This trend can be seen all over the world. India’s Sensex dropped 11% in the last 6 months. Chinese markets are down 12% and the Japanese Nikkei by 11%. There are two main reasons for this. Number one, to cut down the prices the central banks across the world have gotten involved. Across the world interests’ rate are rising and the result is sluggish economic growth. Reason number two is the lockdown in China. Because of this, the exports are down, tourism is down. So, China is dragging the Asian economy along with it.
If the US economy enters recession, the entire world enters recession. In the first quarter of 2022, the GDP shrank 1.4%. Two-quarters of falling GDP means recession. Lot depends on the US Federal Reserves. Their priority right now is to tame inflation. Therefore, the US Fed is planning on more interest hikes. This could be done in two ways. Either the consumer spending falls drastically (recession), or the consumers have enough savings to sustain their spending.
All eyes are on the Fed at this point. But there are certain volatile factors such as the war in Ukraine and the lockdown in China that might block the way. If the Fed keeps hiking the interest rates, economic growth will suffer. Let’s see what the numbers tell us this time.